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Foreclosure vs Short Sale - What You Need To Know

Updated on October 29, 2009

What You Need To Know?

Foreclosure is the result of a borrower's inability to return the debt amount to the lender. The bank 'repossesses' the property whereas in short sale, the house is auctioned to raise the debt amount and pay the lender.

While the homeowner loses the house in both cases, short sale is still a preferred option from the two.

This hub gives a comparison between the two to help the homeowner distinguish between the pros and cons of foreclosure and short sale.

Foreclosure

Suppose you mortgaged a house in lieu of loan and after some time, you forget to repay the installments in time. Therefore, what the lender does is sell the property. Since this is a legal procedure, which involves large amount of money, the return from selling the property gets utilized by the lender to pay off the debts incurred. The whole process is called ‘the lender has foreclosed its mortgage’.

There are two types of foreclosure available: foreclosure by judicial sale and foreclosure by power of sale. These days, the clause of ‘acceleration’ finds mention in the deed, which gives an opportunity to the borrower to clear the remaining debts. If the borrower is unsuccessful, the mortgage goes for foreclosure.

Borrowers can avoid foreclosure through alternate financing, re-financing or even bankruptcy. On the other hand, the debtor may claim for equitability from court to stop foreclosure. The court gives permission for this if the debtor is able to make a bond upto the amount owed. This step is taken to protect the interests of the lender. There have been cases when the debtor has challenged the amount of debt but such cases are an exception. Generally, there is enough paperwork to prove the debt.

Short Sale

This comes under the category of real estate. In this, the homeowner can sell the mortgaged property in an auction provided the lender agrees to such transaction. The proceedings from the sale go in clearing the debt to the lender. Sometimes, the bank or the lender may agree to discount some amount but there is no guarantee for such benefit. This arrangement gets preference most of the time as foreclosure can be avoided. In business dealings, short sales are the desired option.

However, there are other departments, which may prevent short sale such as HELCO lenders, tax lien holders, mechanic’s lien holders, and HOA. If there is mortgage insurance loan, then the insurer also becomes a party to this transaction and the insurer may oppose it as the insurer needs to ‘pay’ a part of the claim to ‘offset’ the lender’s loss resulting from short sale. Thus, we see, short sale is more complex than foreclosure process as it needs to undergo several approvals and parameters.

For this reason, short sales have higher failure rates than successes. Since it is difficult to get full knowledge of the process and glitches, the homeowner needs to hire specialists like mitigation specialist, short sale specialists, or real estate lawyers for complete smooth working of formalities.

Which Is The Better Option For Homeowners?

When the question is to save a home, one needs to tread the path carefully. At the outset, let me say that foreclosure should be avoided at all cost. It leaves an indelible and negative credit report drowning you for years to come. Apart from this, the lender may ask for a judgement against you to pay for the foreclosure costs. You lose home and you lose more money!

In contrast, short sale is the next best option. Not only you pay less than the amount owed but also the expense incurred on this is much lesser. The biggest hurdle is to get the lenders and the allied services to agree on this arrangement. Most of the time, they do not!

Another disadvantage of short sale is its negative impact on ‘credit score’. You lose around 200 points but unlike foreclosures, this effect can be overcome by keeping at least one credit card active for some time.

The last tip - Make sure you pay debts in time. If so happens that you find paying installments difficult, do not wait for nature to take its course. The more you delay; chances are that foreclosure will remain the only option, sadly. Take hold of the situation and contact a professional right away to avoid foreclosure through short sale.

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    • seanwilder profile image

      seanwilder 

      9 years ago from Enfield, CT

      You may be interested in this awesome short sale management system that I have been using. Even if you already have something, I bet this will blow it away. Check it out at http://www.managemyshortsale.net

      And great post.

    • RealEstateJoe profile image

      RealEstateJoe 

      9 years ago

      Thanks for the straightforward definitions. These sales ahve been fueling about 50% of all transactions in most markets right now and will be instrumental in stopping price declines and turning around the market. It would be nice if the lending institutions would come on board and make the process easier and more streamlined. It is in their best interest as well!

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