When homeowners owe more on the mortgage balance of the home than the market value or sales price of the home, a short sale can occur. During a short sale, a homeowner asks the mortgage lender to accept an amount that is less than the actual amount owed. For example, if a homeowner sells their home for $350,000, but the mortgage balance is $400,000, a short sale occurs because the seller is short on paying the lender back. Should the lender accept the terms and close the sale, the seller will be free from further liability because all of the loan debt has been settled. While the debt has been settled, sellers should still be wary of a deficiency judgment. This occurs when the mortgage holder seeks to recover the money lost in the sale (the deficiency) through a court order that places a lien on the debtor for further money. While some states have outlawed deficiency judgments, sellers should still be informed if it occurs after the short sale has closed.
When a homeowner is unable to make mortgage loan payments for an extended period, foreclosure can occur. A homeowner that misses 3-6 months of mortgage payments will be notified by the County Recorder’s Office that the home is at risk of foreclosure through a Notice of Default; upon foreclosure, the homeowner will also be evicted. After receiving the Notice of Default, the homeowner enters the pre-foreclosure period, where they have the opportunity to settle the loan debt by either conducting a short sale or paying the owed mortgage balance. Performing a deed in place of foreclosure is another way to be free from the loan debt; this occurs when a homeowner transfers ownership of the home to the lender in exchange for loan settlement. If the debt is not paid by one of these actions within 30-120 days, the lenders will foreclose on the property. They will sell the home to a third party via foreclosure auction, which is typically held either at the property or the local courthouse. If the house does not get bought at the auction, it is then considered a bank-owned property.
Short sales and foreclosures are both options for homeowners who cannot make their mortgage payments due to financial distress. While both of these options have negative impacts on a homeowner’s ability to get a loan in the future, they differ in process. To summarize, short sales occur when a lender allows the homeowner to sell the home for less than what they owe on the mortgage. Short sales still involve the entire home selling process, can take up to one year to close and are less damaging to credit scores. On the other hand, foreclosures occur when the lender takes the home back after the homeowner misses too many months of their mortgage payment. Foreclosures skip much of the home-selling process and can be closed within months of the initial notice. They are also quite damaging to the seller, as they will have to wait five years to purchase another home, and the foreclosure will remain on their credit report for seven years. If a homeowner starts to experience difficulty in paying their mortgage, they should sit down with their lender to discuss options in advance. The homeowner’s financial circumstances and amount owed will be determining factors in whether a short sale or a foreclosure will occur.
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