The majority of the population purchase their first homes by taking out a mortgage. A mortgage is a loan specifically for buying properties. The person who takes out the loan is the mortgagor and the person or bank lending the money is the mortgagee. Purchasers keep the property as collateral when taking out a mortgage. Individuals buy their dream place using a mortgage and pay off the loan with time.
However, life is unpredictable. Sometimes, people can lose their jobs and fortunes in an instant. When a situation like that happens, the mortgagor loses the ability to make regular mortgage payments. Hence, either mortgagors have to sell the property at a price lesser than the amount it cost or the mortgagees will forcefully seize the property. Selling one's property at a lesser price to pay off the mortgage is a short sale. The forceful seizing of properties by the lender because of failure to make payments is foreclosure.
This article focuses on the processes involved in both short sales and foreclosures. It also explores the differences between the two procedures.
Short Sale vs Foreclosure
Short sale and foreclosure are procedures involved in mortgage repayments. In the event, a mortgage payer cannot make their payments anymore; they can request permission from lenders for conducting a short sale. In a short sale, the mortgagors sell their properties at a price lower than the mortgage amount. The mortgagors are responsible for repaying the remaining loan amount to the lenders. In a short sale, the mortgagors take voluntary action to sell the property and pay back the loans. The entire process might take several months to complete. A short sale leaves individuals with negative credit scores but it does not cause damaging effects on their credit report. The people can request another mortgage loan after 2 years.
In foreclosures, the mortgagees realize their borrowers are not making payments on the loan. They send out notifications and provide advice on different methods to pay back the money. When the mortgagors do not pay back the amount, the lenders take the case to court. Through legal proceedings, the mortgagors gain control of the property. They then sell the property as soon as they can before the property loses its value. All money generated through the sale of foreclosed property goes to paying off the loan. In foreclosure, the homeowners do not take voluntary action to sell. The homeowners involuntarily give up ownership of their property. The entire process for foreclosures takes several months and it is a longer process than short sales. A foreclosure has a damaging effect on an individual’s credit score. People will not be able to request another mortgage loan for 7 years.
Difference Between Short Sale and Foreclosure in Tabular Form
| Parameters of Comparison | Short Sale | Foreclosure |
| Meaning | When house owners sell their property at prices less than the one for which they bought the property. | When the lenders seize the property when house owners consistently fail to pay the mortgage |
| Use | When property owners fail to make mortgage payments and the value of the house is less than the debtor owes | When property owners fail to make a mortgage payment |
| Effect on credit score | The credit score of the individual will be affected but to a lesser extent | The credit score of the individual will be severely affected |
| Application for a new mortgage | Individuals can apply for a new mortgage 2 years after a short sale | Individuals can apply for a new mortgage only 5 years after a foreclosure |
| Who initiates the process | The property owner initiates the process after receiving permission from the lender | The lender initiates the process |
| Action of mortgagors | Voluntary | Involuntary |
| Money received from the sale | The mortgagors sell the property at a price lower than the mortgage amount and all the money goes to the mortgagees. | All money received from the sale of the property goes to the mortgagees |
| Time required for the process | Short sales require a shorter duration than foreclosures. However, they may still take several months. | Foreclosures require comparatively more time to complete the entire process |
What is a Short Sale?
Just as the name suggests, a "short sale" is a situation when mortgagors have to sell their properties at a price lower than the cost of the property. A few years after the mortgagors buy their property, it begins to lose its value in the market. Hence, the selling price will be lower than what the current owners initially paid.
Mortgagors engage in a short sale when they are not able to pay off their mortgage. The owners might have had a recent job loss, which left them unable to make their regular payments. Therefore, with the permission of the lender, they sell the property to pay off the mortgage. The lenders are usually banks. The mortgagors require the permission of the mortgagees before making a short sale because the mortgagors are selling the property at prices less than the mortgage amount. Hence, they need documentation that the mortgagors will pay back the remaining mortgage amount. The mortgagee also requires documentation from the mortgagors as to why they are not able to pay back the loan and needs to sell the property.
In the short sale process, the price at which one sells the property will always be less than the mortgage owed. The mortgagors are responsible for paying off the remaining amount to the creditors. The remaining amount that mortgagors need to pay off is “deficiency”. Often, the mortgagees have two choices in terms of deficiency. They can choose to forgive the remaining amount and close the entire case. Otherwise, mortgagees can choose to go to court and try to claim the remaining amount. The court ruling, which makes the mortgagor pay back the deficiency amount, is a "deficiency judgment".
Reasons For Refusing A Short Sale
Sometimes a mortgagee may refuse homeowners' request for a short sale. This refusal happens in the following circumstances,
- Mortgagees refuse requests for a short sale when the mortgagors have not defaulted on payments. That is, they are still making regular mortgage payments.
- If the mortgagees can recover the entire remaining amount by foreclosing the property, they will refuse the mortgagor's request for a short sale.
- If the mortgagor had a co-signer at the time of taking out the loan and that person is capable of making the required payments, the mortgagees will refuse the request for a short sale.
Effect On Credit Rating
A person’s credit rating determines their likeliness of paying back loans. Short sales do not have a damaging effect on the mortgagors’ credit rating. However, short sales do leave negative credit marks on the mortgagors’ credit reports. They may cause certain restrictions for individuals to take out another loan, but they do not stop it. Mortgagors can take out another mortgage loan within 2 years.
Pros Of A Short Sale
- Going through with a short sale, helps owners to avoid the negative effects of foreclosure.
- A short sale helps to reduce the debt amount of mortgagors.
