Short Sale vs. Foreclosure: What You Need to Know

How do you define short sale vs. foreclosure? What’s the difference between short sale and foreclosure? Here’s what you need to know.

You own a home, and you’ve fallen behind on your mortgage payments.

Perhaps you lost your job. Maybe you racked up too much credit card debt. Or, you might be stuck with a pile of unpaid medical bills.

Any of these situations that happen to millions of Americans can cause fear and confusion about what to do with your house. The whole thing feels pretty overwhelming.

Two common but not-so-appealing scenarios for getting out of a jam like this are foreclosure and short sale. For some homeowners, these could be two of only a few potential solutions for coping with a mountain of mortgage debt.

Here’s what you need to know to differentiate short sale vs. foreclosure, with alternatives to both of them.

What is a foreclosure?

There’s no way sugarcoat it. A foreclosure is the harshest way to get out from under mortgage debt.

Foreclosure is a set of proceedings governed by law that allow a mortgage lender to force a transfer of title on a property. In other words, if you haven’t made mortgage payments for a certain period of time (usually at least four months), your lender can take away your property.

By pursuing foreclosure, the mortgage holder takes ownership of your property, kicks you out, and sells your home. In a foreclosure, you end up with none of the money that you invested in the property.

The lender will send you warnings ahead of a foreclosure. This gives you a relatively short window of time to explore alternatives that can head off eviction.

If you run into trouble making mortgage payments, reach out to your lender immediately. You might be able to work out a payment plan to keep your home. The best advice: confront the issue head on, and don’t ignore it.

Check out the federal government’s Making Home Affordable program, state-run housing programs, or nonprofit housing agencies that offer resources for keeping families in their homes. These free public resources aim to prevent foreclosure.

Financial fallout of foreclosure

Aside from the fact that you’ll lose your home, another harmful aspect of foreclosure is that it damages your credit. A foreclosure will appear on your credit report for seven years after the first missed mortgage payment. Your credit score can drop by 100 points or more and stay at that level for at least three years.

On top of all of that, a foreclosure will make it difficult for several years to qualify for another mortgage.

What is a short sale?

A short sale is an alternative to foreclosure. But it’s not necessarily a short process.

Simply put, a short sale lets you sell your home for less than what you owe on the mortgage. It also steers you clear of foreclosure.

For example, let’s say your mortgage balance is $195,000. Either because the local housing market is weak or you just want to relieve your mortgage burden fast, you sell the house for just $175,000 in a short sale. If your lender approves this short sale, you can sell the house at a loss and be done with it. The lender then releases the mortgage lien on your house, and you don’t owe them anything.

By selling your house for an amount that’s “short” of what you owe, you avoid both the foreclosure and the possible damage done to your credit.

Another benefit of a short sale is that your lender most likely prefers this option, too. Lenders tend to prefer short sale vs. foreclosure because a short sale carries less financial risk for them.

Cons to doing a short sale

One drawback of a short sale is that you’ll typically need to hire a licensed real estate agent to handle the deal, and the agent will earn a commission. Furthermore, your house will need to be staged for sale and need to be available for showings.

Keep in mind that some unlicensed scammers prey on people considering short sales, claiming to be able to “process” or “facilitate” a short sale. You also may encounter predators who offer to “negotiate” or “resolve” your mortgage debt. In most case, their true intention is to steal some of your much-needed money.

Another concern with a short sale is what’s known as a deficiency judgment. The amount between the mortgage balance and sale price is called a deficiency. So, in the previous example, the mortgage balance was $195,000 and the sale price was $175,000. In this case, the deficiency is $20,000.

In some states, a lender could file a deficiency judgment against you in court seeking to recover that $20,000. If the lender wins a deficiency judgment, it could garnish your wages or siphon money from your bank account to cover the $20,000 deficiency. If you find yourself in this circumstance, you might be able to negotiate a smaller lump-sum amount ($10,000 versus $20,000, for example) or to work out a payment plan.

To avoid a deficiency dilemma, get the lender to agree in writing to waive the deficiency before you proceed with a short sale. One thing to note: The federal government might treat this forgiven debt as taxable income.

As with a foreclosure, any late payments associated with a short sale can push your credit score down by at least 100 points over the course of several years. The mortgage account will stay on your credit report for seven years, but “short sale” won’t appear on the report. Instead, the report probably will show that the mortgage balance was settled for less than what was owed.

Additionally, those late payments likely will make it harder for several years down the road to qualify for another mortgage.

Alternatives to a Foreclosure or Short Sale

Fortunately, there are alternatives to a foreclosure or short sale. Among the most common options are:

• Working out a payment plan with your lender.
• Modifying the terms of the loan, such as the interest rate or the monthly payments.
• Seeking forbearance. This happens when the lender pauses or decreases your payments for a certain amount of time. Forbearance doesn’t wipe out debt, though.
• Asking for a foreclosure delay (as long as 120 days) so you can sell the house. This is known as a “permanent hardship.”
• Selling your home off market. Working with a company like Sundae allows you to quickly and simply sell the house in “as is” condition.” This means no cleanup, repairs, or showings necessary. You get one fee-free price to maximize proceeds from the sale, which you can use to pay off your mortgage debt.