Short sales and foreclosures used to be almost unheard of for most Americans, but the past years have made both of these scenarios so common that most people at least know someone who has been through one of these situations. If you haven't been involved with a short sale or a foreclosure personally, it can be difficult to know how they are different from each other.
Both a short sale and a foreclosure start when a homeowner with a mortgage falls behind on their loan payments. After the first payment becomes more than thirty days late, the bank will send a formal notice to the homeowner that the mortgage is in danger of foreclosure.
At this point, a homeowner can try to negotiate with the bank. If the homeowner owes less on the mortgage than the home is worth, it may be possible to refinance the mortgage in order to get the homeowner a payment that they can afford. It's also possible to sell the home and use the profit for a new residence.
In the event that the home is worth less than the amount of the mortgage owed, however, the options available become a lot more limited. If the home is sold, the homeowner will still owe a lot of money to the bank, which they more than likely do not have the funds to pay back. In some cases like this, the bank will agree to allow the homeowner to try a short sale. Essentially, this allows the homeowner to sell the home to another entity, and the bank accepts this payment in lieu of the total amount owed on the mortgage.
The advantage to the bank under this scenario is that the property does not fall into disrepair as is typically the cases during a foreclosure. Short sales also keep the property from having to go through all the legal motions of a foreclosure. In fact, most banks will require homeowners to agree to certain basic maintenance items while the house is going through the short sale process. The homeowner gets a better timetable of the eviction process in exchange for maintaining the property and making it available for showings. This makes it much easier to plan and find a new place to move to. After the home is purchased, the homeowner's credit report will show that the mortgage was closed through the short sale process, sometimes referred to as a “deed in lieu”. This notation on the credit report does not affect a credit score nearly as much as a foreclosure.
If the bank does not agree to a short sale, then the home will most likely go into foreclosure if the homeowner doesn't make payments. A foreclosure will have to go through the court system, and can take anywhere from a few months to several years depending on local laws. At the end of the process, the former homeowner will have a much lower credit score.
