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When a homeowner is unable to continue making the monthly mortgage payments on their home, they are often faced with the choice of a short sale vs foreclosure. There are several important factors to consider before choosing one option over the other and time is usually a major factor in the availability and viability of either alternative.
We have created this guide to help homeowners understand the differences between short sale vs foreclosure as well as the potential benefits and limitations of each option. We have even included some common pitfalls to watch out for. Keep reading to learn how homeowners and potential buyers can best navigate the decision of a short sale vs foreclosure as painlessly, and ultimately as successfully, as possible.
What Is a Short Sale?
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A short sale is a popular financial option that is available to borrowers who are in default after being unable to make their mortgage loan payments and have suffered a drop in the value of their property. This drop usually makes the property worth less than the dollar amount owed to the lender.Borrowers who find themselves in a situation where they are unable to make the required payments to repay their mortgage loan and have experienced a significant decrease of 20% or more in the assessed value of their property have options. They can approach a lender about the possibility of conducting a short sale of the property in lieu of the lender foreclosing on the property.If the lender is amenable to the borrower’s request for a short sale option, the borrower must then immediately list the home for sale on the real estate market. The listing must designate the property’s short sale status to alert potential buyers of the additional time and documentation that will probably be required.
Short Sale Process
The short-sale process requires more documentation from the potential buyer than is required in the traditional home buying process. Short sales also require a significantly longer window of time from placing a purchase offer on a home to completing the purchase and taking possession of the property. Short sales can easily take more than a year to complete.The short sale process generally progresses through three distinct phases. A general summary of each of these phases is provided below.
Short Sale Package
A short sale package is a financial statement package compiled by the homeowner to provide evidence of financial hardship and inability to continue making payments to satisfy mortgage loan. This package of financial statements is generally accompanied by a letter detailing the reasons the borrower believes they will be unable to meet the obligations required to satisfy the mortgage loan agreement and requesting the lender’s authorization to proceed with a short sale option as an alternative to an inevitable default and foreclosure scenario.
Short Sale Offer
When an interested buyer makes an offer to purchase a short sale property, the transaction will initially proceed just as a traditional home sale would. The potential buyer will make an offer to purchase the home for a specified dollar amount and the seller will either accept the offer, or decline the offer and counter by suggesting a purchase price they will accept. In a short sale, the seller will have little to no flexibility to accept or negotiate a lower purchase price as the sale terms must be acceptable to the lender who will be taking a loss on the borrowed amount and is unlikely to deepen their loss further. Short sale buyers should understand that any offer below the full listing price is unlikely to be accepted by the homeowner’s lender.If the homeowner is successful in gaining an offer for the full listing price from a qualified buyer, then a purchase agreement will be drawn up hammering out any contingency requests, such as repairs or appliance inclusions, just as in a traditional purchase agreement. The homeowner’s real estate agent will submit the completed purchase agreement and an approval letter from the buyer’s financial lender confirming the buyer’s ability to fund the purchase to the current lien holders for approval. If the initial short sale financial package has not yet been submitted to the lien holders, the agent will submit one at the same time as the short sale offer package.
Bank Processing
This is the phase that differs the most from a traditional home sales process and therefore requires the most patience and cooperation from the homeowner and the potential buyer. There is little required of the buyer and seller during this phase as they must wait for the submitted packages to be reviewed by all lenders with an interest in the current mortgage. If there are multiple lenders on the existing mortgage, each one must accept the offer for the transaction to proceed. There are several reasons that the bank processing time may be prolonged or that the buyer’s purchase offer may be declined. We have listed several of the most common reasons below.
- The homeowner’s financial statement appears to show that they still have the ability to pay existing mortgage payments
- The payout from the private mortgage insurance policy will reduce the lender’s loss enough to make foreclosure a more attractive option
- The short sale is unlikely to succeed due to problems on the title, such as a contractor’s lien or home equity loan which are unable to be dismissed
- The property is already in foreclosure and the process has advanced too far for a short sale to be a viable alternative
- The homeowner has initiated bankruptcy proceedings (short sales are considered a form of debt collection and prohibited during a bankruptcy)
- The homeowner refuses or is unable to make a satisfactory contribution to reduce the lender’s loss on the original debt
- The short sale package or short sale offer are incomplete
- Evidence of a relationship between the seller and buyer, and the buyer is prohibited from selling or leasing the property back to the seller
- A lien holder or subordinate lender has unreasonable requirements that the seller and the other lenders are unable to satisfy
- The offer submitted is an egregiously low-ball offer
What Is Foreclosure?
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A foreclosure is the process through which the lender regains possession of a property when the homeowner has been unable to make the agreed upon payments.
Pre-Foreclosure
The number of payments that can be missed before triggering the foreclosure process varies from state to state. For instance, the lender may legally initiate the foreclosure process in as few as 27 days after a missed payment in the state of Texas, or they may have to allow as much as 290 days with no payment before initiating foreclosure, as is the case in the state of Wisconsin. The majority of states have regulations that fall somewhere in the middle of the two extremes, allowing lenders to initiate the foreclosure process after approximately 3 – 6 months of missed mortgage payments.
