Short Sale vs. Foreclosure

Today's questions is, what is the difference between a short sale and a foreclosure?

First, we’ll discuss short sales. We will go over the pros and cons of a short sale, followed by a brief discussion of the pros and cons of foreclosure, then we’ll do a more in-depth comparison of the two options.

1. What are the Benefits of a Short Sale?

There are a few main benefits to doing a short sale rather than a foreclosure.

From a credit standpoint, you are softening the blow to your credit score. You are preserving your credit to the best extent possible, and you are positioning yourself to borrow money down the road to finance the purchase of a new home.

Not to mention, within the context of a short sale transaction you may be entitled to certain relocation incentives. The bank will actually give you money in the form of relocation assistance to help with the big move.

Finally, while you're selling your property short, you can continue living in the home rent-free. These are the key benefits of a short sale that appeal to most homeowners who are facing foreclosure.

2. What are the Downsides of a Short Sale?

The time issue is one that comes to mind. There is nothing really short about a short sale.

It can take upwards of six months, if not longer, to complete a short sale start to finish.

Not to mention there is a lot of paperwork involved.

For some folks, that paperwork might be a little burdensome. We will be requesting borrower financial documents including tax statements, bank statements, paystubs, etc. And again, for some folks that can be tedious.

Those are the main “cons” of a short sale, if you will.

3. What are the Benefits of Foreclosure?

The benefits of a foreclosure instead of doing a short sale mainly revolve around convenience.

A foreclosure is a very passive process. You are not an active participant in your own foreclosure.

Foreclosure is done to you; you don’t do it to the bank.

With that being said, there is no paperwork involved. You don’t have to collect your borrower financial documents. Simply put, the benefits of a foreclosure revolve around convenience.

4. What are the Downsides of Foreclosure?

Well, from a credit standpoint, a foreclosure will have a much more negative impact on your credit score than a short sale will.

Not to mention the fact that if you have a second loan, a second mortgage or a home equity line of credit following a foreclosure, the second lender will be able to pursue you for the entire deficiency balance. Oftentimes in a short sale, the deficiency balance can be forgiven through a deficiency waiver.

With that being said, if you have a second loan or second mortgage it would probably be in your best interest to pursue a short sale so that we can settle that mortgage debt within the context of a short sale transaction.

Knockout Round

So, when going head to head in key areas, which option is really going to give you the best outcome: foreclosure or short sale?

Credit score

If your home is foreclosed on, you are looking at losing 200, 300 or even more points off your credit score.

If you opt to do a short sale, the hit can be as little as 70-100 points off your credit score (potentially more if the lender files a delinquency judgment).

Winner: short sale

Long-term impact on credit score

Many Americans know that a foreclosure will stay on your credit record for seven years. But it often takes as much as three years before your credit score even starts to come back up again after that initial hit.

After a short sale, you can bring your credit rating back up in as little as 12-18 months.

Winner: short sale

Credit record

While foreclosures must be reported, legally, that means they may stay on your public record for as long as 7-10 years.

Short sales don’t have the same regulations requiring banks to report them in the same way, and there really is no standard way to report them. Sometimes banks will report one as “agreed settlement short of full payment” and some may not report them at all.

Winner: short sale

Getting another mortgage

After a foreclosure, you won’t be eligible for loans with giants Fannie Mae or Freddie Mac for 5-7 years.

You could be eligible for another loan with Fannie Mae or Freddie Mac in as little as two years after your short sale. It’s possible you could even qualify immediately if you weren’t delinquent on your payments.

Winner: short sale

Deficiency balance

With a foreclosure, the deficiency balance won’t be waved on junior liens (second mortgages, second loans, home equity lines of credit, etc.) 

The government’s Home Affordable Foreclosure Alternatives Program, or HAFA, eliminates all deficiencies. There is the potential for full settlement and deficiency waiver on all loans.

Winner: short sale

Tax consequences

This is one area where the answer is the same on either side:

In most cases you will not have to pay tax on forgiven debt if the foreclosed home was your principal residence.

Winner: tie

Relocation incentives

There are no relocation incentives offered by government programs for foreclosures.

The HAFA program offers a $10,000 relocation incentive for sellers after a short sale so that you get some help getting into a new place to live.

Winner: short sale

Selling price of the home

Foreclosed upon homes typically sell for significantly less, due to the nature of the procedure. That means there can be a much higher deficiency balance owed on the home.

With a short sale, you’ll have the opportunity to market your home, using a real estate professional if you desire, so that you can get the best, highest offer for your home. That will mean a substantially reduced deficiency balance, which means a greater chance of a full settlement with your lender.

Winner: short sale

First lender incentive

There are no incentives for lenders to foreclose on homes. It actually costs them a surprising $59,000 on average to do a foreclosure.

HAFA will pay the primary loan servicer $1,500 cash incentive, and up to $2,000 towards the release of the junior lien.

If you think about that for a minute from the lender’s perspective, why would you pay $59,000 to get LESS for a home than you would if you were to do a short sale? Plus, short sales are usually way less hassle for the lenders themselves.

Winner: short sale

Junior lender incentive

Again, there are no incentives for junior lenders to do a foreclosure. In fact, they typically get wiped out entirely at the foreclosure auction.

Whereas with a short sale, the junior lender receives a partial payment, so they’re more likely to facilitate the process, and potentially settle the debt in full.

Winner: short sale

Making decisions

In a foreclosure, the bank calls the shots. You’re pretty much hands off, and they do what’s best for them throughout the process.

In a short sale, you make the decisions.

And the winner is…

By now, you’re probably not surprised to find out that a short sale can actually be overwhelmingly in your best interest (and in the lender’s).

If you are a struggling homeowner, remember: you are not alone.

Today, nearly 7 million residential mortgages are classified as “non-current,” or behind on payments.

Over 25 percent of all homes are worth less than the value of their mortgage.                                            

If you are unable to make your mortgage payments, or are stuck with a mortgage that is much larger than the value of your house, you still have viable options for positive resolution.                                         

It can be hard to get inspired to act when you feel you are only falling deeper into debt. But, as tough as it may be, taking action to get out of a worsening situation not only feels good - it also means that all of these negative consequences of a foreclosure on your record, for seven or more years to come, will be avoided.                                                  

For many struggling homeowners, a short sale is the best and fastest strategy for getting rid of debts that they have no hope of paying.                                            

Don’t wait for your lender to pursue you. Take charge, and open the door to a new start in life.

Call Ark Law Group today for your free consultation on how to get started.                    

The Complete Guide to Short Sales

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