The Difference Between a Short Sale and a Foreclosure
The primary difference between a short sale and a foreclosure is the major negative impact that a foreclosure will have on your credit versus the minimal impact of a short sale.
If you fall behind on your mortgage, the mortgage lender can foreclose on the property. In states that require a judicial foreclosure, the mortgage lender has to file a foreclosure proceeding in state court, which will appear in the public record/judgments sections of your credit report. Maryland requires that at a minimum a notice to docket be filed in the circuit court for a foreclosure to proceed. In addition, the non-payment of your mortgage, which leads to the foreclosure itself, will also show up on your credit report for each month that you do not pay and can severely diminish your credit score. Once the mortgage lender forecloses, they may also obtain a deficiency judgment, which the lender can use to garnish your paycheck or attach your bank accounts. In addition, you usually need to wait 2-3 years after a foreclosure before qualifying for another mortgage.
A short sale is initiated by the homeowner, who is upside down on their mortgage (they owe more to the mortgage lender than the house is worth). The homeowner markets the property for sale to the general public either through a licensed realtor or on their own. Though short sales are generally marketed on an As Is basis, the sales price is based on the market value of the property, not a discounted auction value as is generally the case with a foreclosure. Once an offer is received, it has to be submitted to the mortgage lender(s) for approval, which is the primary reason that a short sale can take longer than a regular sale to close (the short sale process can take anywhere from 2-6 months). The lender may either forgive the deficiency or require a promissory note from the homeowner. If the homeowner continues to pay the regular mortgage up until the closing of the short sale, the only reporting on their credit report will generally be a notation on the mortgage stating “paid in full for less than the full balance,” which has much less negative impact than “foreclosed.” Many mortgage lenders provide for moving expenses or a short sale incentive to the seller in exchange for their participation in a short sale.
Short sales are generally viewed as a more “responsible” way to remove the homeowner’s liability on a property that is underwater because the homeowner sells the property at market value rather than allowing the property to be sold at an auction for less than the market would normally bear. Foreclosures are negative for a neighborhood because they lower the market value for all the neighboring homes, whereas a short sale will generally just be seen as a regular sale to neighbors and reflect the true value of comparable homes in the neighborhood.