Short Sale vs. Foreclosure: Which Is the Better Option?

Should you opt for a short sale or a foreclosure? As a homeowner faced with a difficult situation, there are pros and cons to each. Generally, a short sale will work more in your favor. As a homebuyer, both offer the opportunity to purchase under-market-value properties. Short-sale properties are generally in better condition than foreclosure properties, but both will usually require significant repairs or renovations. How do you choose? Read on for the key differences between short sale versus foreclosure to guide your property sale or new home search.

What Is a Short Sale?

A short sale means the homeowner decides to sell the home for less than they owe on the mortgage loan. Owners in dire financial situations or risk foreclosure may opt for short sales. In a short sale, the lender of the original mortgage gets all of the proceeds of the sale. The lender will then either forgive the difference on the mortgage or require the original borrower to pay what’s left via a deficiency judgment.

For lenders, a short home sale is preferable to a foreclosure sale. It offers the homeowner and the lender a way to recapture capital and clear the debt. However, buying a house on a short sale is not always a good investment as the property might require significant repairs or have other major issues. 

What Is a Foreclosure?

In the case of a foreclosure, the lender enters a legal process attempting to recover the mortgage balance from a borrower who has stopped making payments. In a foreclosure, the lender works to force a sale of the asset used as collateral for the loan. A foreclosure is a last-resort option for both the lender and the homeowner that allows the lender to seize the home. 

A foreclosure doesn’t happen overnight. In most cases, a lender can only proceed with the foreclosure process if the loan is at least 120 days delinquent. Next, the loan is referred to a foreclosure counsel. This varies by state, but generally, a foreclosure attorney files a complaint or a notice of default, depending on the state. The next step is judicial foreclosure and nonjudicial foreclosure before eviction. You can check the Consumer Financial Protection Bureau’s tools to avoid foreclosure. 

As a buyer, purchasing a foreclosed property can lead to significant cost savings but only if you have the resources to perform necessary repairs and renovations. 

Key Differences Between Short Sale and Foreclosure

There are major differences between a short sale and a foreclosure that can affect buyers. Here’s what you need to know:

Ownership

In a short sale, the homeowner voluntarily sells their property for under-market value. They must submit a financial package for the lender’s approval to sell the property for less than the amount they owe. 

In a foreclosure, the bank or lender has taken possession of the property and is selling it as the current owner. For that reason, you may be able to secure a better rate on a foreclosure, but it may also require more significant repairs or renovations. 

Process

The differences in the process for short sales and foreclosures come down to the role of the homeowner in the process. Short sales are voluntary actions by the homeowner but require approval from the lender, which could make reaching an agreement take longer. 

Foreclosures are involuntary for the homeowner. The lender takes control of the property and sells it, often at auction. In that case, as an owner, you’ve lost control. As a buyer, you could close quickly on the property but might not secure the price you expected in an auction setting. 

Impact on Credit

Homeowners who end up in the position of choosing either a short sale or a foreclosure can see a drop in their credit score. Any late or missed payments hurt your score. Your total debt, credit utilization ratio, age of the oldest account, credit mix and total available credit can also affect your credit score.  

Both a short sale and a foreclosure can hurt your scores. You’ll see the biggest impact in the months and years after it appears on your credit reports. Over time, you can rebuild your credit score. Buying a foreclosed or short sale should not affect your credit score more than taking a mortgage or loan for any other home purchase. 

Consequences for Homeowner

The key difference between a short sale and a foreclosure for the homeowner is whether it is voluntary. A short sale is voluntary for the homeowner; a foreclosure is not.  

In addition, short sales don’t damage the homeowner’s credit score as much as foreclosures. But they still leave negative credit marks. Foreclosures stay on credit reports for seven years, while short sales can drop off sooner.

Timeline

The timing between a short sale and foreclosure can differ greatly. A foreclosure is much faster. A short sale can take up to one year to close. Foreclosures move faster because lenders want to recover the money they’re owed quickly. If you want to purchase the property, buying a foreclosure can help you close faster. 

Financial Implications 

Both short sales and foreclosures can lead to negative marks on your credit score and financial loss. A foreclosure will stay on your credit score for seven years, leading to longer-term negative impacts. 

Availability of Housing Options

Homeowners looking to purchase a new home soon after the short sale or foreclosure should aim to complete a short sale. The short sale will have less of a negative impact on your credit score, allowing you to qualify for a mortgage and purchase a new property sooner. After a foreclosure, finding reliable housing options that don’t require a credit check can be more challenging. 

What Do Short Sale and Foreclosure Mean for Homebuyers?

Homebuyers can take advantage of short sales and foreclosures. Here’s how:

How to Buy a Short-Sale Home

Seeking out a short-sale home to purchase can allow you to secure an under-market-value property in a reasonable state of repair. You can find short-sale homes through Realtors and real estate listing sites. The process to purchase a short-sale home is similar to any other home. You’ll submit an offer to the homeowner, and once you agree on the terms, go through the inspection or contingency process. With a short sale, you may need to be more flexible about the inspection or repair requirements. 

Pros of buying a short sale home:

• Possibility to get the property under market value
• The property might not need major renovations

Cons of buying a short sale home:

• The deal could fall through
• The short-sale process could take up to a year

How to Buy a Foreclosed Home

You can find foreclosed homes to buy through listing websites, local Realtors or by contacting banks and mortgage lenders. Some foreclosure homes will go up for auction. In that case, you’ll need to understand the lender’s specific requirements for the auction. In other cases, you can make an offer directly to the lender.

Pros of buying a foreclosed home:

• Faster closing
• Lower price
• Under-market-value investment opportunity

Cons of buying a foreclosed home:

• Lack of access to see or inspect the home before buying
• Possible major repairs required
• A competitive market or possible bidding war
• More cash may be needed for repairs

When to Choose Short Sale vs. Foreclosure

Should you choose a short sale or a foreclosure? If you have a choice as a homeowner, a short sale is the better option for your long-term financial opportunities. It gives you a better chance of rebuilding your credit score quickly and purchasing a new home. As a homebuyer, both foreclosures and short sales offer good financial opportunities. Which is better depends on your timeline and goals. Learn more about real estate investing and find a complete guide to buying a foreclosed home here. 

Frequently Asked Questions