Short Sale vs Foreclosure | Which is Better, Pro’s and Con’s, and What To Do

In 2009, I went through a short sale of my personal home…

It was not a good experience to go through. Now, having been through a short sale vs foreclosure, I can say that I am glad I went with a short sale instead of the foreclosure.

In the short sale, we lost our home, credit got hit pretty hard, and we had to start all over.

BUT… It could have been much worse.

Because of going through a short sale, I wanted to share with you what happened so you can be ready for it yourself if it happens to you.

Related Article: Foreclosures are Great Investment Properties

The short sale and foreclosure process for a property are ways for a homeowner to get out of a mortgage they used to buy the property.

In most cases, the borrower is unable to continue making the mortgage payments they agreed to so the bank has two processes to take care of the debt.

The difference between the short sale vs foreclosure really comes down to the bank. A short sale of a property is when the borrower and bank agree to sell the property for less than the balance of the loan. A foreclosure of a property is when the bank completely takes over the property, removes the tenant and repossesses the property.

In both cases, the borrower is left without a house and possibly future issues with credit, debt, and taxes.

For us real estate investors, the short sale vs foreclosure process is a way to make a lot of money. We do this by buying the property for less than it is worth and then rent out the property.

Buying Short Sales vs Foreclosure

Prices of homes are going up in all major housing markets with each passing year.

If you are thinking of buying a home but resist the temptation because of high prices, you have the option of buying either a foreclosure home or a short sale home.

You can save a lot of your hard-earned money if you can search either of these two types of homes and work with a realtor to buy the house.

Most people do not understand the difference between short sale and foreclosure. For a buyer, it doesn’t make much of a difference if he can buy a home for less than market prices.

However, there is a difference in the two processes for the homeowners who have fallen behind their payment schedules and trying to get rid of the burden on their head.

What is a short sale?

If a homeowner fails to pay one or more of his monthly repayments to his lender, he obviously falls short on his repayment schedule.

In such a scenario, the homeowner owes more to the lender than the current market value of his property.

One way to get out of the financial mess is to request the lender to agree for a short sale. In this arrangement, the homeowner pleads with the lender to agree for an amount that is less than what he owes to him.

For example, if a homeowner owes $400000 to his lender but the market value of his home is $350000, the lender sometimes agrees to accept $350000 that is generated through the sale of the house.

In this arrangement, the homeowner is $50,000 short on his payment. This is the reason it is called a short sale.

Once the lender agrees to short sale, the mortgage is deemed as settled and there is no further liability on the homeowner if he closes the deal and pays the amount agreed upon to the lender.

What is a foreclosure?

Foreclosure is a dread word for most homeowners. It is a legal process initiated by the lender to take back the ownership of the home from the borrower when he has fallen behind in his repayment schedule.

If you try to buy a home in foreclosure, you effectively buy it from the lender rather than the borrower who owned it previously.

A lender resorts to foreclosure only when it feels there is no way of recovering the money it gave to the borrower in the form of a mortgage.

A notice of default is sent to the borrower after he misses several of his monthly payments and if he does not respond positively, the lender initiates proceedings for a foreclosure.

The lender takes back the property form the borrower and arranges an open auction to sell the house to the highest bidder.

The lender advertises such auctions in local newspapers and the house is sold to the highest bidder during the auction.

In a foreclosure, you buy the house directly from the lender often against the will of the owner who has been evicted from the property.

Buying a foreclosure property can be a beneficial transaction for you as these homes are often available at less than their market value. You can expect a saving of up to 30% on the market price when you buy a foreclosure property.

However, a foreclosure property is also a risky proposition as it comes with no warranties and you cannot ask for a home inspection before buying it.

Advantages of short sale vs. foreclosure

For the owner of a house, short sale is a better choice than foreclosure as it is less damaging to his credit.

He gets away by selling the house as a proud owner while he is evicted from his home in a foreclosure. What are the implications of buying a foreclosure or a short sale house for a buyer? Let us find out.

