For both buyers and borrowers, a foreclosure and short sale present different challenges and advantages. Foreclosed properties are owned by banks but in a short sale the property is still owned by the borrower.
When a borrower consistently fails to make mortgage payments, the property is foreclosed i.e.the lender assumes ownership of the property and evicts the borrower. Foreclosed properties may be sold at an auction or via traditional real estate agents. For a borrower, a foreclosure badly damages their credit rating.
A short sale is often used as an alternative to foreclosure because it mitigates additional fees and costs to both the creditor and borrower. Credit is also typically damaged much less than from a foreclosure, but a short sale usually involves a lot more paperwork.
When the market value of the property is less than the outstanding mortgage principal, and the borrower cannot afford to pay the mortgage, the lender (one or more banks) may choose to accept a short sale. In a short sale, the proceeds from selling the property fall short of the mortgage balance. Any unpaid balance owed to the lenders is known as a deficiency. Short sale agreements do not necessarily release borrowers from their obligations to repay any deficiencies of the loans, unless specifically agreed to between the parties.
Buying a property in a short sale usually takes a lot longer because it's not just the buyer and the seller who have to agree to the sale. All the lenders that hold a lien on the property have to agree to the sale. If the first mortgage has been re-sold by the original lender, it may now be owned by multiple banks. If there is a second mortgage on the house, the lender(s) in the second mortgage also may be lienholders. Getting all lenders to approve takes time and could even prevent the deal from closing if a lender does not agree.
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