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Difference Between a Short Sale and a Foreclosure

This article aims to explore the differences between a short sale and a foreclosure, which are house selling procedures that have become rampant on account of the slump in the housing market. Here, we also identify the inherent advantages of a short sale, over the latter option.
Aparna Iyer
Home Affordable Foreclosure Alternatives (HAFA) Program
The HAFA program provides assistance to individuals facing financial hardships, who are on the verge of getting their homes foreclosed. Provided certain conditions are met, the program can free individuals from their debt burden, helping them make a smooth transition to affordable housing.

Homeowners typically buy a house by taking a mortgage, for which the house functions as a collateral. He or she is expected to make timely mortgage payments, failing which, the house is seized by the lending institution.

The real estate market crashed in 2007 and resulted in a number of people defaulting on mortgage payments. The reasons for defaults could be attributed to the fact that the borrowers were subprime and their only chance of repaying the borrowed amount hinged on their ability to refinance the home at a lower rate of interest.

Another possibility was selling off the house in an upmarket and thus encash the built up home equity. This hope was thwarted since the home owners were unable to sell off the home for a profit on account of the housing market crash. Rising interest rates and declining home prices resulted in defaults. In fact, many borrowers were unable to pay the taxes imposed by the Federal and the State government and became an easy target for tax lien foreclosures. As of 2014, seven years down the road, the real estate market in USA has seen a slow revival, with prices rising steadily and median home prices appreciating by US$30,000 to US$200,000. This fresh spike in equity value has helped many people refinance their homes.

What is a Short Sale?
A short sale, in the context of real estate, refers to selling off a house at a price, which is insufficient to meet the mortgage payments still owed on the house. In this case, lenders may be willing to accept the proceeds of the sale, as settlement for the money due and forgive the remaining amount that cannot be requited. The reason why a lender may be willing to accept a lower payment, than what is actually due, is to avoid lengthy and costly foreclosure proceedings.

What is a Foreclosure?
When an owner fails to pay the mortgage installments for a home, over a period of time, he is served a foreclosure notice by the bank or related financial institution. Usually through court proceedings, the property is sold in an open auction to recover the repayment amount. A foreclosure leaves a blot on the credit report of the individual and substantially reduces his credit score, besides inhibiting him from purchasing a new property for at least 5 years in the future.

Short Sales Vs. Foreclosures
Short Sale Foreclosure
Opted for when
Borrower defaults mortgage payments, but the price of the property is less than the loan to be repaid Borrower defaults on mortgage payments
Process is initiated and the house is sold by
Homeowner Lender
Control of the Real Estate is with
Homeowner Lender
Selling Method
Generally sold through a realtor Generally auctioned at a trustee sale
Credit Score Impact
May lead to a loss of 50 - 150 points May lead to a loss of 200 - 400 points
Impact on Credit History
Gets listed on the report if the debt reduction is reported by the lender to concerned agencies Stays on the report for 7 years
Mention in Future Loan Applications
May not necessarily be mentioned in future loan applications Reporting is mandatory in future loan applications
Eligibility for Future Real Estate Purchases
Is immediately eligible to purchase, under certain conditions Becomes eligible to purchase in 5 years with certain restrictions and in 7 years, without any of them
Home Affordable Foreclosure Alternatives (HAFA) Program Eligibility
Yes No

Benefits of a Short Sale Over a Foreclosure
Given that the government is providing assistance to homeowners to stop a foreclosure, short sales seem like a better option. According to Fair Isaac corporation, both foreclosures and short sales have a negative impact on credit scores, which has been quantified in the table presented above. However, short sales are lesser of the two evils and they have a comparatively softer effect on your score.

Compared to the almost seven years of waiting time required to buy a new property after a foreclosure, individuals who opt for a short sale, may go for a newer property almost immediately.

On February 18th, 2009, the Obama Administration announced the Making Home Affordable (MHA) Program. It aims to stabilize the housing market by reducing mortgage payments on both primary and secondary mortgages, to affordable levels, thus preventing avoidable foreclosures. Borrowers, who are unable to retain their homes despite being covered under MHA, may opt for short sales as an alternative to foreclosure.

Under the Home Affordable Foreclosure Alternatives Program, the homeowner may get up to US$3000 as relocation expense after the short sale, besides getting the remainder of his debt waived off. Moreover, the seller does not have to pay taxes on forgiven debt, provided the property that was sold, was his primary residence. For more information about this program, you may call 88-995-HOPE (4673).

Hence, in the current scenario, a short sale is much better than a foreclosure. However both foreclosures and short sales will force the borrower to work at building his damaged credit history. According to Freddie Mac and Fannie Mae guidelines, assuming that the seller intends to buy a home some time again in the future, he would require a minimum FICO score of 680 for loans. FHA-insured loans would require the borrower to have a credit score of 580 for the purpose of getting a mortgage after foreclosure.