Buying a short sale is always a better option for you as compared with a foreclosure.

In a short sale, you buy the house form the owner and this sale is approved by the lender. This means there are no legal hurdles for you as the owner and lender both want to get rid of the property.

You also stand to benefit from the less price of the property as the house is sold at a price that does not allow the lender to recover his dues from the borrower.

In the case of a foreclosure, you buy the property after bidding on it in an auction attended by other buyers and investors.

This competition jacks up the sale price of the house and you make a very small profit. Also, the lender adds up all the costs borne by him in the legal proceedings as well as repair and maintenance of the property. 

As a buyer, you find the price of a foreclosed property higher than the price of a short sale house.

You get total cooperation from the homeowner during the purchase of a short sale house.

This is because he is getting a chance to settle his issues with the lender without having any adverse impact on his credit score.

On the other hand, there have been instances where borrowers have refused to make way for the buyer even after he has paid the money to the lender for the purchase of the house in an auction.

Short sale vs. foreclosure credit impact

As discussed above, the main difference between a short sale and a foreclosure lies in the impact on the credit score of the borrower.

In the case of a short sale, the lender agrees to accept a lower amount that is owed by the borrower on his mortgage.

Also, the lender allows the homeowner to sell the house as an owner and settles the debt he owes in a peaceful manner.

Borrower gets a chance to sell the home through a realtor as a homeowner and his credit also does not take a beating in case of a short sale.

The lender can avoid many expenses that are associated with foreclosure if he accepts to a lower price of the house than is owned by the borrower.

On the other hand, foreclosure is resorted to by the lender only when it feels that the borrower is either incapable of repaying or does not intend to repay his mortgage obligations.

He takes over the possession of the house from the borrower and sells it through an auction to the highest bidder for the property.

In a nutshell, it is always better for your credit if you can get your lender to agree for a short sale rather than allowing him to proceed to a foreclosure which damages your credit for a very long time.

Can you do a short sale while in foreclosure?

Once a lender issues a notice of default, there is this constant worry about foreclosure in the mind of the borrower.

If the borrower does not respond or contact the lender after receiving this notice for default, the lender can initiate the proceedings for foreclosure after a waiting period of 90-120 days.

You can request the lender to consider a short sale in place of foreclosure.

If the lender agrees to a sale price less than what you owe to him, it is possible to get away with a short sale with the help of a realtor.

Pros and cons of short sale vs. foreclosure

As a buyer, you should know that both short sales as well as foreclosures are a result of homeowners falling behind their repayment schedule in their mortgage.

You get an opportunity to become the owner of a property by paying less than the fair market value of such properties.

Foreclosure pros

• You buy a home at less than its market value
• Process is quick as lender want to recover their money
• You can secure a deal if you have the cash to buy in an auction

Foreclosure cons

• Auction can be intimidating for many buyers
• You must buy the home in as is condition without any inspection

Short sale pros

• These homes are sold at much less than their market value
• Process is straightforward just like a regular sale

Short sale cons

• It can be a very long process for the buyer
• Bank must agree to the loan
• Waiting for approval from lender can make you miss out on another buying opportunity.

Short sale vs. foreclosure tax consequences

For the IRS, a real estate transaction has taken place whether you have sold your home for a profit or incurred a loss in the form of short sale or foreclosure.

The title of the house has been transferred in the name of the buyer and that is enough for the IRS to demand taxes from you.

If the lender has cancelled any amount of your mortgage as a relief, this amount is taxable and considered as income by the IRS.

How to get out of a short sale or foreclosure?

Short sale or foreclosures are situations that all homeowners want to avoid at all costs.

If you live within your means, have the umbrella cover of life and health insurance, and pay your EMIs to the lender on time, it is easy to avoid a short sale as well as foreclosure.

If you have received a notice of default, it is prudent to talk to your lender and work out a solution rather than wait and do nothing.

Things can spiral out of control very quickly and it is therefore important to take corrective action when you are staring at short sale or foreclosure.