Two options for homeowners who fall behind on mortgage payments are a short sale and foreclosure. While the prospect of losing a home is a hard reality that many people face, it's important to understand the difference between these two processes. How long do short sales and foreclosures take? Which is more detrimental to a borrower's credit? Let's discuss the details.
What is a short sale?
A short sale happens when the owner owes more on the mortgage than the market value of the property. During this process, they are essentially asking the lender to accept a lesser amount than the total it's owed. If the bank accepts the terms, the debt will be settled and the borrower released from any further liability once the short sale is closed, says Realtor® Paola Martinsen with Equity Real Estate in Murray, UT.
Like other homes for sale, short sales will be listed by a real estate agent. They can be a good deal, but buying one can be a headache.
“I wouldn't recommend them for first-time buyers, who may get frustrated with the extra paperwork and long waits,” says Marlene Waterhouse, a Realtor and the owner of Short Sale Solutions.
The average short sale takes around 90 to 120 days, and sometimes even longer. Why? The lender often won't approve the sale without buyers agreeing to its demands like paying for all repairs, wire transfers, and closing costs. These are all costs the seller would typically be on the hook for, but in a short sale, the lender is stuck with the bill. Therefore, to reduce its costs, the lender tries to negotiate these costs with the buyer.
Other than the involvement of the bank, a short sale will proceed much like other sales. You can get a mortgage (although a lender is far more likely to accept the sale if you make a cash offer) and have the opportunity to seek an inspection.
What is a foreclosure?
Foreclosure is a legal process that happens when the homeowner (although "borrower" might be a more appropriate term) is unable to make mortgage payments for a significant period of time.
After three to six months of missed mortgage payments, the lender will issue a Notice of Default with the County Recorder's Office. This notice is to let the borrower know he is at risk of foreclosure and could be evicted.
After receiving the Notice of Default, borrowers can try to settle their mortgage debt with their lender either through a short sale or by paying the money they owe. This period is called pre-foreclosure and can last anywhere from 30 to 120 days after receiving the Notice of Default.
If the debt is not recouped, the lender will step in and schedule a foreclosure auction to sell the house to a third party. Foreclosure auctions will be advertised in local newspapers and are typically held at either the property or the local courthouse, says Cathy Baumbusch, a Realtor with Re/Max Allegiance in Alexandria, VA. Foreclosed properties can be purchased only with cash.
While these properties can be a great deal, they also come with a great deal of risk, says Baumbusch. “Keep in mind that foreclosures sold at the courthouse are bought without warranty and sight unseen.”
That means you will not be able to have the home inspected for structural problems, mold, infestations, or other issues with the house. You will also assume all liens that might be tied to the property.
If no one buys the home at auction, the lender becomes the owner and its considered a bank-owned or REO (real estate owned) property.
What's the difference between short sale and foreclosure?
Short sale and foreclosure are two financial options for a homeowner in financial distress, but each option has a different process and will have different financial consequences. A short sale occurs when a homeowner's lender allows the homeowner to sell the house for less than the amount owed on the mortgage. For example, the homeowner sells the house for $250,000, but the remaining loan balance is $300,000. Foreclosure is the process of the lender repossessing the house.
Short sales can take up to one year to close, while foreclosures generally move along much faster because the lender is intent on recovering the money it's owed.
For homeowners who find themselves in mortgage trouble, a short sale is far less damaging to their credit than foreclosure. In fact, people who go through the short sale process can usually buy another house without having to wait, although securing a mortgage might be more challenging. Foreclosure, on the other hand, will stay on the homeowner's credit report for seven years. They'll also have to wait five years to buy another house.
If paying your mortgage has become a real challenge, the smartest step to take is to talk to your lender to discuss your options. Chances are, the lender will be able to offer the best plan of action based on your unique situation and the foreclosure laws in your state.