Short Sales Vs. Foreclosures: A Guide To The Differences

If you’re in a financial crisis and can’t make your mortgage payments, you may be staring at two possibilities: a short sale or a foreclosure. While you’ll permanently vacate your home with either option, the main distinction between them is that one is technically voluntary while the other isn’t.

Homeowners in this position can benefit from understanding the central differences between a short sale and a foreclosure.

What Is A Short Sale Vs. A Foreclosure?

A key distinction between a short sale in real estate versus a foreclosure is who initiates the proceeding.

• Short sale: The homeowner initiates the short sale process. It happens when a homeowner falls behind on their monthly mortgage payments, and their home is underwater, which means it’s worth less than the remaining mortgage balance. To avoid foreclosure, their lender agrees to let them sell the property for less than the loan balance.
• Foreclosure: The lender initiates the foreclosure process. This happens when a homeowner misses mortgage payments and can’t catch up on the missed payments during the reinstatement period, forcing the lender to repossess the property and sell it to recover as much of their investment as possible.

While both processes ultimately result in the borrower losing their home, significant credit score damage and likely debt issues in the future, the mechanics of each process and its impact level differ.

Short Sale Vs. Foreclosure: At A Glance

Both short sales and foreclosures can relieve your financial burdens, but their processes and long-term consequences differ significantly. Use our table to compare the two.

How Real Estate Short Sales Work

Real estate short sales frequently present a more favorable option than foreclosures. Short sales mitigate additional fees and costs for the lender and borrower, are typically less damaging to your credit score and may allow you to buy a new home sooner than if you went through a foreclosure.

Below are some key ways a short sale differs from a foreclosure.

1. Servicer Approval Is Required

With a short sale, you move forward with a somewhat traditional sale and work with a real estate agent. Before a homeowner can finalize the short sale, they must get approval from their lender. To secure approval, a homeowner submits a hardship letter with documentation that proves financial hardship. Some lenders may also require an offer from a potential buyer with the application.

The homeowner needs the lender’s approval because the lender must agree to accept receiving less money than the entire amount owed. In exchange, the lender will release the mortgage lien on the property.

2. You May Be Eligible For Relocation Assistance

Instead of homeowners receiving the sale proceeds from the short sale, lenders use the money to settle as much of the mortgage debt as possible.

However, you may be eligible to receive relocation assistance funded by a government program, or your lender may offer a cash incentive. With relocation assistance, you and your lender can avoid high foreclosure-related costs, and you’ll receive financial assistance to transition to a new place.

Short sale incentive program opportunities include:

• Fannie Mae and Freddie Mac short sales
• Private investor and bank short sales
• Federal Housing Administration (FHA) short sales
• Department of Veterans Affairs (VA) short sales

3. Future Homeownership Is Relatively Achievable

If a borrower’s mortgage payments were never more than 30 days late, and the lender doesn’t require them to make up the difference between the home sales price and loan amount after the short sale is complete, the borrower may be able to purchase a new home relatively soon.

However, this sort of turnaround isn’t guaranteed. A short sale stays on your credit report for 7 years. Finding a new lender and securing a new home loan right away can be challenging with certain loan types. Depending on your situation, there may be no waiting period for an FHA loan, but you may need to wait 4 years before applying for a conventional loan.

How Foreclosures Work

Foreclosure should be the last resort for any homeowner. Triggered by unresolved debt with your lender, this legal process can severely hurt your chances of getting another home in the near future.

The preforeclosure period typically lasts 120 days after you receive a notice of default.

1. The Lender Takes Control And Ownership

Because a borrower has missed multiple mortgage payments, the lender has the right to take ownership of the property. The lender controls the selling process to recoup the amount they’re owed.

2. An Eviction Process Takes Place

A borrower can usually live in the home until the foreclosure process is complete. However, depending on state law and your situation, a lender may be able to evict a homeowner before finalizing the foreclosure process.

Once the lender or bank sends a notice of loan default, the homeowner must correct the default by a specified deadline. Otherwise, foreclosure proceedings will follow, and they’ll receive an eviction notice from the lender that requires them to vacate the property by a specific deadline.

3. A Cash For Keys Deal May Be Offered As An Incentive To Vacate

Lenders or banks commonly offer cash for keys agreements as an incentive for tenants to voluntarily vacate a property. The agreement can expedite the eviction process or facilitate a smoother foreclosure process.

To receive the cash incentive – which can range from a few hundred to a few thousand dollars – homeowners agree to move out by a specified date and leave the property damage-free and in good condition. They can use the cash to cover the costs of relocating.

You’re more likely to receive this offer if the property becomes real estate owned (REO) at the foreclosure sale because no one bought it. You can also negotiate a cash for keys deal as an alternative to an eviction to receive financial assistance for your relocation.

4. It May Take Time Before You're Eligible For Another Mortgage

After foreclosure, you may wait as long as 7 years before you’re eligible to purchase a new home. The wait to buy a new home can vary by loan type. It could be as short as 1 year, depending on the loan and any extenuating circumstances from the foreclosure.

If you submit a mortgage application with a foreclosure on your credit report, a lender is more likely to approve the loan if you check the following boxes:

• Your credit score has improved.
• You saved for a larger down payment and emergencies.
• You reestablished your income, and it’s steady income.
• You can prove a one-time event caused the foreclosure.

How Short Sales Vs. Foreclosures Work For Buyers

Buyers interested in purchasing a short sale or foreclosure may discover a worthwhile bargain. A buyer can typically treat a short sale as a traditional sale – except there’s a longer timeline to close on the property. While a buyer can likely find a bargain with a foreclosed home, buying a foreclosed home may be an expensive investment if the property requires major repairs.

One of the main differences between buying a short sale and a foreclosure is the home inspection contingency. You can request an inspection on a short sale and back out if the necessary repairs are significant, but foreclosed properties at an auction are typically purchased as is.

However, properties that aren’t sold at auction become real estate owned (REO) properties. You can order an inspection on an REO property before purchasing so you know what you’re dealing with.

Foreclosure Vs. Short Sale FAQs

Find answers to frequently asked questions about foreclosures and short sales in real estate.

How can I avoid a short sale or foreclosure?

Be proactive. Take action before financial hardship spirals out of control. Homeowners in preforeclosure can try to lower their mortgage payment by requesting forbearance. If you speak to your lender early enough, you may even be able to apply for a loan modification or refinance.

If you’re struggling to keep up with your mortgage payments and receive a notice of default, talk to your lender as soon as possible to discuss your options to avoid foreclosure.

Do short sales and foreclosures affect my credit?

A short sale can drop a borrower’s credit score by 50 – 150 points. With foreclosure, a borrower’s credit score can plummet by 100 points or more. Because short sales and foreclosures can stay on a credit report for 7 years, their consequences can range from hurting your chances of qualifying for a new mortgage to employers denying you a job.

Are there tax implications from a short sale or foreclosure?

Tax laws may require you to report losses from a short sale or foreclosure. If your mortgage lender forgives or cancels part of your mortgage debt, you may owe federal taxes because the IRS classifies relief as taxable income.

The Bottom Line

While no new homeowner imagines losing their home through a short sale or foreclosure, life can throw unexpected challenges and financial hardships at you. If you qualify for a short sale and your lender agrees to it, you can avoid the severe credit damage associated with foreclosure. Going through a short sale rather than a foreclosure may also improve your chances of owning another home sooner.

What’s important is to finally free yourself from mortgage debt by pursuing a path that helps you recover financially.

If you’re struggling to pay your mortgage and want to avoid a short sale or foreclosure, start a refinance application and take the next step toward financial relief.