If you’re falling behind on mortgage payments and facing default, you’re probably searching high and low for solutions – and as a result, you’ve probably come across the terms “short sale” and “foreclosure.”
Here in our home base of Illinois and around the country, homeowners often find themselves trying to determine the difference between these two courses of action. Both are options for borrowers who have fallen behind on mortgage payments or have a mortgage that is underwater, and both will ultimately result in the homeowner having to leave the residence.
In practice, however, short sales and foreclosures are quite different; in fact, a short sale is often considered an alternative to facing the foreclosure process.
Searching for answers or clarity in a difficult moment? Let’s see if we can break down some of the key differences of foreclosures versus short sales for borrowers struggling to make mortgage payments:
What Is a Short Sale?
In brief? A short sale is the process of a homeowner attempting to sell their property for less than the outstanding balance of their mortgage – for instance, if the owner sells the property at $350,000, but their remaining mortgage loan balance is $400,000. Short sales are most commonly used in situations where the market value of a property has decreased since the home was last purchased.
In practice, a short sale often proceeds like a typical real estate transaction – albeit with a few key differences. Chiefly, it’s important to note that the lender or mortgage servicer must give their approval to execute a short sale, and give final approval to the buyer who is attempting to purchase the property. Sellers must be prepared to communicate with their mortgage lender and explain why a short sale makes financial sense; buyers and sellers alike must be prepared for a process that can be protracted, and involve multiple rounds of negotiations with the bank or mortgage company.
As a result, short sales may take up to a year, and involve lots of paperwork and document processing. Compared to foreclosures, however, short sales will often have less of a long-term impact on the seller’s credit rating. In many situations, homeowners with a short sale on their record will also be able to purchase a new home fairly quickly – sometimes within a year or less, depending on their unique circumstances and the type of loan they’re considering.
One more key thing to consider? As you pursue a short sale, it’s important to keep deficiency judgments in mind. A deficiency judgment occurs when the mortgage holder attempts to recover the “deficiency,” or the amount they lost in the short sale. It may be important to work with your mortgage company or bank to ensure that you will, indeed, be released from further liability after the close of your sale.
What Is a Foreclosure?
Foreclosure occurs when a mortgage company or bank seizes a home as collateral, after the borrower falls significantly behind on loan payments. The foreclosure process is often considered something of a last resort, both for borrowers and mortgage companies, as it can be time-consuming and involved for both parties, depending on the circumstances.
Whereas a short sale is initiated by the borrower, a foreclosure is a process driven by the mortgage company or bank. After the borrower misses payments, the mortgage company will send a notice of default before beginning the foreclosure process. Here in Illinois, we use a process of judicial foreclosure, meaning that the mortgage company must file a suit in court.
Broadly speaking, the foreclosure process is intended to allow the bank or mortgage company to take possession of the home, so the can resell it in an auction or sale to recoup the costs that they have invested through the mortgage loan. To learn more about the specific steps of the foreclosure process here in Illinois, you may read our guides to foreclosure, available here and here.
The foreclosure process is typically faster than the short sale process. For the borrower, a foreclosure will often mean a significant hit on their credit rating (with a notice of foreclosure that will remain on the borrower’s credit report for up to seven years). Homeowners who have experienced a foreclosure may also need to wait significantly longer before being able to purchase a home in the future – perhaps five years or longer, depending on the circumstances.
Are There Any Other Courses of Action If You’re Behind on Your Mortgage?
While selling the home or undergoing foreclosure are potential courses of action for borrowers who have fallen behind on their mortgage, there are other resolutions that may be attempted, as well. Broadly speaking, homeowners who have fallen behind on their mortgage payments may be able to pursue other strategies to mitigate their loss, or potentially even keep their home, including:
- Reinstatement or Repayment Plans. One of the first options during a “pre-foreclosure” period, reinstatement involves the borrower and the bank working out an agreement to pay the full amount that is due, as well as any fees or penalties, by a specified date, generally as one lump sum. The parties may also be able to work out a repayment plan, in which the borrower will be responsible for paying their regular loan amount, with a portion of the past-due amount added on, until they catch up.
- Forbearance. Forbearance is an arrangement through which the borrower and the loan servicer agree to temporarily reduce or suspend mortgage payments, for a set period of time. At the end of that time window, the homeowner will then generally be required to resume making regular payments, and get the loan current.
- Loan Modification or Refinancing. The borrower may be able to negotiate with their mortgage company to alter the terms of their mortgage, such as reducing the interest rate or extending the life of the loan.
- Bankruptcy. Chapter 13 bankruptcy can allow homeowners to take advantage of the “stay,” which bars their mortgage company from selling their home or seeking additional payments. Moving forward, Chapter 13 enables homeowners to set up a three- to five-year repayment plan with their creditors.
- Deed in Lieu of Foreclosure. While it will not allow the borrower to retain possession of the property, a deed in lieu can allow borrowers to get out of their liability by granting their mortgage company the deed and title to the property as a way of satisfying their outstanding obligation.
The Importance of Discussing Your Options With a Local Expert
For borrowers looking to understand all of their options when it comes to foreclosures, debt relief, bankruptcy, and real estate matters, one of the most effective steps may be to consult with an experienced local attorney. An attorney can offer counsel and guidance, observing your situation and empowering you to find the right solution for your unique circumstances.
Above all, remember that no two cases will ever be exactly alike! When it comes to debt relief, foreclosures, and real estate, you may be surprised by just how much each individual’s distinct circumstances can come into play.
If you have any questions about your specific situation, don’t hesitate to get in touch with the attorneys and staff of the Gunderson Law Firm to keep the discussion going. The Gunderson Law Firm specializes in bankruptcy and real estate law. Our team possesses unparalleled expertise and insight, reinforced by years of experience and long-term connections throughout Chicago’s real estate, finance, and insurance industries. Don’t hesitate to drop us a line whenever you’d like to keep the conversation going.