What Is the Difference Between a Short Sale and Foreclosure?
The real estate market is is a difficult one to navigate, especially for first time homebuyers. Now that the market has bounced back, competition is stiff, home prices are increasing, and wages are stunted, finding a home in your price range has become increasingly difficult.
For this reason, many people have begun to consider purchasing properties that are distressed, somewhere in the foreclosure process, or in short sale.
Table of Contents
- 1 What Is a Short Sale?
- 2 How Does a Short Sale Impact Credit Scores?
- 3 Should I Choose a Short Sale Instead of Foreclosure?
What Is a Short Sale?
A short sale occurs when there is more debt on a home than the property is currently worth. In essence, if the borrower undergoes substantial financial hardship that impacts the repayment of the mortgage, the lender may agree to sell the home for less than the amount that is owed and forgive the borrower’s debts. This prevents the property from going into foreclosure, which is typically a painful process for all parties involved.
In a short sale, the seller is left with a balance still owed to the bank. In these scenarios, the lending institution can hold the borrower liable for the full amount, reduce that amount to an amount that is more manageable to the original lender, or decide to forgive the debt altogether.
It’s a process that happens more than one might think. Recent data suggests that short sales make up nearly 3 percent of all home sales in the United States.
A short sale can be a best-case scenario, but not everyone on the market is a good candidate to sell or purchase one. The term ‘short sale’ is actually somewhat of a misnomer, as the process is often drawn out over a long period of time, and requires a lot of effort from buyers, lenders, and backing institutions.
When Does a Short Sale Occur?
If you’re facing foreclosure and can’t afford to make home payments, short sales are an alternative that is worth looking into, especially if you fall into one of the following categories:
- You are ineligible or unable to refinance or modify your mortgage
- You’re facing a long-term hardship that compromises your ability to pay off your debts
- You’re significantly behind on your mortgage payments and are at risk of foreclosure
- You owe more on your home than it’s worth
- You have not been able to find a new buyer for your home at a price that covers your current mortgage balance
- You can no longer afford your home and need to leave
If you qualify for a short sale option, the process is generally similar to that of a typical real estate transaction. The difference is that you will be working with not only a realtor in order to find buyers, but all sales transactions will also have to be approved by your original lender. They will help to set the sale price, collect financial information, review acceptable offers, and agree to the terms of the sale.
How Long Does a Short Sale Take?
One downside of the short sale process is the length of time it takes for transactions to be approved by the original lender. Buyers, agents, and in many ways borrowers have no control over the short sale process. It’s heavily reliant on the lending institution.
In 2012, lending institution Fannie Mae updated their policies in order to expedite the process. This allowed the process to be more efficient and transparent, but short sales still require a lot of time and patience.
“If you happen to fall in love with a home that happens to be a short sale and you have time, it’s OK to write up an offer,” Nathan Bangs,a property expert for Keller Williams Realty in Florida tells US News. “If you’re short on time, … if you’re adamant that you need a home in the next 30, 60, 90 days, then we need to uncheck the box ‘search for short sales’ and just focus on traditional sales.”
The amount of time that short sales take varies vastly between lending institutions. The best way to shorten the amount of time required is to work with a real estate agent who is familiar with the short sale process.
How Does a Short Sale Impact Credit Scores?
Many borrowers are under the impression that short sales will have less of an impact on their credit score than a foreclosure will, but in many ways, foreclosures and short sales are similarly detrimental. Sellers can expect that their credit score will drop anywhere from 85-160 points depending on their specific situation.
This is because short sales often appear on your credit report as “settlements” rather than “paid debts.” This isn’t always the case, as on occasion a lender will agree to report a short sale as a debt that has been paid. Typically, however, this only occurs if the homeowner has never missed payments, took the time to write a compelling letter of hardship, and already has a stellar credit history.
In most cases, however, a short sale will significantly impact your credit score, as you didn’t repay the full debt as agreed upon in your mortgage agreement.
How Long Does a Short Sale Stay on Your Credit Report?
According to Experian, short sales will impact your credit score for as long as seven years after the date that your mortgage was settled.
Failing to pay your mortgage debt will always have a negative impact on your credit score. With time and positive steps taken, it’s possible to rebuild your credit.
How Long After a Short Sale Can I Buy a New Home?
If you’ve been through the short sale process, you may be wondering how long you will have to wait before securing a new mortgage agreement. Since your credit takes a hit after short sale, you might have to wait awhile.
The waiting period after short sales depends on the type of loan you originally secured, as well as your individual financial circumstances and the lender.
If you were not in default on your prior mortgage and made consistent payments punctually for a significant period of time, you might not have to wait at all.
If this wasn’t the case for you, you’ll need to wait for three years before applying for another Federal Housing Administration (FHA) loan. However, there are extenuating circumstances that could allow you to forego the three year rule. Those include:
- Serious illness or death in the family
- Job loss
Typically, these extenuating circumstances only help your case if you had a positive credit history throughout the time preceding the short sale.
For loans administered through Fannie Mae specifically, there are specific loan requirements which can lessen the amount of time that you must wait before obtaining a new loan. These generally require that you prove in writing that the short sale was due to the result of extenuating circumstances, and also require that you have a significant downpayment for the new property.
To see the specifics of these requirements, find more information on the Fannie Mae website.
Should I Choose a Short Sale Instead of Foreclosure?
If a financial hardship has put you in a position where you’re forced to break the terms of your mortgage agreement, putting your home up for short sale, or allowing your home to go into foreclosure, are options you may be considering.
It’s important to recognize early on that your credit score is likely to take a hit regardless of the option you choose, despite the fact that alleviating the damage is touted as a major benefit for going the short sale route.
It’s also important to note that a short sale does not automatically cancel your obligation to pay off the remaining portion of your mortgage. Some lenders require borrowers to sign new promissory notes before approving of a short sale, meaning you’re legally responsible for the remaining debt on the mortgage.
It’s also important to recognize that while each party can benefit in different ways by going through the short sale process, some lenders may choose to go through the foreclosure process in order to protect their assets. If the lender believes they will have a qualified buyer at a foreclosure auction, they might choose to deny the possibility of a short sale.
Overall, choosing to pursue a short sale or a foreclosure is a process that is highly dependent on individual circumstance. Above all else, you should speak to your lender as early as possible in order to avoid confusion and make a decision that is ideal for your individual circumstances.
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This post was updated February 28, 2019. It was originally published May 24, 2018.