Short Sale versus Foreclosure

People often ask me the difference between a short sales and foreclosures. While related, there is a substantial difference, both in the process and in the impact on the owner’s credit report.
A foreclosure is initiated by the lender, typically due to the borrower being delinquent on their payments. For a residential foreclosure in Colorado, the lender will file a Notice of Election and Demand (NED) giving notice that the debt must be paid and establishing a foreclosure date – typically about six months out. If the debt is not cured by the foreclosure date, the lender will make a bid for the property and that will become the initial bid for an auction of the property. Highest bidder wins and upon immediate payment owns the property. The borrower is still on the hook for any “deficiency” – i.e the difference between what was owed and what the property sells for at foreclosure. If the lender is the high bidder, they will typically put the property back on the market for sale.
Let’s look at another scenario. An owner wants to sell the home but he owes more than the property is worth. His desire to sell might be driven by a pending foreclosure or it might just be because he wants to move. In a standard sale, the owner would bring money to the table. Say he can sell the house for net proceeds of $300,000 but he owes the bank $350,000. In this case he would need to come up with $50,000 to close the sale. But let’s say the borrower doesn’t have the extra $50,000. In this case, he can go to the bank and negotiate with the bank to accept less that it is owed. This is a short sale. The bank is willing to forgo its lien on the property even though it is not getting paid in full. Now a short sale does not necessarily let the borrower off the hook. Unless the negotiations stipulate otherwise, as in a foreclosure, he will still owe the difference between what he initially owed and what the bank received from the short sale or foreclosure auction.
Why go for a short sale rather than just let the bank foreclose? Two significant reasons. First, foreclosures generally will produce a greater hit on your credit score – i.e around 200 points versus 50 points for a short sale. Secondly, after a foreclosure, a borrower is ineligible for Freddie Mac backed loans for 5 years and then only eligible number of packages. The ban is 2 years after a short sale and all packages are then available.
None of the above should be construed as legal, financial or tax advice. This discussion is based on practices in Colorado. Laws very from state to state. Please consult with your attorney, accountant and or financial adviser before making any decisions regarding a short sale or foreclosure. If you would like more information about the processes or ramifications of a short sale or foreclosure, or need help negotiating the selling/buying process call 970 515-7900 ext 3 for a free recorded message and to receive my Short Sale and Foreclosure seminar presentation.