Many people dream of buying their own home. It is more than just a place to live and raise a family. It can also be a lucrative and timely investment. Owning a home can improve your credit. Flipping houses can earn you extra money. If you’re a real estate agent you can earn your livelihood (plus more) through selling houses. Because homes cost a lot of money it is most common to deal with banks or other financial institutions to structure loans in order to purchase or even refinance a home. In lending you a large sum of money the bank will expect timely repayments when it comes to satisfying your loan. It is the obligation of the homebuyer to meet those requirements on a set basis in order to keep the home.
Sometimes this is not as easy as it sounds, and with the fluctuating economy it is not unheard of for a homeowner to miss payments. When this happens there are several options, but if the missed payments continue for too long the bank may feel a need to restructure the deal, or worse, take the house. If you find yourself at this point you need to know your options when it comes to a bank foreclosure or the institution of a short sale. Understanding the difference as well as what to expect in either case is part of the necessary real estate analysis when it comes to home investment. Udemy has several great courses to help you plan in the unfortunate even you land in this predicament.
What is Foreclosure?
In order to understand the difference between the two, you need to first know the basics of a foreclosure. A foreclosure is the legal process taken by a lender (such as banks or other financiers) to recover the balance of a loan from a borrower (homeowner or house flipper) who has stopped paying back that loan. In order to recover the lost payments the bank forces the sale of the house. This is because in most loan contracts, the house itself is used as collateral against the money lent. Foreclosures come at the point of absolute default, and most often this is after as set amount of missed payments, as stipulated in the loan contract.
There are three types of foreclosures. A judicial foreclosure is when the sale of the mortgaged property is enacted under the guidance and supervision of the courts. In this instance the money from the foreclosure is used to repay the mortgage debt. After that any lienholders are repaid, after which the borrower is given any remaining proceeds. In this type of foreclosure a lawsuit must be filed.
A nonjudicial foreclosure is also known as a foreclosure by power of sale. This is when the courts are not involved in the foreclosure. The process is most often done when a deed of trust was used. These foreclosures are much cheaper and faster than a judicial foreclosure. Here the mortgage holder and other lien holders are the first and second to be repaid.
A strict foreclosure is less available than the others. Historically this was the original method of foreclosure. It is when the court orders the defaulted mortgager to pay the mortgage back in full within a specified period of time. In some ways it is like a court ordered extension. If that mortgager still fails to repay the specified amounts then the mortgage holder (or homeowner) is given back the house with no obligation to sell.
What is a Short Sale?
A short sale is a process that a lender and borrower go into to avoid foreclosure on a property. Generally, a bank or financial lender does not want to begin the process of foreclosure. It requires a lot of time, administration, and effort. A short sale, unlike the actual process of foreclosure, is a way to structure a deal as a last chance stopgap to avoid the inevitable. Short sales are often executed by third party sellers that work both with the homeowner and the lending institution, which will have to approve of the transaction. Engaging in a short sale will require you to know the value of your house. (For more information on the real estate valuation process, be sure to check out this great Udemy course.) An appraiser can be brought in by the lender, homeowner, or broker to begin this necessary first step.
In order to be eligible for a short sale, however, a homeowner has to qualify for it. A major difference here is that the only qualifications for a foreclosure are repeatedly missed payments. Foreclosures can happen to anyone but if you qualify a short sale can hold off the inevitable a little while longer.
To qualify for a short sale you’ll have to prove a few things. First, your house must be worth less than you owe on it. With interest from missed payments and the unstable housing market this is not always as easy as it sounds. It is not uncommon for owners to owe more than their house is worth. Secondly, you also must be able to prove that you are the victim of actual financial hardship. You will need to provide proof of lost wages, job loss, or any medical conditions that has changed your ability to make the same income that you made when you signed the mortgage contract, and upon which that contract was based.
If you can prove those two items to the bank or lender then you can begin the process of a short sale and hopefully be able to successfully get back on track.
What are the Benefits of a Short Sale?
A foreclosure will not necessarily eliminate your liability to the bank or lending institution. If there is a balance deficiency during a foreclosure sale a homeowner is most often liable to the lender for that money. If a house is valued at $400,000 and the foreclosure auction ends at $300,000 then in most situations – because yes, there are always exceptions – you will still owe the bank $100,000. Worse still is that you might still be liable to the IRS for that money as well. And lastly, a home going into foreclosure will appear on your credit, making it impossible to buy a home in the future. A short sale is a viable way to avoid a foreclosure. And contrary to popular opinion, banks would much rather structure a short sale than go into foreclosure.
Furthermore, short sales will not cost you money out of your own pocket. The example above is proof how a foreclosure could leave your strapped for cash, but a short sale will not leave you on the hook in the same way. Short sales often have incentives for the homeowner. Generally a realtor performs short sales and they charge a commission that is paid for by the bank. In many communities there are non-profit organizations that can enact a short sale as well. Regardless, it is important to remember that if you are a seller of a property, you should never have to pay for any short sale costs up front.
What is the Bank’s Prerogative?
The term ‘short sale’ does not have to do with the amount of time that it takes to sell the home in question. It applies to the borrower’s inability to pay back their loan in a timely and specified manner. It is called a “short sale” because the borrower is “short” the amount of money owed.
Short sales actually can take an extended period of time. If you have reached out to your lending institution and an agreement has been reached to go into short sale you will need to exercise patience.
Assessing previous owner financing, something you can learn more about through this Udemy course, can be a complicated matter. The bank is going to lose money and they will need a lot of people to ‘sign off’ on that loss. This could be one banker or entire committees within the organization. If a private mortgage insurer underwrote your loan the bank or lender may need approval from that group before moving forward. If you took a second mortgage from another institution then its possible that mortgager will need to approve of the short sale as well. The process is longer than a foreclosure, but it can be much less damaging to all involved.
What Else Do I Need to Know?
A short sale happens in the interim between taking the home loan and defaulting on your mortgage and subsequently going into foreclosure. This means that the closer the home gets to foreclosure, the greater the debt of the homeowner is. Therefore, the closer a home gets to foreclosure the harder it is going to be to be to do a short sale. When it comes to short sales it is important you are on top of your finances. Time is absolutely of the essence in a short sale, because each day the bank is out more money, the less likely they are to engage in a short sale.
This does not mean that if you have been sent a foreclosure notice you are no longer eligible for a short sale. This is a common misconception that causes many homeowners to miss the opportunity. Every state and lending institution has different timelines in regards to foreclosure. Just remember the longer you wait, the less options you have.
If you’re a real estate agent and you’re looking to increase your income you might consider becoming involved in the short sale process. Acting as an intermediary between homeowners and lending institutions in short sales might not be as lucrative as an all out sale, but the process is faster and the needs are greater. This means that you might be able to bring in extra cash performing this service. Furthermore, because you will get a commission from the bank on the sale you’re payment is more guaranteed.
When it comes to buying, selling, brokering, or lending homes there is always a risk. That is why banks and other lending institutions structure their loans so specifically. If you are a homeowner who has defaulted on a payment, or an investor who flips houses don’t lose all hope. Short sales are a viable option when it comes to avoiding foreclosure. Don’t wait until it’s too late. The first step to a strong course of action is doing the proper research. You can start by checking the options that Udemy has to offer, including Udemy’s real estate flipping course. The second is talking to your bank or lender. Once you’ve done both you can begin the process of getting back on track.