Difference Between Short Sale and Foreclosure

Short Sale vs Foreclosure

Short sale and foreclosure are two dreaded words that any home owner would never like to hear. Neither does any lender wish to make use of any of these instruments. But the use of these or either of the two becomes necessary when a home owner defaults on payments of EMI to the bank from which he has taken a home loan. As banks have the documents of the property as collateral with them, they can invoke either of these two instruments to safeguard their capital that they had loaned and the interest that has accrued. Banks are not in the business of selling properties and they are more interested in getting back the money they lent. But if the circumstances are such that they feel the homeowner may not be able to pay back their money, they resort to these options.

Short Sale

Short sale is a procedure that allows a home owner to sell his property (when he is in a financial mess and unable to pay money to the bank) and avoid the foreclosure. The home owner sells the house for an amount which is less than his outstanding loan amount and pays the lender. The lender agrees to forget the remaining loan and accepts the sale proceeds as final payment. The reason why it is called a short sale is because the proceeds of the sale fall short of the outstanding loan amount. A short sale can only go ahead if the bank is prepared to accept the amount and forget about the deficiency.

For example, if the outstanding loan amount is $200000 and the short sale proceeds are $175000, the bank can choose to accept this amount as final payment and then the homeowner can sell his house.

If the bank thinks that the property cannot fetch more than this, or if people in the area are going for new homes, or if the property value has depreciated, it can accept short sale.

Foreclosure

When a home owner has defaulted in his payments and the bank feels that he is unable to repay the money owed to the bank, it can resort to a foreclosure. This is a legal proceeding in which the bank retains the right to sell the house and get back its dues from the sale. If the house sells for more than the amount due to the bank, the difference is paid back to the borrower. In a foreclosure, the borrower not only loses his home, but also suffers a jolt as far as his credit worthiness is concerned and there is a decrease of at least 200-300 points in his credit score. This means that he cannot apply for a new loan in the near future. This is the reason why every homeowner tries to avoid foreclosure at any cost and tries to negotiate with the bank to modify the terms of loan so as to make it easier for him to repay the loan.

Difference between short sale and foreclosure

In a way, both short sale and foreclosure are tools to help the borrower to somehow fulfil his financial obligations when he is financially broke and cannot repay the bank. But there are many differences between the two which are as follows.

If the bank agrees for a short sale, it is a real bargain for any homeowner who is already in distress. But in reality it is difficult to find a buyer even for this short amount. Most buyers take time to decide and are not willing to pay the asking price which makes it real difficult for the home owner. In the case of foreclosure, the bank takes the responsibility to sell the house and allows the home owner to stay for a period of 4-12 months in the house during the proceedings. During this period, the homeowner does not have to pay any money to the bank which is in effect a saving, which he can use for transfer when he has to vacate the house.

In both the short sale as well as foreclosure, there is a drastic decrease in the credit score of the home owner. However, while in the case of short sale, the home owner can buy a property after 2 years, he cannot make a move for next 5-6 years if he has gone under foreclosure.