When discussing the sale of distressed properties, many homeowners and property investors—particularly “house flippers” who as a matter of practice target homes being sold below market rates—use the terms “short sale” and “foreclosure” interchangeably. What they don’t recognize is that there’s a difference between the two. So, what is a short sale, and how does it differ from a foreclosure?
Short Sale vs. Foreclosure
Simply put, a short sale is the sale of a property where the final sales price falls short of completely paying off the amount owed. This can happen for many reasons. The most common reason for a short sale is a homeowner who is “upside down” on the home. This means that the owner owes more on the home than they can recover in a standard sale. The short sale has some similarities with a foreclosure, but it has many important differences.
A foreclosure is a legal process in which a homeowner has stopped making payments on a property and the lender forces the sale of the property to recover the balance owed. A foreclosure typically involves a uncooperative homeowner, and in the event the lender does not recover all the money owed through foreclosure, they sometimes pursue additional action against the borrower to recover the remainder due.
In a short sale, the homeowner attempts to cooperate with the lender to avoid foreclosure and maintain good credit, as foreclosure typically results in significant damage to a borrower’s credit history. If they cooperate and have their short sale request approved by the lender, there is a chance the lender will forgive any remainder owed after the sale. This will also have a reduced impact on the homeowner’s credit.
Why doesn’t everyone just do a short sale?
In order to qualify for a short sale, a homeowner must submit a hardship letter detailing a legitimate for why they cannot make their payments. Legitimate reasons can include things such as the death of a spouse, medical hardship, job loss, and the like. There is no guarantee that the lender will grant the short sale, and there is no requirement for them to do so.
The general public often believes that simply being upside down on a property is enough of a hardship to qualify for the short sale, but that is entirely incorrect.
No matter the reason for being late on mortgage payments, it is important to be proactive in your communication with the lender. It may seem shocking, but it is not uncommon for a lender to not respond to warnings of pending late payments or non-payments until a certain number of installments have been missed or a certain amount of time has passed. This is because there are many homeowners that are late on payments and find a way to catch up or make good on the amount due. Don’t worry, they did not forget about your mortgage and the money owed! They are just giving you a chance to catch up.
However, this also means that if there is a larger financial issue where you believe that you won’t be able to catch up, don’t just tell them that you might be late with a payment. You need to inform your lender in detail as to what is going on, so that you can try to negotiate an exit plan and minimize the potential damage to your credit.