The terms "short sale" and "foreclosure" are often used interchangeably when discussing distressed properties. However, they are two distinct processes that homeowners may go through when they are unable to make their mortgage payments. In this blog, we will discuss the differences between a short sale and a foreclosure.
What is a Short Sale?
A short sale is when a homeowner sells their property for less than what is owed on the mortgage. The lender agrees to accept the proceeds from the sale as full payment of the debt. A short sale is often used as an alternative to foreclosure because it allows the homeowner to avoid foreclosure and the negative consequences that come with it.
The process of a short sale typically begins when the homeowner contacts their lender and explains their financial hardship. The lender will then determine if the homeowner is eligible for a short sale. To be eligible, the homeowner must demonstrate that they are unable to make their mortgage payments due to a financial hardship, such as a job loss, medical bills, or divorce.
Once the homeowner is deemed eligible for a short sale, they will need to find a buyer for their property. The lender will typically have to approve the sale price and terms of the sale. The lender may also require the homeowner to provide a hardship letter and other financial information to demonstrate their inability to make their mortgage payments.
If the lender approves the short sale, the homeowner will need to sign a sales contract with the buyer. The proceeds from the sale will go directly to the lender to pay off the mortgage debt. If the sale does not cover the entire mortgage debt, the lender may agree to forgive the remaining balance or require the homeowner to pay it back over time.
What is a Foreclosure?
A foreclosure is a legal process in which a lender takes possession of a property due to the homeowner's inability to make mortgage payments. When a homeowner falls behind on their mortgage payments, the lender will typically send a notice of default, which gives the homeowner a certain amount of time to catch up on their payments. If the homeowner is unable to catch up, the lender will initiate foreclosure proceedings.
Foreclosure proceedings can vary by state, but typically involve a court proceeding in which the lender seeks to take possession of the property. If the court approves the foreclosure, the homeowner will be given a certain amount of time to vacate the property. The lender will then take possession of the property and may sell it to recoup their losses.
Foreclosure can have severe consequences for homeowners, including damage to their credit score, eviction from their home, and a deficiency judgment, which is a court order requiring the homeowner to pay the difference between the sale price of the property and the remaining mortgage debt.
Key Differences between Short Sale and Foreclosure
There are several key differences between a short sale and a foreclosure. The most significant difference is that a short sale is a voluntary agreement between the homeowner and the lender, while a foreclosure is a legal process initiated by the lender.
Another key difference is the impact on the homeowner's credit score. A short sale will typically have less of an impact on a homeowner's credit score than a foreclosure. A short sale will appear on the homeowner's credit report as a settled debt, while a foreclosure will appear as a default. A foreclosure can remain on a homeowner's credit report for up to seven years, while a short sale may only remain for two to four years. As a result, a foreclosure can have longer-lasting consequences for the homeowner, including difficulty obtaining credit in the future and difficulty renting a property. Most South Florida landlords and HOAs require a certain minimum credit score (in our experience, 620 is typical) before even considering a would-be-renter’s application.
Another significant difference is the impact on the lender. In a short sale, the lender may agree to forgive the remaining mortgage debt or require the homeowner to pay it back over time. In a foreclosure, the lender takes possession of the property and may sell it to recoup their losses. However, if the sale price does not cover the entire mortgage debt, the lender may seek a deficiency judgment against the homeowner to recover the remaining balance.
It's important to note that both short sales and foreclosures can have tax implications for homeowners. In a short sale, the forgiven debt may be considered taxable income by the IRS. In a foreclosure, the homeowner may also be liable for taxes on the forgiven debt, as well as any capital gains tax if the property is sold for more than the remaining mortgage debt.
Here is a Quick Summary of Pros and Cons of Short Sales and Foreclosures for Homeowners
- Allows homeowners to avoid foreclosure and the negative consequences that come with it.
- May have less of an impact on credit score than a foreclosure.
- Allows homeowners to sell their property and move on.
- May be able to negotiate the remaining mortgage debt with the lender.
- Can be a lengthy and complicated process.
- May require the homeowner to find a buyer for the property.
- The lender may not approve the short sale or may require a higher sale price.
- May have tax implications for the forgiven debt.
- Allows the lender to recoup some or all of their losses.
- May be a quicker process than a short sale.
- Removes the homeowner's responsibility for the property and mortgage debt.
- Can have severe consequences for the homeowner, including damage to credit score and eviction from the property.
- May result in a deficiency judgment, requiring the homeowner to pay the remaining mortgage debt.
- Can make it difficult for the homeowner to obtain credit or rent a property in the future.
To sum up, short sales and foreclosures are two distinct processes that homeowners may go through when they are unable to make their mortgage payments. A short sale is a voluntary agreement between the homeowner and the lender, while a foreclosure is a legal process initiated by the lender. A short sale allows the homeowner to sell their property and avoid foreclosure, while a foreclosure can have severe consequences for the homeowner, including damage to their credit score, eviction from the property, and a deficiency judgment. It's important for homeowners to understand the differences between short sales and foreclosures and to consult with a financial advisor or real estate professional before making any decisions.