Difference Between a Short Sale and a Foreclosure

The Difference Between a Short Sale and a Foreclosure

If you are a person who has never bought a home or if you haven't bought a home in a few years, you might not know what a short sale is. I didn't know about short sales until a few years ago.

"Short sale" is an oxymoron. It takes a long time to get through a short sale transaction. Three to six months is the norm. I've heard of some taking over a year.

But a short sale just means that the seller comes up short when trying pay off their mortgage from the sale of their house. They don't have enough from the proceeds of the sale to pay off their mortgage(s). Without the mortgage being paid off, the lien isn't removed and the sale can't take place.

Sometimes the seller can afford to write a check for the shortfall in the sales proceeds. But not too many people have the resources to do that.

Most people might just think that nothing can be done other than stop making payments and let the bank take back the home in foreclosure. Foreclosure isn't great for the credit record of the seller and it usually ends up being very expensive for the foreclosing bank.

So an alternative to foreclosure is a "short sale". It stinks a little less for everyone involved.

The seller convinces the bank to take less than the full amount to pay off the mortgage. They also try to get the bank to agree to never come after them for the difference.

The first question is, "Why would a bank take less than the full amount?".

The answer is that it is in the bank's best interest to do so.

Usually before a bank will allow a short sale to happen, they have to be convinced that:

The seller doesn't have the means to come up with the difference. Usually a hardship is required but I've heard of short sales being approved even if the seller is a millionaire if...
The bank will end up better off financially with the short sale instead of a foreclosure.
The house just isn't worth as much as the mortgage that is owed on it.

With a short sale, you still are negotiating with the current seller. The seller's bank is just there to approve the loss that they are willing to take.

The process starts with the offer that the seller gets for the buyer. That gets the wheels started with the bank's Loss Mitigation department. The bank isn't going to tell the seller up front how little they are willing to take. First they want to see what offer the seller gets and then it will do the due diligence to figure out if that is the best deal for them.

Many times the seller doesn't really care how little the home goes for. They already know they aren't getting a penny from the sale. The only thing that will motivate them to try to get a higher price is if they can't negotiate a waiver of any future deficiency judgment by their bank. In many states, if the bank doesn't get full payment of the mortgage, either through a short sale or a foreclosure, they can come after the seller for the difference (deficiency).

The seller might also have to consider the "forgiveness of debt" tax that the IRS can impose. If someone forgives you a debt, the IRS looks at that as income that you owe taxes on. I know it sounds crazy, paying taxes on money you never see, but it is a possibility in some cases.

This whole process take a lot of time. Banks aren't staffed to handle the load of short sale requests that they are receiving. It might take a month or two just for a negotiator to be assigned to the case. Then the appraisals and Broker Price Opinions have to be ordered and evaluated. If one little detail is left out of the short sale package that the seller submits, you might have to start waiting in line again.

Many times the seller's listing agent will place the home on the market at a ridiculously low price in order to get a quick offer that they can get submitted to get the wheels turning. This does not mean that the seller's bank will approve that price, or anything close to that price. If the bank thinks it's too low, they'll just foreclose on it and put it on the market themselves at a higher price.

There are some benefits to a buyer in pursuing a short sale but unless you are getting a huge discount and aren't in a rush, it's probably more productive to pursue a bank owned foreclosure. At least with those, you know that the bank has set the price and is willing to sell it at that price. You won't have to wait around for four months and find out it's back to square one.

Each bank has it's own policies and procedures when it comes to short sales and foreclosures. Just like each seller is different and has different motivations. You just have to have the right expectations going in and deal with the details as they come.

Tim Maitski
Atlanta Communities
www.HomeAtlanta.com
404-216-0472