Short Sale vs Foreclosure: What is the Difference?
What is the difference between a short sale and a foreclosure? Short sales and Foreclosures are both options for homeowners who fall behind on mortgage payments, but it’s important to understand the difference between these two processes.
Short sale and foreclosure are similar in that they’re both financial options for individuals who need to sell their home, but owe more than the home is worth. In many cases, the seller is facing a form of financial hardship, but not always. Both a short sale and a foreclosure have a negative impact on your taxes, credit score, credit report, and future ability to buy a home.
But short sales and foreclosures differ greatly in how much they affect the above items and the overall process. A short sale transaction occurs when mortgage lenders allow the borrower to sell the house for less than the amount owed on the mortgage. (For a deeper explanation of the short sale process, make sure to read “What is a Short Sale”.) The foreclosure process occurs when lenders repossess the home through an auction or court action.
Timing can differ greatly. A short sale can take up to one year to close, while foreclosures generally move along much faster because lenders are intent on recovering the money they’re owed.
Furthermore, a short sale is far less damaging to your credit score than a foreclosure. In fact, people who go through the short sale process can usually buy another house without having to wait, although securing a second mortgage might be more challenging. Foreclosure, on the other hand, will stay on your credit report for seven years, and you will have to wait a minimum of five years to buy another house.
Short Sale vs Foreclosure Comparison
If you’re struggling to pay your mortgage and aren’t sure what to do, below is a comparison of the two options to help determine which is the better option for you.
|Foreclosure||Successful Short Sale|
|Method of Sale||Sold in a public auction at the courthouse.||Sold through a realtor, the same as a traditional sale.|
|Privacy||Public Knowledge.||It can be handled discreetly.|
|Option to Receive Money/Relocation Assistance||No||Yes. In most cases, we are able to obtain “relocation assistance” for our sellers.|
|Who Is In Control||The Lender||The Seller|
|Credit Score||A foreclosure will show up as a public record on your credit report. (Similar to bankruptcy.) Typically will drop 200-400 points and will remain on credit for 7 to 10 years.||Only the late payments will be reported. Once the short sale is completed, it will be reported as “settled for less than the full amount due” (or similar verbiage). Depending on overall credit, the impact can be as little as 50 points and on average is between 50-150. A short sale’s effect can be a brief as 12 to 18 month|
|Future Home Purchase||Any individual that loses their property to foreclosure will not be eligible for 5 years with restrictions or 7 years with no restrictions.||Can purchase immediately in some circumstances, and can be up to 2 years.|
|The Balance of the Loan (Deficiency Rights)||In California, many loans give the lender the right to pursue the homeowner for a deficiency after the foreclosure has taken place. (Each state’s laws are different.||During the short sale negotiations, we negotiate to have the lender agree in writing to forgive the remaining balance and release the homeowner from any future deficiency right after the close of escrow.|
|Employment||Most employers have the right to check the credit of employees who are in sensitive positions. In some positions, a foreclosure may be grounds for reassignment or termination.||A short sale is not a public record and is reported separately on a credit report. The employer will only see late payments and an account that has been settled. This shows that you worked with the lender towards a resolution and typically looks much better to the employer.|
|Security Clearances||Foreclosure is the most challenging issue against a security clearance outside of a conviction of a serious misdemeanor or felony.||A Short Sale on its own does not challenge most security clearances.|
Foreclosure vs Short Sale
If you fall behind on mortgage payments, you have a lot of options: but the list may be dazzling and confusing. Wish someone would just tell you what option would work for your situation? We’ll explore two main options, foreclosure and a short sale.
What is a Short Sale?
A short sale is a quick sale on a house that occurs when the homeowner owes more on the loan than the sale price of the house is going to fetch. Basically, a short sale means that you ask the lender to accept less money than they expected on the loan. If you have a house that you can sell for only 300k but the loan balance is 325k, then you have to ask the bank to accept a “short” sale in which you pay them back less than you took out. (Visit our “What Is A Short Sale” page for further details.)
Keep in mind that short sales only really work when the bank cannot leverage a deficiency judgment against the loan. In a deficiency judgment, a bank can seek to recover the loan difference (in our example, the 25k) after the short sale is over. You can’t do this in California if the borrower has used the loan for a primary residence—but it’s something to keep in mind.
What is Foreclosure?
Foreclosure is a process where the lender seeks to recover the home and the loan value from a borrower who has fallen behind on payments. Lenders typically issue a notice of default after 3 to 6 months of payments that are missed. After a 90-day period when the notice of default is issued, the lender can then move to take the house to auction and sell it themselves. (Visit our “What is Foreclosure” page to learn more.) The US Department of Housing and Urban Development also has a resource page for people facing foreclosure.
How Foreclosure and Short Sales Work for Lenders and Borrowers
As a borrower, you’re looking to avoid the highest costs and hits to your credit score. Avoiding both a foreclosure and short sale is obviously ideal, but if it is inevitable that you’re losing your house, then you’ll want the least painful process.
Banks and lenders, on the other hand, are just trying to recover the highest possible value on the house. If they are not going to get the full cost of the mortgage, then they want the most money possible. Banks will usually not reject the offer of a short sale unless the short sale is near the market value of the house. There are also usually laws that prevent banks from selling a house for more than the value of the mortgage, and in California law prevents banks from chasing down a deficiency judgment to recover extra money on top of the short sale.
Generally speaking, banks and lenders want you to make a short sale. Banks that take houses to auction probably won’t get a better offer than a short sale. But this depends on the state of the real estate market at the time. If banks feel like your house is worth a lot of money and they can recover their costs and then some, they may pursue foreclosure.
Who Can Authorize a Short Sale or Foreclosure?
Unlike foreclosure, a short sale must be agreed on by both parties. You cannot make a short sale of your house if the lender doesn’t allow it, and in no case can the lender force the borrower to make a short sale. Most lenders will allow a short sale to go through—it will probably recover more of their money, and it puts the burden of work on the borrower to sell the house.
Foreclosure, on the other hand, doesn’t require anyone’s authorization to go through. If you’re behind on payments the lender can begin the foreclosure process without your consent.
What Happens to a Credit Score?
Foreclosure is one of the worst things that you can have on your credit report, and it hangs around for seven years. Foreclosure makes it very difficult to get another house and another mortgage unless you can prove that something substantial has changed. You definitely won’t get good rates, and you’ll be considered a very risky borrower in the future.
Short sales, on the other hand, don’t destroy your credit rating in the same way. You will experience a drop and will definitely be considered a riskier borrower. But you’ve shown tenacity and ability to get out of a tough financial spot. Your credit score hasn’t dropped as much, and in some cases, you can get another home immediately.
Ultimately, if you’re a borrower, you should aim to make a short sale of your house to avoid foreclosure. It prevents your credit score from tanking in the same way. Learn more about the effects on credit after a short sale or foreclosure.