Foreclosure vs Short Sale: What’s the Difference?

Most experts agree that real estate is one of the safest investments you can make.

Not only can you earn passive income from rental properties, but it’s also a safe way to make a long-term investment. But, buying real estate takes more than researching CMAs.

The type of property you buy is important, too. For instance, many investors prefer buying short sale or foreclosed homes.

Knowing the difference between foreclosure vs short sale is important if you’re getting into the real estate game. If you haven’t considered these types of properties yet, we’re here to help.

In this guide, we discuss the differences so you can make the most informed decision for your financial future.

What You Already Know

More than 65% of American homeowners have a mortgage. This means that they put some cash down on their home and financed the rest. The most common mortgage terms are for 15 or 30 years.

This means it will take the homeowner 15 or 30 years to own their home free and clear. Now, there are exceptions, like paying the loan off early or selling it before then. Some people refinance their loans, which can alter the maturity date.

Every month a homeowner pays money towards the interest, principal, and in many cases, into an escrow account. But there are times when the owner runs into an emergency or falls into extreme financial peril.

If this happens and the homeowner falls behind on their mortgage payments, they have some options. If none of the options help or they don’t qualify, the bank can start the foreclosure process.

What Is a Foreclosure?

A foreclosure is one of the least favorable options for a homeowner or borrower. This is when, after three to six months of missed payments, the lender steps in to take possession of the home.

This is a legal process and can take a long time.

The lender files a Notice of Default with the court. This is the pre-foreclosure period which can last up to 120 days. The borrower gets notified of the lender’s intention to take possession of the property.

The lender will have a set amount that the borrower can pay to keep the property. Usually, this is back payments, late payments, and added filing and administrative fees. If the borrower can pay the amount, they’re in the clear and can keep their home.

But, if they can’t amend the issue, the lender steps in and takes possession. From there, they sell the house at auction to recoup some of their money.

What Is a Short Sale?

During the pre-foreclosure period, borrowers can try to sell the property. This becomes a short sale home.

Don’t let the name fool you, though. It is not a quick process. The term “short sale” refers to the lender getting “shorted” on what the borrower owes.

In other words, say a mortgage balance is $200,000, but the home is only worth $150,000. In a short sale, the bank would have to agree to accept the $150,000.

Differences Between Foreclosure vs Short Sale

In a foreclosure, the lender recoups their money at an auction. Often, they don’t get the full value of the mortgage.

In a short sale, they don’t either, but there are significant benefits to the bank for agreeing to it.

There’s a lot of paperwork involved in a short sale. The first step is to prove the short sale makes sense for the lender. If it’s approved, the new buyer has to get financing from a third-party lender or pay cash.

If it’s getting financed, the third-party lender has to agree to the exact amount the original bank agreed to in the short sale. That means, there isn’t room for negotiating price.

Then, there are mounds of more paperwork. It can also be a lengthy process. Some short sales can take up to a year to process.

In both cases, the original borrower will lose their home. But in a short sale, it’s a softer blow to their credit score. In a foreclosure, your credit gets hit harder, and you will have financial repercussions, but it’s often more convenient.

But About Buying These Kinds of Properties?

If you’re looking to invest in these kinds of properties, the first thing you need to do is reach out to a professional. There are lenders, real estate agents, and lawyers that specialize in short sales.

You already know it’s an arduous process. Hiring professionals that understand the ins and outs of laws and guidelines will make the transaction go smoother.

Now, you also know that in a short sale, you have to get approved for financing first. You can’t find the home, negotiate a price, then find a lender based on the final sales price.

But the good news is that you can finance a short sale home pretty easily. With a foreclosure, it can be more difficult.

When you’re considering buying a foreclosure vs short sale, there is another thing to consider: The state of the property.

With short sale homes, the original borrower/homeowner has taken some steps to salvage their credit and financial future. At least, they do this as much as they can.

In a foreclosed property, the borrower has, in essence, just let it go. Often, these homes are in disarray and need a lot of work.

You may come across a short sale that is also distressed. But in most cases, the owner/borrower lives in the home until the sale goes through. This reduces the likelihood that it’s in complete disrepair.

You may want to do some updating or renovations, but for the most part, the home is in working order.

If you buy a foreclosed home, prepare for the worst. You’ll pay less than if the home is a short sale but you’ll make that up in remodels and renovations. Sometimes, you can spend thousands just to get the plumbing to work again.

Foreclosure vs Short Sale: Knowledge Is Key

When you’re considering you’re foreclosure vs short sale options, the key is knowing what you’re getting into.

Research all your options, know the timeframe involved in the process, and hire professionals.

If you’re still not sure if investing in these kinds of properties is best for you, check out our blog. We have more helpful tips on investing in short sale properties.