- Short sales are a comparatively fast process of selling properties.
- Selling the property off through short sales can help relieve the owners of their financial burdens.
- A short sale can sometimes have potential tax benefits.
- Short sales have a less damaging effect on a mortgagor's credit score.
Cons Of A Short Sale
- Even though short sales do not have a damaging effect on an individual’s credit score, they still have a negative impact.
- The entire process can take up to several months to complete.
- Sometimes, the lenders may not approve a short sale.
- In a short sale, mortgagors sell properties for a lesser value than their original cost.
- Even though the mortgagees may sometimes forgive the deficiency amount this is not always the case. Sometimes, they may take a homeowner to court and get a deficiency judgement ruling.
- In a short sale, the mortgagor is responsible for paying all the legal and other associated costs.
What is Foreclosure?
People take out mortgages to buy properties and put the property as collateral. In the event a mortgagor is not able to pay off his mortgage amount, the lender can seize the property and sell it themselves. This situation is foreclosure. Since mortgagors put up the property as collateral, their right of ownership to the property will be lost. This way the mortgagees gain the right to sell the property themselves.
Mortgagees cannot simply go ahead and sell a property when a mortgagor does not pay off his loan. The process of foreclosure is a legal process. Mortgagees have to file a civil lawsuit to terminate the mortgagors’ right to the property. After mortgagees file the lawsuit, the court gives the mortgagors one chance to claim the property. The court gives a period by which he should make the mortgage payment. If the mortgagors fail to make the necessary payments within this period, the mortgagees gain the right to the property. The mortgagees can then sell the property themselves and regain their money.
Process of Foreclosure
Pre-foreclosure Proceedings
When a mortgage payer fails to make repayments several months in a row, the mortgagees start the pre-foreclosure process. The mortgagee issues notifications to the homeowners about making payments. They give homeowners different options to make payments and reach the intended amounts. When all fails and the homeowners are not able to make the payments, mortgagees take the matter to court.
Filing Civil Lawsuit
The mortgagee files a legal civil lawsuit against the mortgagors. The court presides over the case. They give the homeowners a deadline by which to make the necessary payments. If the mortgagors fail to make the mortgage payment, they lose ownership of the property. The mortgagees thus gain control of the property and have the right to sell it to regain their loaned amount.
Eviction And Zombie Foreclosures
After the mortgagees gain ownership of the property, they have the right to evict the current owners to sell the property. Evicting current occupants are a part of foreclosures.
Sometimes, the owners would have left already and only the property remains. In this case, the mortgagees can directly foreclose the property. This type of foreclosure of abandoned properties is “zombie foreclosure”.
Sale
After the occupants leave the property, the mortgagees order an appraisal of the property. When they receive appraised prices, they move forward with the sale of the property. Mortgagees sometimes give foreclosed properties for auction at trustee sales.
How Mortgage Is Paid
When foreclosing the property, three situations can happen. They are,
- The sale of the property generates more money than the mortgage amount, the mortgagees take the required amount to pay off the loan and give the rest to the mortgagor.
- The mortgagees manage to sell the property but the property does not generate enough money to pay off the loan, the mortgage is liable to pay off the remaining amount.
- The mortgagees are not able to find a suitable buyer and sell the property. In this case, the mortgagor is responsible for paying back the entire mortgage amount.
Effect On Credit Rating
Foreclosures tend to have a damaging effect on the mortgagor's credit rating. The incidence of foreclosure will be available on the mortgagors’ credit report for 7 years. Mortgagors can apply for another mortgage loan only after 7 years.
Pros of Foreclosure
- Foreclosures help mortgagees to regain their money.
- Foreclosures help sell vacant properties and thus free up housing inventories.
- Foreclosures increase the number of available properties in an area.
- Foreclosures allow investors to buy the property at lower costs.
- The threat of foreclosures keeps mortgagors from defaulting on payments.
- The availability of foreclosure procedures helps mortgagees to protect their money.
Cons of Foreclosure
- Foreclosures have damaging effects on a mortgagor's credit score.
- Foreclosures force mortgagors to liquidate their assets to pay off debts.
- During the process of foreclosure, the mortgagees evict current residents from their homes. This causes an increase in homelessness.
- Mortgagees have to resell foreclosed properties at low prices.
- Foreclosures can lead to an increase in social problems like crime, poverty, etc.
Main Differences Between Short Sale and Foreclosure (in Points)
- Short sales happen when homeowners sell their property at prices less than the one for which they bought the property. Foreclosures happen when the mortgagees seize the property because the mortgagors defaulted on payments.
- In the case of short sales, the property owners initiate the sale repay debt using the received money. For foreclosures, the mortgagees initiate the sale and regain their money as best as they can.
- When homeowners realise they cannot pay back the loan, they can voluntarily initiate a short sale. Foreclosures are involuntary on the part of the homeowner the lender initiates the process.
- The homeowners who paid back the mortgage through short sales can apply for another loan within two years. In the case of foreclosure, individuals do not receive mortgage loans for seven years.
Conclusion
In conclusion, short sales and foreclosures are processes initiated when a mortgage payer becomes unable to pay the mortgage. In short sales, the mortgagor, after becoming incapable of making regular payments, initiates the process of foreclosure. The mortgagor requests permission from the lender to sell the property and when allowed sells it at a price lesser than the mortgage amount. The mortgagor remains responsible for repaying the remaining amount. In foreclosure, the mortgagee initiates the process after the mortgagor consistently refuses to repay the loan amount. They gain control of the property and sell it as a means of getting their money back.
