Short sale and foreclosure are two options for real estate investors or homeowners in financial distress (those who fall behind on the mortgage payment). In both cases, real estate investors will lose the investment property. However, each option has a different process and different financial consequences. Thus, it’s important to understand the difference between short sale vs. foreclosure in real estate investing.
Short Sale vs. Foreclosure: Process
Short sales in real estate investing are initiated by the real estate investor or homeowner when the value of the real estate property drops by 20% or more. The short sale process begins when the lender – typically a bank – approves to sell the house for less than the amount owed on the mortgage. For example, the lender allows the real estate investor to sell the investment property for $250,000 when the remaining mortgage balance is $300,000.
Foreclosures in real estate investing, on the other hand, are initiated only by the lender. In this case, the real estate investor or homeowner fails to make the mortgage payments, and, as a result, the lender seizes the real estate property and forces the sale in an attempt to recollect the initial investment of the mortgage. Moreover, foreclosed real estate investment properties can be auctioned off for real estate buyers to bid on them in a public process.
In general, short sales in real estate tend to be a lengthy process, sometimes taking up to a full year to close. Alternatively, foreclosures normally move along much faster than short sales because the lender is concerned with recovering the owed money quickly.
Short Sale vs. Foreclosure Winner: Tie
Related: Should I Sell My House or Rent It Out to Fund Mortgage Payments?
Short Sale vs. Foreclosure: Control
A short sale is a paperwork-intensive process. After getting the approval from the lender, real estate investors selling the investment property through short sale have to gather documentation that proves their current financial hardship. Basically, they have to prepare a financial package and submit it to the lender. Short sale packages normally include a letter of authorization, a listing agreement, a preliminary closing statement, a completed financial statement, a hardship letter, two months’ worth of bank statements, and comparative market analysis or a list of recent comparable sales. Gathering all these documentation naturally makes real estate investors or homeowners more in control and allows them to play more of an active role in the process.
As for foreclosures, real estate investors don’t have to collect financial documents as a foreclosure is a very passive process. Real estate investors or homeowners are not active participants in the process of selling the investment property through a foreclosure, but rather they are at the mercy of the bank’s attorneys.
Short Sale vs. Foreclosure Winner: Short Sale
Short Sale vs. Foreclosure: Credit Score
As mentioned earlier, short sales usually take a long time to complete. However, they are not as damaging to real estate investors’ credit rating as a foreclosure is. Real estate investors or homeowners will still lose points (70-100) of their credit score, but this is nothing compared to what they’ll lose from a foreclosure.
In addition, from future lenders’ perspective, short sales look better as they show that the real estate investor took action before the bank had to repossess the real estate property. It is better to recover a portion of the mortgage than to face a total loss.
On the other hand, a foreclosure will have a much more negative impact on your credit score. Real estate investors’ credit score will drop by over 100-300 points, which is enough to make credit card companies consider credit limit decreases and rate hikes.
Short Sale vs. Foreclosure Winner: Short Sale
Short Sale vs. Foreclosure: Impact on Credit Record
A real estate investor or homeowner who has gone through a short sale might be eligible to purchase another real estate investment property immediately in certain situations, meaning he/she can apply and borrow money for his/her next investment. However, a real estate investor who experiences a foreclosure must wait at least five years before he/she can buy other real estate investment properties or obtain a second mortgage. In addition, the foreclosure will stay on his/her credit report for seven years.
Related: The Pros and Cons of Buying a Foreclosure
Short Sale vs. Foreclosure Winner: Short Sale (Obviously)
Short Sale vs. Foreclosure: Selling Price/Saving Money
Many real estate investors opt for short sale over a foreclosure because it gives them the opportunity to market their real estate investment properties – using a real estate professional if they desire – so that they’ll get the best and highest offers. This will lead to a considerably reduced deficiency balance owed on the real estate property.
In contrast, looking back at the nature of the short sale vs. foreclosure process, foreclosed real estate investment properties usually sell for significantly less because banks are trying to liquidate the asset as quickly as possible. This means that the deficiency balance can be much higher.
Furthermore, within the context of a short sale transaction, you may be entitled to certain relocation incentives. Sometimes, the lender actually offers money to real estate investors or homeowners after a short sale (as a form of relocation assistance) to help them move into a new place to live. Moreover, while in the process of selling the investment property short, the real estate investor can continue living in the home rent-free, which saves him/her some money. These benefits are not offered in the foreclosure process.
Related: The Best Investment Strategies to Make Money in Real Estate
Short Sale vs. Foreclosure Winner: Short Sale
Short Sale vs. Foreclosure: Real Estate Buyers
Buying real estate investment properties through both short sale and foreclosure can be advantageous to a real estate buyer as both of these options are below the market value buying prices and gaining access to information about the real estate property is quite easy. Yet, many real estate buyers opt for a short sale.
A short sale real estate buyer first negotiates over the purchase price with the real estate seller and then seeks approval from the lender. Real estate buyers also will have the freedom to work with the short sale real estate seller in renting the real estate property back to him/her, which gives him/her the chance to rebuild the credit.
Another reason why real estate buyers opt for short sales is due to the number of scandals and dishonest opportunities related to foreclosures that leave real estate buyers with a not so smart real estate investment decision, and real estate sellers owing even more money.
Short Sale vs. Foreclosure Winner: Short Sale
Short Sale vs. Foreclosure: Bottom Line
By now, you shouldn’t be surprised to find out that in this battle of short sale vs. foreclosure, it is in your best interest to opt for short sales. As tough as it may be to lose your home, taking the initiative to get out of this situation means that all of the negative consequences of a foreclosure will be avoided.
If struggling with paying the mortgage has become a real challenge for real estate investors or homeowners, talking to the lender to discuss their options is a smart move. The lender will offer the best course of action based on the situation and the foreclosure laws in your state. For more guides and information on anything real estate, don’t forget to visit Mashvisor and start your trial to find the best real estate investment properties in the US real estate investing market.