A short sale is a real estate transaction in which a home is sold for less than the amount of the outstanding mortgage on the home.
Imagine, for instance, that Mr. and Mrs. Smith borrowed $400,000 seven years ago in order to buy a house. When the house was purchased, it was appraised at $400,000 and the purchase price was based on that figure. As a result of Mr. Smith losing his job, the couple’s mortgage payments are falling behind, and the couple is in debt. Based on the findings of a comparative market analysis, the Smiths learn that the value of their home has declined, and that it is now only worth $310,000 compared to its previous value of $400,000.
The Smiths are short of $385,000 on their loan, so instead of looking into government refinancing options like the Federal Affordable Refinancing Program, and asking the lender for permission to sell it for $310,000, they prefer to sell their home for $310,000. It is likely that the Smiths will not get the full amount they borrowed from the bank when the house is sold; in most instances, however, the bank will receive less.
The transaction benefits both the bank and the seller, since the bank will be able to avoid the costly and time-consuming foreclosure repossession process, while the seller will be able to avoid the negative credit ramifications of foreclosure (and the bankruptcy that may accompany it in some cases)
Short sales and foreclosures are both financing options available to homeowners in trouble who are behind on their mortgage payments, have a home that is under water (i.e., their mortgage balance is less than the outstanding balance on their mortgage), or both of these things. As a result of the owner being forced to separate from the home in both cases, the timeline and other consequences of the separation are different for each case.
It is important to keep in mind that there are different reasons why a homeowner would choose a short sale instead of a foreclosure.
When a home’s value drops by 20% or more, a short sale is usually initiated by the owner of the home. Prior to the short sale process being started, the lender who owns the mortgage must sign the decision to execute a short sale before the transaction can begin. Furthermore, the lender, usually a bank, needs documents explaining the rationale behind a short sale; after all, the lending institution could lose a lot of money if a short sale goes through.
In the event that a short sale is approved, the buyer will negotiate with the owner and then seek approval from the bank for the purchase once the owner has agreed to the sale. A short sale cannot be completed without the approval of the lender, which should be kept in mind when considering the short sale process.
When it comes to short sales, it can take a long time to process them and there is a lot of paperwork to be filled out, sometimes taking up to a year to complete the short sale process. The result is that short sales do not have the same effect on a homeowner’s credit rating as foreclosures do.
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In the long run, a short sale will look better to future lenders and creditors due to the fact that it shows that you took action before the bank had to repossess your property. It is even possible for a homeowner who has been through a short sale to even be eligible, with certain restrictions, to buy another home right away.
A foreclosure is the process by which the lender seizes a home after the borrower defaults on the payments due to non-payment of the mortgage. Due to the fact that the house is being used as collateral on the note, this is the last option for the lender. Contrary to short sales, foreclosures are initiated solely by the lenders themselves, in contrast to short sales. There is a tendency for lenders to take action against delinquent borrowers by forcing them to sell their homes in the hope that they will be able to recover their initial investment in the loan. In addition, unlike most short sales, many foreclosures are the result of an abandoned home, rather than a short sale. As part of the foreclosure process, if the occupants have not yet moved out of the property, the lender will evict them.
When the lender has access to the home, he/she will order their own appraisal and proceed with the process of trying to sell it. It is usually not as long for a foreclosure to be completed as a short sale, because the lender is more concerned with liquidating the asset as quickly as possible. There is an option of auctioning off a foreclosed home in a “trustee sale,” which is a public auction of the home in which buyers bid on the home.
As a rule of thumb, homeowners who experience foreclosure must wait a minimum period of five years before they can purchase another home, or three years if they apply for an FHA loan. Foreclosures remain on a person’s credit report for seven years after they have been sold. Barry Paperno, manager of consumer operations at Fair Isaac, says that your FICO score will fall by more than 100 points as a result of foreclosure (it will also drop after a short sale, probably because you’re in default on your mortgage). Taking out a mortgage is the first step. Even though this amount may seem like a relatively small amount for a default on a major asset, it is enough to cause credit card companies to think about raising their interest rates or decreasing their credit limits as a result of the default.
State-by-state, the short sale process varies from state to state, but there are generally a few steps involved:
The process of buying a short sale property is somewhat similar to that of buying a traditional property in some ways. However, there are a couple of ways in which the purchase agreement that you and your real estate agent prepare differ from each other. There will be a clause in the contract that specifies that the terms of the contract are subject to the approval of the mortgage lender. The seller would be the only party that would need to approve the sale in a normal transaction.
There should also be a statement on the contract that the property is being purchased “as is.” It is acceptable to include language that allows you to back out if a thorough inspection reveals significant problems with the property, but you shouldn’t expect that you will be able to negotiate a lower price because of these problems. As the bank is unlikely to make any repairs to the property, and as the seller was forced to pay cash for the property, he is likely to be less able to assist. It may also be necessary for you to have enough money for closing costs as well, depending on the situation. In Understanding the Escrow Process, you can learn more about how the closing process works.
In a short sale, the lender does not own the property, which is different from a foreclosure. However, because you must approve the sale. As a result, it will appear as if you are buying the property from the bank because you will receive the proceeds from the sale (based on the property).
Whenever a short sale is performed, there are benefits for all parties involved: Lenders avoid the long and costly foreclosure process; borrowers keep foreclosures off their credit reports; and buyers can purchase properties at a reduced price. Even if it is a short sale, a buyer shouldn’t assume the property is a great deal just because it is a short sale, however. Make sure that you conduct your own comparative market analysis.
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