Before we dive into whether a short sale is better than a foreclosure, you have to know what exactly short sale means. In simple terms, a short sale is when you sell a property for less than the amount you owed on a mortgage. This means that you’re short on the full cash you were expected to repay your mortgage lender.
You’re probably unfamiliar with short sales because they are quite rare now, mostly due to economic improvement. Short sales were prevalent during the great recession when many U.S. homeowners owed more on their homes than the value of the house.
How Does a Short Sale Work?
A short sale is sometimes referred to as a “pre-foreclosure sale” and must be negotiated with the bank in advance.
Short sales occur following a low appraisal or when the property value drops. For example, if you purchase a home for $300,000 and after five years you’ve only paid $60,000 of the principal amount, you’ll have $240,000 left on the mortgage.
Now, assuming you badly need to sell the house, you’d have to sell at $240,000 to break even. On the flip side, if the appraisal is less than the $240,000—because sometimes the value of a property can drop—you’ll be “short” the difference between $240,000 and the appraised worth. And that’s a short sale.
Once you understand the math, it’s pretty straightforward from there.
Who is Involved in a Short Sale?
The most important factor for the success of a short sale is the lender(s). Your lender must agree to accept less than what you owe on a mortgage; but be ready for contingencies. In some cases, your lender has to conform to the amount you’ve set for the sale price, which can make this process a tad longer than private sale.
You might have to wait a couple of months, or possibly even six months to a year, for a short sale. During this period, your lender is reviewing the offer and, based on their final decision, will either accept, deny or request more information from the purchaser.
Keep in mind that a foreclosure is still possible at any time during this phase. If you’re looking to buy a short sale home, you cannot negotiate the sales price because this is strictly between the seller and their lender.
How Will a Short Sale Benefit the Seller?
If you’re selling a home, thoroughly investigate other options and calculate the risks and opportunities. It would be best if you also looked at other personal financial possibilities before deciding. Although a short sale isn’t exactly a perfect solution for someone going through a financial setback who owns a home that is valued at less than the mortgage, it is one of the best options. Consider these benefits:
- A short sale does not affect your credit score like a foreclosure will; this allows you to get another home in the future.
- With a short sale you don’t have to bear the burden of fees and charges, which also includes real estate agent commissions which range from 3% to 6% of the total home sale. Instead, those fees are covered by the bank.
How will a short sale affect the home seller?
When you make a short sale on your home, you don’t earn any profit from the sale. Banks or mortgage lenders get all proceeds from the sale. You’ll also be heavily dependent on the lender for the decision-making process. And because you’ve earned no profit, you won’t be able to steer home sale assets toward the purchase of a new home. Rather, you’ll have to start from scratch.
Is a Short Sale Better than Foreclosure?
The truth is that banks and other lenders prefer a short sale to foreclosure, and any short sale blog or real estate agent will agree. Foreclosure is a legal process by which a lender takes over the house of a borrower or homeowner when they’re unable to make mortgage home payments.
A short sale is beneficial to the homeowners for two reasons. Firstly, it is a voluntary action while a foreclosure is compulsory. Secondly, if your house is foreclosed, you’ll have to wait a standard of a whopping seven years before obtaining another mortgage loan while for a short sale you could wait for only two years.
For lenders, a short sale is better than a foreclosure because they can get as much as the original loan back without any legal drama. Some homeowners and lenders will sometimes even agree to pursue a foreclosure after first attempting a short sale.
What are My Other Options?
If the idea of a short sale is too daunting for you, you can also consider some other alternatives:
Rent Out: You can rent out the property. However, this only works if the rent exceeds the mortgage payments.
Refinance: You can replace the existing mortgage with a loan that has better terms. This means that you will have to pay off an existing mortgage to create a new one. The main aim of refinancing is to lower your interest rate.
Loan Modification: With this option, you can modify the payment by either reducing interest rates or extending loan terms. This makes it easier to afford to pay the loan and have a fresh start.
Forbearance: This allows you to reduce or suspend loan payments temporarily. Your lender might grant you forbearance based on either a temporary situation causing you to default or if you’ve never missed any payment before the situation.
Bankruptcy: All other preceding options are dependent strictly on the lender. With bankruptcy, you’re the one “calling the shots.” Lenders have no decision if you declare yourself bankrupt. Claiming bankruptcy can stop a foreclosure outrightly.
Seek Professional Advice
Regardless of what you’ve read so far, the best solution depends on a ton of other intricacies: your financial standing, your lender’s readiness to negotiate and other nitty-gritty.
You must, above anything else, seek professional advice from accountants, real estate professionals, and attorneys that specialize in this sector. Seek out the best solution that will be of benefit to you in the long-term and take note of the implications of your choice.
Prepare for the future the best you can by facing your financial trouble and mortgage head-on. And always keep your credit ratings in mind. Your credit score can get significantly worse from a foreclosure (200- to 300- points) than from a short sale (50- to 100- points). You can also speak to your lender for other practical options that can be of great benefit to you.
