If you browsed are home buying guides here on RealtyTrac.com you already know that we give advice on how to buy foreclosures homes. But what about Short Sales – are they a good alternative?

Before we answer that, let’s start with a quick reminder on the terminology used.

What Is A Foreclosure?

Foreclosure is when a bank repossesses a home after the homeowner fails to make their scheduled mortgage payments. Foreclosures are a lengthy process that doesn’t happen overnight – homeowners usually have between 3-6 months after missing their first mortgage payment to settle their outstanding balance and avoid foreclosure.

What Is A Short Sale?

A short sale is a recourse for homeowners who realize they’ll be unable to pay their mortgage off in time and want to avoid foreclosure. A short sale may also occur when the amount owed in mortgage payments is higher than the property’s market value. In this scenario, homeowners may try to sell their property in a short sale to avoid foreclosure or to avoid paying more than the property is worth.

For example, imagine the remaining mortgage balance on your home is $120k, but due to unforeseen market conditions, the home’s market value drops to $100k. In that case, you can try to sell your home – with the lender’s approval – in a ‘short sale’ for $100k to pay off the home’s current market value and avoid foreclosure. All proceedings from the short sale go to the lender.

Some states require the homeowner to pay off the difference between the value and the remaining mortgage balance – also known as a deficiency judgment. You can look up online if your state supports it.

What’s Better For Buyers? – Foreclosure Vs. Short Sale

If you’re looking for a cheap property – whether to flip it or as a primary residence –foreclosures and short sales are among the best places to start. However, it’s worth mentioning they have some key differences, and one type of property may be a better fit for you – here’s how they stack up on these five categories:

Price

Even though properties sold at short sales are, by definition, sold at below-market prices, it’s tough to beat foreclosure prices. Foreclosed properties aren’t just sold cheaply; the banks selling them are very motivated to complete the sale and get the passive costs of maintaining a vacant property off their books as soon as possible.

When it comes to price, foreclosed properties have the edge.

Property Condition & Repairs

If a homeowner can’t keep up with their mortgage payments, chances are they’re not keeping up with basic repairs and aren’t allocating any money to the upkeep of the property. For that reason, foreclosed homes tend to be in considerable disrepair and not in move-in condition.

In short sales, on the other hand, the homeowner is motivated to maintain the property in top condition to complete the deal as soon as possible and avoid foreclosure.

Properties sold as short sales aren’t necessarily move-in ready, but they’re generally in better condition than foreclosed properties.

Liens & Encumbrances

Foreclosed properties are usually sold with no liens, as banks pay off any liens attached to them to find a buyer as quickly as possible – it’s recommended that you verify anyway by purchasing title insurance.

On the other hand, short sales almost always have liens of one kind or another and are generally harder to sell than foreclosures. Short sales aren’t something lenders (banks) plan but rather a proposal from the homeowner. Banks ultimately have the last word on any short sale and can even reject short sales if they believe they can recover more money from foreclosing or holding a co-signer responsible.

Foreclosures are a better option if you’re looking to purchase and renovate a property as quickly as possible.

Competition

Finally, competition. Foreclosed properties have much more competition because they’re sold at a considerable discount – not just below market price. In foreclosure auctions, you’ll find other real estate investors looking to purchase a property and flip it for a quick profit.

Additionally, some savvy investors know how to keep track of public records and even divorce and death announcements to find prospective properties that may fall into foreclosure. Overall, there’s much more demand for foreclosures than short sales.

FAQs

How Do Short Sales And Foreclosures Affect Credit Ratings?

Both foreclosures and short sales are damaging to a homeowner’s credit history. Foreclosures are only behind bankruptcy in terms of damage, and if your house ended in foreclosure, you will also have each missed mortgage payment on your record.

For that reason, homeowners looking to avoid foreclosure have additional motivation to sell their equity on the property in a short sale.

Why Would A Bank Deny A Short Sale?

There are three main reasons a bank or lender may deny a short sale:

• They deem the current value of the home to be too low
• They’ve already invested money in the property and expect to make up for their investment
• They think they might get more by selling the property at a foreclosure auction

For Homeowners – How Do Short Sales And Foreclosures Affect Your Credit Score?

Both short sales and foreclosures will appear on your credit report. Foreclosures will have a more significant impact lasting up to seven years in your credit report – seven years from the Day of First Delinquency or when you first missed your mortgage payment.

Short sales are a more attractive alternative for homebuyers facing financial hardships looking to minimize the impact on their credit history.