Foreclosure Process
Once the state’s required grace period has elapsed, the lender is free to initiate the foreclosure process. This is accomplished by filing or recording a Notice Of Default (NOD), which informs the borrower that they are in default and outlines the options for reinstatement that must be completed to bring the mortgage loan back into a current or non-delinquent status and halt the foreclosure process. The time allotted for borrowers to complete the required tasks varies by state with some providing as few as 5 days to complete the required tasks and stave off foreclosure. The majority of states call for a reinstatement period of approximately 60 – 90 days.If the borrower is not able to reinstate the mortgage loan in the allotted time frame, the lender may move forward to regain possession of the property and evict the borrower. Again, depending upon the state, the lender may proceed with either a Judicial or Non-Judicial Foreclosure. Both processes are described below.
Judicial Foreclosure
A Judicial Foreclosure requires that the lender file a lawsuit against the borrower in a state court to regain legal ownership rights to the property used as collateral to secure the defaulted loan. To prevail in the lawsuit, the lender must prove that the borrower owes the debt and that the borrower has not satisfied the required tasks to bring the debt current, thus defaulting on the loan.If the lender is successful, the judge will rule in their favor and the borrower will be issued a notice of sale alerting them that the home has been foreclosed by the lender and will be sold at a trustee auction.A trustee auction of foreclosed homes is officiated through a trustee such as the sheriff’s department or another official office sanctioned by the state to perform this task. The winning bidder must pay for the full dollar amount of their purchase in cash on the day of the auction before being issued an unencumbered deed to the property.Judicial foreclosure is an available option in all U.S. states with the exception of Michigan, New Hampshire, Tennessee, Utah, West Virginia and Washington D.C. The judicial foreclosure process can take between 6 months to 2 years to complete.
Non-Judicial Foreclosure
A Non-Judicial Foreclosure allows the lender to avoid the time and expense of filing a lawsuit in state court. A non-judicial foreclosure is permissible in cases where the original mortgage agreement contains a Power of Sale clause. The Power of Sale clause is the borrower’s tacit consent that the lender may foreclose on the property without obtaining a court order in the event the borrower is unable to meet their obligation and the loan is in default. A little over half of the states in the U.S. allow the use of non-judicial foreclosures.In a non-judicial foreclosure, once the notice of default has been recorded and the reinstatement period has expired, the lender can immediately auction the property.The lender is permitted to bid on the property in non-judicial foreclosure auctions, an activity that is strictly forbidden in a judicial foreclosure auction. The winning bidder is required to pay the full purchase amount in cash on the day of purchase before being issued an unencumbered deed to the property. The new owners may have to file a lawsuit against the current residents of the property to obtain an adverse possession judgement to have them evicted.Non-judicial foreclosure is available in the following U.S. states only: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Georgia, Hawaii, Idaho, Iowa, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada, New Hampshire, North Carolina, Oklahoma, Oregon, Rhode Island, South Dakota, Tennessee, Texas, Virginia, Washington, West Virginia, Wisconsin, Wyoming and Washington D.C. The non-judicial foreclosure process can take between 1 month to 1 year to complete.
What Are the Differences Between Short Sale vs Foreclosure?
There are several important distinctions when considering a short sale vs foreclosure. For the homeowner, there is a significant benefit to choosing a short sale vs foreclosure with respect to the effect each option will have on their future housing and employment opportunities. A homeowner who defaults on a mortgage loan and has their home foreclosed by the lender is likely to suffer a loss of 200 – 400 points or more from their credit score. A loss of that magnitude can severely limit the ability to finance another home or a vehicle for many years. It may also limit employment opportunities in companies that routinely include credit checks as part of their hiring process. In contrast, a short sale may cause a loss of around 100 points, and in some cases may not cause any reduction in credit score at all. The potential impact to the homeowner’s credit score and future credit worthiness is the primary distinction in choosing a short sale vs foreclosure, but there are a few more considerations. A homeowner in bankruptcy will need to choose foreclosure. If a homeowner is forced to foreclose because they refuse a short sale, this can have an adverse effect criminal records of a new buyer is forced to sue for eviction.
Conclusion
For homeowners faced with the choice of a short sale vs foreclosure, the best choice they can make will always be the short sale. The process of gaining lender approval for a short sale and finding a qualified buyer willing to jump through the required hoops to complete the short sale can be daunting, but the potential benefit in regards to their future ability to buy a new home, a new vehicle, or obtain a coveted employment position at a large corporation makes any extra effort required well worth the hassle. For home buyers choosing between a short sale vs foreclosure property, there are benefits and risks to both which render them fairly equal. Ultimately the better option will be the option which best fits the specific circumstances the home buyer is facing. However, home buyers with time to spare may benefit more from a short sale vs foreclosure because the short sale affords an opportunity to view the home and discuss any potentially costly repairs that the homeowner may be willing to remedy in exchange for a full-price offer.