A short sale involves selling a property for less than the mortgage owed with lender approval. A foreclosure occurs when the lender takes ownership of the property due to the borrower’s failure to make mortgage payments. As a real estate investor, you should know the difference between both to understand the specific legal, financial and timeline implications.
Whether you’re looking to buy real estate as a first home or as an investment, a financial advisor can help you analyze different options for your portfolio.
What Is a Short Sale?
A short sale occurs when a homeowner sells their property for less than the amount owed on the mortgage, typically during a foreclosure when the property’s market value has dropped below the mortgage balance. This process requires considerable documentation and negotiation with the lender, who must agree to accept less than what is owed.
What Is a Foreclosure?
Foreclosure is the legal process by which a lender takes possession of a property after the homeowner fails to make mortgage payments. Unlike a short sale, foreclosure is initiated by the lender. The lender will then sell the property, often at a public auction, to recoup the unpaid loan balance. Foreclosure can be swift, depending on state laws and the lender’s policies, and leaves the homeowner with little control over the process.
Short Sale vs. Foreclosure Pros and Cons
Pros of a Short Sale for Sellers
- Better for credit. Less damaging than a foreclosure, and a shorter waiting period to buy a new home.
- More control. Sellers can negotiate on price and move out date.
Cons of a Short Sale for Sellers
- Complex and risky. Extensive negotiations with the lender with no guarantee of approval..
- Taxes. Forgiven mortgage debt might be considered taxable income, leading to a hefty tax bill.
Pros of Foreclosure for Sellers
- Speed. Once the lender initiates foreclosure, the process moves quickly.
- Debt relief. Lenders may sell properties for an amount that covers the outstanding loan, depending on state laws and the terms of the mortgage agreement.
Cons of Foreclosure for Sellers
- Worse for credit. A seller’s credit score can drop by 200-400 points and remain on their credit report for up to seven years.
- Public process. Foreclosure can be embarrassing and stressful for the homeowner. They lose control over the sale of the property, and often end up evicted.
Pros of a Buying a Short Sale for Buyers
- Higher quality. Buyers often find prices below market value but, since short sales are typically still occupied, these properties are often in better condition than foreclosed homes.
- Negotiation. Buyers can negotiate the price, repairs, and other terms. Short sales are often less competitive than foreclosures, too.
Cons of a Short Sale for Buyers
- Lengthy. The extended timeline can take months, frustrating buyers who are eager to move in or invest quickly. Additional negotiations with the lender can lead to additional delays.
- Hard to finance. Lenders are not obligated to approve a short sale, even if the seller agrees to the terms, which makes it difficult for buyers to get a loan through a mortgage company or bank.
Pros of Foreclosure for Buyers
- Low prices. Foreclosed are typically sold at auctions or through real estate-owned (REO) listings, where lenders are eager to offload them quickly even if it’s below market value.
- Flipping. Because foreclosure moves quickly, there’s greater opportunity for investors to flip properties without long holding periods.
Cons of Foreclosure for Buyers
- Damages. Foreclosed properties are often sold “as-is,” meaning buyers may inherit a range of issues, from structural problems to unpaid taxes or liens. Without a proper inspection, buyers can face unexpected expenses.
- Competition. Bidding wars can drive up prices, sometimes negating the discount advantage. Buyers must also have the financial resources ready, as many auctions require immediate payment or a substantial deposit.
Bottom Line
Both a short sale and a foreclosure can carry long-term financial and personal implications. Each option offers distinct advantages and challenges, from the impact on credit scores to the future prospects of homeownership. By thoroughly understanding the differences, homeowners and potential buyers can choose a strategy that best aligns with their current situation and future goals.
Investment Planning Tips
- A financial advisor can help you understand how real estate investing could fit into your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Financing plays a central role in real estate financing. Use SmartAsset’s mortgage calculator to estimate and break down the details of the monthly payment your next deal will involve.
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