Until the real estate bubble burst back in the 2000’s foreclosure was an embarrassment you’d do anything to avoid and few people had even heard of a short sale. Fast forward to today and short sales are part of our everyday language and if your home goes into foreclosure the bank will usually take the brunt of any judgment. But what’s the difference between a short sale and a foreclosure?
Short Sale vs. Foreclosure: What’s the difference? A short sale is the voluntary sale of a house, by the owner. The sales price is less than the remaining balance on the mortgage and the owner is responsible for paying the difference to the lender. A foreclosure is involuntary, led by the bank, who evicts the homeowner and then sells the property.
There are additional details and information about which you should be aware if you are in a position where you have to choose between a short sale and a foreclosure, and I’ll discuss them all below.
Short Sale vs. Foreclosure: What’s The Difference?
Both short sales and foreclosures involve a homeowner who has become, for whatever reason, unable, or unwilling to keep up to date with their mortgage payments. Both options involve the homeowner moving out of their property and having the home sold in order for the lender to recoup as much of the outstanding loan balance as possible.
They will both have an impact on your credit score and can result in the lender coming after you through the legal system for any deficiency between the amount the home is sold for and the amount you still owe.
So, at first glance, they seem pretty similar, but when you scratch the surface you will discover an entirely different story.
What Is A Foreclosure?
Foreclosure is a five-stage legal process that results in the homeowner being evicted from their property and the lender selling it.
Foreclosure begins when a borrower is late with a mortgage payment. This is called being delinquent and most lenders will give you a grace period to catch up before they take any further steps. Then, once a number of months have passed, the exact number depends on the lender, if the homeowner hasn’t caught up they are considered to be in default of their loan.
The lender then registers a document with the local County Registers Office which records the date by which the borrower must bring their loan up to date. If this doesn’t happen, the lender will evict the homeowner and force the sale of the property.
What Is A Short Sale?
A short sale happens when a home becomes what is known as “underwater.” This means that the outstanding amount owing on the mortgage is more than the value of the home.
A short sale begins by the homeowner approaching the lender and asking permission to engage in a short sale. If the lender agrees the borrower will put the property up for sale and, with the appropriate permissions from the lender, sell the property.
The proceeds from the sale go to the lender to pay down the outstanding loan and any difference between the proceeds and the loan are the responsibility of the borrower.
What’s The Difference Between A Foreclosure And A Short Sale?
Now we’re clear about what a foreclosure and a short sale are, let’s take a look at the differences.
When Foreclosures and Short Sales Happen
A foreclosure happens when the homeowner is unable or unwilling to make payments and have defaulted on their loan.
Short sales occur when a home is worth less than the outstanding mortgage and the owner no longer makes their mortgage payments.
Who Does What
A foreclosure is initiated by the lender, although you could argue that by defaulting on their mortgage the homeowner has done so. With a foreclosure, the lender is in charge of what happens and it can go ahead with or without the cooperation or approval of the homeowner.
Short sales, on the other hand, are usually initiated by the homeowner, although the process may be suggested initially by the bank. With a short sale, the homeowner does all of the legwork in the sale only requiring the lender’s permission to begin the process and close the sale.
The Way In Which The Property Is Sold
A home that is being sold through foreclosure often gets sold through a trustee auction. These auctions take place on a semi-regular basis, depending on the number of homes for sale, and bidders buy the home “as-is” usually without the opportunity to view the property.
Meanwhile, a property that is sold in a short sale goes through a very similar process to a regular house sale. The main difference is that the homeowner does not have the final say on which offer to accept, or whether to accept an offer at all. Instead, the homeowner must submit the offer or offers to their lender who will have the final say over which one, if any, to accept.
How Long It Takes
Once the process begins a foreclosure usually happens quite quickly. The lender is primarily concerned with getting the property off of their hands as quickly as possible. Depending on how long it will be until the next property auction, a home in a foreclosure can be sold in a matter of weeks.
The steps involved in a short sale make this a significantly more time-intensive proposition. From the time that the homeowner first approaches the lender about the possibility of a short sale, until the ink is dry on the property sale can be as long as a year.
The Impact On Your Credit Score
The impact on your credit score is very different for the foreclosure process and a short sale. A foreclosure is, by its very nature, the result of the homeowner’s inability or unwillingness to keep up with their mortgage payment. Whether this is the fault of the owner or something out of their control is immaterial.
This is why foreclosure will knock somewhere between 200 and 400 points off of your credit score, effectively making it almost impossible to obtain new credit of any kind, any time soon.
The impact of a short sale on your credit score is different. This is because it does not necessarily happen as a result of any financial mismanagement on the part of the homeowner. In fact, it could be argued that by pursuing a short sale a borrower is doing their best to deal with a bad situation.
Consequently, your credit score will only go down by between 50 and 150 points. Having said that, your score may not take a hit at all. Why? Find out in the next point.
How Long It Stays With You
A foreclosure will be reported to the credit bureaus and will stay on your record for up to seven years. You will also have to report your foreclosure on any loan or other credit product for the same seven-year period.
One of the many advantages to a short sale is that it may or may not be reported by your lender, to the credit bureaus. If this is the case it will not appear on any credit inquiries and will not affect your credit score at all, either when it happens or in the future.
You will not be able to buy another home for seven years, or five years with some restrictions, after you have gone through a disclosure.
A short sale will generally impact your ability to buy another home for three or four years, depending on your circumstances and in some cases you may be able to purchase a new property straight away.
Incentives For Homeowners
A homeowner facing foreclosure is not offered any kind of financial incentive to go through the process.
For homeowners who are going to go through the short sale process, there may be an incentive available, of up to $3,000 to help pay for moving costs. Whether or not a particular short sale qualifies for this program depends on your mortgage provider.
While both foreclosures and short sales happen when a homeowner finds themselves in financial difficulties the details behind each of the two processes are very different. If you find yourself in a position where you are facing financial difficulties and you may no longer be willing or able to keep up with your mortgage payments then it is important to give consideration to both options.
Each one has its pros and cons and it is important to ensure you make the right choice for your personal circumstances. In order to do this, you may want to consult a financial counselor or a legal professional with experience in real estate before making any decisions.
About The Author
Geoff Southworth is the creator of RealEstateInfoGuide.com, the site that helps new homeowners, investors, and homeowners-to-be successfully navigate the complex world of property ownership. Geoff is a real estate investor of 8 years has had experience as a manager of a debt-free, private real estate equity fund, as well as a Registered Nurse in Emergency Trauma and Cardiac Cath Lab Care. As a result, he has developed a unique “people first, business second” approach to real estate.
This article has been reviewed by our editorial board and has been approved for publication in accordance with our editorial policy.