Foreclosure or Short Sale: A Quick Comparison
If you are currently having financial difficulties you may be wondering whether to do a short sale or let the bank foreclose on your home. While it may seem easier to simply throw in the towel and opt for the latter, it may not always be the best option. Regardless of which way you ultimately decide to go, it is always advisable to obtain legal and tax advice before making a final decision. Below are the differences between the two approaches as well as some of the advantages and disadvantages of each.
The differences between a foreclosure and a short sale
A foreclosure occurs when a borrower has consistently failed to make his mortgage payments to the lender,
usually the bank. This allows the lender to take possession of the property, evict the borrower and sell the property at an auction in order to recover the outstanding balance on the mortgage.
A short sale is an alternative to foreclosure. It is typically used in cases where the outstanding balance on the mortgage loan exceeds the value of the property. This process is initiated by the borrower and all the lenders need to give their consent. The house is put on the market with a realtor and sold in the ordinary way. The proceeds of the sale are then used to pay a portion of the amount owed by the borrower. In such a case, the lender may agree to accept an amount less than the amount owed in full satisfaction of the mortgage. If the bank will not accept the partial payment in full satisfaction of the mortgage, the amount which remains outstanding after the sale is known as the deficiency. Unless the parties have reached agreement on the matter, the lender may decide to sue for this amount, and obtain a deficiency judgment.
The advantages and disadvantages
There are various benefits of a short sale. Firstly, the process is a lot more dignified. You initiate and maintain control over the sale and you spare yourself the social stigmatisation that is typically associated with a foreclosure. You know exactly who is buying your home and your sale will be handled like any other. Furthermore you do not need to have defaulted on your payments in order to apply for a short sale.
A further benefit of a short sale is that your credit rating will not be as adversely affected. While a foreclosure can cause your credit rating to drop by 200-400 points, a short sale will only cause a drop of 50-150 points. Your credit report will simply state that a loan was ‘settled,’ ‘paid as agreed,’ or ‘paid in less than full.’
If you opt for foreclosure, you may need to wait at least five years before you will be able to obtain a mortgage in order to purchase another home. The foreclosure will be on your credit report for seven years. If however you have opted for a short sale, you may, subject to certain restrictions, be eligible to purchase a new home almost immediately.
While short sales do mitigate the additional fees and costs for both borrower and lender, the process typically involves a lot more paperwork. It can take up to a year to process.
The position of the buyer
Foreclosed properties usually sell for about 30% less than the market value. However the buyer is required to pay in cash on the same day as the foreclosure sale and does not have the benefit of having the property inspected. Buying short sale properties will save you about 10% on the market value. However you may be waiting for many months while the seller’s lender decides whether or not to accept the short payoff.