When a homeowner falls on difficult financial straits and can no longer make their mortgage payments for a certain period of time, there are two ways for that to go (if the owner can’t recover), short sale or foreclosure.
Foreclosure is usually a long process where the homeowner stops paying altogether and the lender who owns the lien on the property eventually takes possession and likely ends up selling it at auction.
On the other hand, if a homeowner owes more on the home than it’s worth, and can prove a dramatic change in their finances, the lender may allow the homeowner to sell the property for less than the amount owed. This is called a short sale.
Once the house is sold, the lender forgives the remaining balance of the loan and the homeowner moves on with their life, mortgage free.
In a foreclosure, the homeowner is evicted from the property and ownership reverts to the lien holder. These properties are called REO (real-estate owned) or bank owned. The lien holder is now responsible for selling the house, usually at auction, in hopes of recouping the mortgage balance. In a short sale, the homeowner continues to live in the home and works with the bank and a real estate agent until it’s sold.
How foreclosures and short sales impact your credit
The hit your credit report takes is dramatically different between the two types of distressed properties. A foreclosure can cause your credit score to plummet up to 400 points and stays on your report for seven years. Homeowners who are foreclosed on will typically need to wait five years to buy again with restrictions and seven years without restrictions.
A short sale only dings your report for 50 to 150 points. In some cases, the homeowner is eligible to buy again immediately, however, most homeowners who short sale will need to wait three years before buying again. A foreclosure will stay on your record for seven years, like a bankruptcy.
How do foreclosures and short sales work?
A foreclosure may or may not involve the court system depending on what state the homeowner lives in. To see if your foreclosure will require involvement of your state’s court system, check out this website.
After three to six months of missed payments, the lender will file a notice of default. At that time, the homeowner is given a specific period of time, which varies by state, to try and bring the mortgage payments current. If the past-due balance is not paid off, the lender will proceed with the foreclosure and send the homeowner a notice of sale.
From there, the home is sold at auction to the highest bidder. Bidding usually starts at the amount of the defaulted loan plus attorney fees.
The short sale process is much different. When a homeowner is underwater, meaning they owe more on their home than it’s worth, and are having difficulty making their monthly mortgage payment, they should pursue a short sale with their lender.
A short sale, by definition, is when the sale price of the home fails to meet to total amount of the loan. In some cases, lenders agree to forgive the remaining loan balance, but that depends on how the short sale was negotiated with the lender. Once the lender has agreed to work with the homeowner to short sell the home, the homeowner is responsible for finding a real estate agent and selling the home quickly.
When an offer is made on the home, the homeowner must first accept the offer and then submit the offer to the lender for its acceptance. If the homeowner’s mortgage has been sold by the original lender, it may now be owned by multiple lenders and they must all approve the short sale individually. This process can take three to six months, depending on the backlog the lenders are processing. Once the offer is accepted by the bank, the process works much like a typical real estate transaction.
Foreclosure and short sale problems for buyers
Buyers looking for a good deal on real estate should cautiously weigh the idea of buying a short sale or foreclosure property. Short sales typically sell for at least 10 percent below market value and foreclosure can sell for up to 30 percent below market value.
The biggest reason for these steep discounts is that the properties are usually sold ‘as is,’ meaning the seller won’t conduct any repairs or improvements to the property.
With foreclosed homes at auction, the winning bidder must typically pay cash within 24 hours of winning the bid.
Short sales on the other hand can be very time consuming. It’s a waiting game while the lender decides whether or not to accept your offer. This process can take up to six months if the lender has a backlog of short sales it’s dealing with.
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