Mortgage debt has many people wondering where to go next and what choices they have. Those who are in financial hardship and are unable to afford their mortgage payments usually have two options: short sale or foreclosure.
What is a short sale and how is it different from a foreclosure? In this article, we'll tackle that difference, as well as the effects each one has on you in the long term.
What is a short sale?
A short sale occurs when the mortgage on a piece of property exceeds the property value. Before beginning the short sale process, the homeowner must show proof of financial hardship. Financial hardship could be losing a job or going through major health issues, for instance.
If the lender approves the short sale, the homeowner can begin to sell the property.
In a short sale, your real estate agent will complete a comparative market analysis (CMA) and present it to your mortgage lender as data for the sale price. If your agent is top-notch, they will then use this CMA to help price your house to satisfy the lender and sell the home as quickly as possible.
If you have someone interested in buying your home, they will need to present you with an offer, which you will turn over to the lender for final approval. This process can take months—or even years!—and the offer still might get rejected.
Those looking to purchase a short sale should be aware that the process is long and doesn't always go through.
What is a foreclosure?
A foreclosure, on the other hand, happens when you stop making payments on your mortgage and the loan goes into default. The bank no longer sees you living in the house as a viable option and will begin the foreclosure process.
In the foreclosure process, you are allowed to live in the house until the bank kicks you out. The lender then tries to sell the foreclosed home either on the market or at the auction.
Short sales and foreclosures both go through your bank, but just because you're foreclosing doesn't mean you don't have options. You can try and short sell your home while it is in the foreclosing process, but you are on a timeline.
The foreclosure process begins when you are unable to make payments on your mortgage. Your bank will send you a notice of default when your mortgage is 30 days late. If you continue to miss mortgage deadlines, the bank will start the foreclosure process.
The foreclosure process involves the bank selling your home and evicting you and the rest of the residents. The timeline for this process varies from state to state, but the US Department of Housing and Urban Development's timeline shows about four months before an attorney schedules a sale.
Benefits of Foreclosure
To some, their house foreclosing is a breath of fresh air. While it's never the most ideal option, it can be a huge weight off an owner's shoulders. Those who can't afford their payments anymore don't have to keep stressing over trying to make the massive mortgage payment each month.
Not only do homeowners in foreclosure not have to make their payments anymore, but they also don't have to complete any repairs if something breaks. In the end, they don't have to prepare the house for a sale or anything—they just simply walk away.
Before you're evicted, foreclosing on your house may seem like a dream come true if you can't make your mortgage payment. Then reality sets in.
Consequences of Foreclosure
As you can imagine, foreclosing on a property and leaving thousands of dollars of mortgage on the table doesn't come without some serious consequences.
One of the major consequences is the impact on your credit. Your foreclosure will remain on your credit report for seven years. Because of that, you will have trouble finding a place to live and won't be able to apply for a loan for several years.
If you're using a Fannie Mae loan, you'll need to wait a minimum of five years. If you're lucky enough to be using an FHA loan, that time is reduced to 12 months with certain terms.
The amount of time you need to wait before applying for a loan depends on the reasons you're facing foreclosure. If you are forced into foreclosure due to job loss, for example, a lender might be more willing to lend to you before the seven years are up.
Short Sale Process
Some people think you have to default on your mortgage payment before you can sell via short sale, but that is not true. The short sale process begins when you owe more on your house than it is worth and can prove you are in financial hardship.
It's important to work with an experienced real estate agent from the very beginning of the short sale process. They'll compile a list of comparable homes in the area for the bank to gauge the value of your home. The bank will then compare that to your mortgage.
Once the bank approves the short sale, it's crucial that you price your home wisely. Your real estate agent will use the list of comparable sales (also known as comps) they gathered for the lender to price your home. As you receive offers on your home, your real estate agent will submit the offer to your lender for approval.
Waiting for the approval from the lender can take several months to even a year. More than half the time, the lender sends the offer back without approving it. If you are unable to reach an acceptable offer, you may go into the foreclosure process.
Once the lender approves the offer, your real estate agent will complete the paperwork necessary to transfer the title and nullify your debt. You'll want to have a real estate expert look over the contracts to make sure the lender cannot come after you for the difference owed to the bank.
Benefits of a Short Sale
There are multiple benefits to a short sale.
Retaining Your Privacy
For some people, going into foreclosure would be a hit to their ego. While financial problems are often not anything to be ashamed of, it's understandable that foreclosing may hurt your dignity or pride. However, no one has to know that your house is selling via short sale. Of course, if the neighbors look up your listing online, they'll see it in the details, but nearly every other aspect is like a regular house sale. This goes a long way in helping your pride stay intact during a difficult time.
Fewer Credit Consequences
The hit to your credit is significantly lower when you sell via short sale instead of foreclosing on your property. Although your credit does take a bit of a hit, that hit could be as low as only 50 points versus the potential 400 lost from a foreclosure.
Buy a New House Sooner
In some cases, you'll be able to buy a home immediately after your short sale. In either case, you'll be able to buy a home much faster than you would if you were to foreclose instead.
Consequences of a Short Sale
Of course, there are consequences to getting out of your mortgage without paying it in its entirety. Here are some to watch out for.
When you close on the short sale, your lender will give you a 1099 with the difference between your mortgage and what the home sold for. That money will be shown to the IRS as profit, and will be taxed as income. Depending on the value of your house and size of your mortgage, that can be quite a lot of money!
Although your credit doesn't drop quite as low as if you were to foreclose, you can still take quite a credit hit nonetheless. Many banks won't even think about lending you money for the first couple of years after your short sale if your credit dropped significantly.
The process is fairly quick in a foreclosure: Default on your loan, neglect paying it, and eventually get kicked out.
In a short sale, on the other hand, you are stuck in the house until the bank accepts the offer (which could be never) or until you foreclose.
Short Sale vs. Regular Sale
Selling your home short sale is smack dab in the middle between a regular home sale and a foreclosure. It's like a regular home sale in the sense that you list and show your home while maintaining your dignity.
But when push comes to shove, you are still being forced to leave your home.
Buying a Short Sale or Foreclosed Home
Buying property from the bank is quite a different process than from a regular seller.
When looking for a short sale, don't expect to get a deal. Many people look into buying a short sale house because they think they'll save some money. That couldn't be further from the truth.
The bank wants to recoup as much money as they can on the house, and as the buyer, your money is their way to do that.
When looking to purchase a foreclosure, make sure it is actually being sold by the lender. Although that may not save you any money, it will save you time. Foreclosed houses sold at the auction close within 30 days on average.
When buying short sale or foreclosed properties or selling your house short sale, make sure you have a quality agent by your side. These contracts can get pretty sticky and a good agent can help vet it for you as well as provide you with all the necessary paperwork.
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