For both buyers and borrowers, a foreclosure and short sale present different challenges and advantages. Foreclosed properties are owned by banks but in a short sale the property is still owned by the borrower.
When a borrower consistently fails to make mortgage payments, the property is foreclosed i.e.the lender assumes ownership of the property and evicts the borrower. Foreclosed properties may be sold at an auction or via traditional real estate agents. For a borrower, a foreclosure badly damages their credit rating.
A short sale is often used as an alternative to foreclosure because it mitigates additional fees and costs to both the creditor and borrower. Credit is also typically damaged much less than from a foreclosure, but a short sale usually involves a lot more paperwork.
When the market value of the property is less than the outstanding mortgage principal, and the borrower cannot afford to pay the mortgage, the lender (one or more banks) may choose to accept a short sale. In a short sale, the proceeds from selling the property fall short of the mortgage balance. Any unpaid balance owed to the lenders is known as a deficiency. Short sale agreements do not necessarily release borrowers from their obligations to repay any deficiencies of the loans, unless specifically agreed to between the parties.
Buying a property in a short sale usually takes a lot longer because it's not just the buyer and the seller who have to agree to the sale. All the lenders that hold a lien on the property have to agree to the sale. If the first mortgage has been re-sold by the original lender, it may now be owned by multiple banks. If there is a second mortgage on the house, the lender(s) in the second mortgage also may be lienholders. Getting all lenders to approve takes time and could even prevent the deal from closing if a lender does not agree.
Foreclosures are used when a homeowner has defaulted on their mortgage payments and the lender takes possession of the house in payment.
Short sales are available when the borrower is no longer able to make their mortgage payments and owes more than their home’s current worth on the market. It is available both in situations where the homeowner is current on their mortgage payments and when they have fallen behind. However, the bank is not obligated to accept a short sale.
edit Short Sale vs Foreclosure Process
edit Foreclosure process
In a foreclosure, the lender takes possession of the property and auctions it at a Trustee Sale at the court house in the county where the property resides. After three to six months of missed payments, the lender will record a Notice of Default, which notifies the borrower that they are facing foreclosure and gives them a reinstatement period, typically until 5 days before the home is auctioned, for them to dispute this or repay the unpaid balance on the loan. If this is not done within three months, the homeowner receives a Notice of Sale. The property is then auctioned at a Trustee Sale to the highest bidder, who must pay in cash within 24 hours. The opening bid is usually equal to the outstanding loan balance and any additional attorney fees the bank have accrued.
Here is a good video that compares the process and impact of foreclosures to short sales based on 5 major criteria:
edit How do short sales work?
In a short sale, the homeowner puts the house on the market with a Realtor. It is handled like any other home sale. Once the homeowner has accepted an offer, it must also be accepted by the bank. It can take anywhere from 3 to 6 months for a short sale to close and its success is not guaranteed. However, the Federal Housing Finance Agency announced new rules in 2012 that would make this process easier and faster. For example, mortgage lenders now have to respond to a short-sale offer within 30 days of receiving it.
In August 2012, the Federal Housing Finance Agency announced measures to make short sales of underwater homes (where the outstanding mortgage is greater than the current market value of the home) easier for homeowners, including extending help to people who have financial difficulties but haven't missed mortgage payments. Under the plan, which has an effective date of Nov 1, 2012 and applies only to mortgages guaranteed by Fannie Mae and Freddie Mac, a $6,000 cap will apply on the amount of money that holders of second mortgages can receive when a short sale is completed. The idea is to reduce the incentive for holders of second mortgages to haggle over their slice of the home-sale proceeds, thus avoiding delays and making it easier to complete the sale. The new rules also allow homeowners with missed mortgage payments and serious financial problems to submit fewer documents to be approved for a short sale. Homeowners will receive speedier approval if they are experiencing a financial hardship such as a lost job, divorce, death in the family or job relocation.
edit Complications for Buyers in Foreclosures vs Short Sales
Short sales typically sell for a 10% discount to ordinary homes, compared with a 30% discount for foreclosures, said Sam Khater, deputy chief economist at real estate data firm CoreLogic Inc. However, these purchases are not without complications.
Foreclosed properties are usually sold for the outstanding mortgage balance, which can mean an incredibly low price. However, they must be paid for with cash on the same day as the auction, and buyers cannot inspect the property before purchase. The buyer may be required to pay unpaid property taxes from the current owner, and they may have difficulty evicting the current owners from the house.
Short sale properties are also often bought for less than appraisal price. However, the process can be very time-consuming, as you must wait for approval from the lending bank. It take between 3 months to 12 months to finalize the sale. Moreover, it is risky, as the bank can pull the house off the market at any point with no repercussions.
edit Credit Rating
A foreclosure can cause a credit rating to fall by 200 to 400 points. It remains on the credit report for 7 years.
A short sale can cause a drop of 50 to 130 points in the homeowner’s credit rating, although major falls are usually due to the borrower being in default of the loan. The credit report will state that the loan was “settled,” “paid as agreed,” or “paid in less than full.”
edit Future Homeownership
After foreclosing on a house, an individual is eligible to buy another home in 5 years, with some restrictions, or in 7 years with no restrictions. Individuals must report the foreclosure on all future loan applications.
After a short sale, the individual may be able to purchase a new home immediately, if their payments had never been more than 30 days late and the lender does not require them to pay back the loan. However, finding a new lender may be difficult.
edit Books and Videos
This is a list of useful, popular books and videos about foreclosures on Amazon.com:
- 23 Legal Defenses To Foreclosure
- The Complete Guide to Locating, Negotiating, and Buying Real Estate Foreclosures
- The Complete Idiot's Guide to Buying Foreclosures
- The Pre-Foreclosure Property Investor's Kit: How to Make Money Buying Distressed Real Estate -- Before the Public Auction
edit Did you know?
According to Realty Trac, US data for May 2012 shows that
- TOP cities with highest no. of foreclosed homes are
- Miami, FL
- Chicago, IL
- Las Vegas, NV
- Los Angeles, CA
- Phoenix, AZ
- Number of new foreclosures grew 9.12% from Apr'2012 (188,780) to May'2012 (205,990).
- Number of Foreclosures Sold for Apr'2012 (66,529) dropped 22.37% as compared to Mar'2012 (85,702).
- Avg Sales Price for a foreclosed property grew 16.64% from Apr'2012 ($170,532 ) to May'2012 ($198,915).
- Short sales are headed for a record year: sales are up 33% in Jan2012 over the year before.
edit Recent Foreclosure News
- Short sale - Wikipedia
- 'Short Sales' to Get a Boost - Wall Street Journal
- What's The Difference Between Short Sales, Foreclosures, and REOs? - Trulia
- How Can I Get Cash for Doing a Short Sale? - About.com
- Difference Between Short Sale and Foreclosure - LoanSafe.org
- Advantages and Disadvantages of Buying a Foreclosure - FrontDoor.com