Short sales and foreclosures are two financial options available to homeowners who are behind on their mortgage payments, have a home that is underwater or both. The term short sale refers to the fact that the home is being sold for less than the balance remaining on the mortgage – for example, a person selling a home for $150,000 when there is still $175,000 remaining on the mortgage. A foreclosure is the act of the lender seizing the home after the borrower fails to make payments. This is the last option for the lender, since the home is used as collateral on the note.

There are different reasons for why a homeowner would opt for a short sale versus a foreclosure. The owner is forced to part with the home in both cases, but the timeline and other consequences are different in each situation.

Short Sale

Before the process can begin, the lender that holds the mortgage must sign off on the decision to execute a short sale. Additionally, the lender, typically a bank, needs documentation that explains why a short sale makes sense; after all, the lending institution could lose a lot of money in the process.

If approved for short sale, the buyer negotiates with the homeowner first and then seeks approval on the purchase from the bank second. It is important to note that no short sale may occur without lender approval.

Short sales tend to be lengthy and paperwork-intensive transactions, sometimes taking up to a full year to process. However, short sales are not as detrimental to a homeowner's credit rating as a foreclosure is. A homeowner who has gone through a short sale may, with certain restrictions, be eligible to purchase another home immediately.

Foreclosure

Unlike a short sale, foreclosures are initiated by lenders only. The lender moves against delinquent borrowers to force the sale of a home, hoping to make good on its initial investment of the mortgage. Also, unlike most short sales, many foreclosures take place when the homeowner has abandoned the home. If the occupants have not yet left the home, they are evicted by the lender in the foreclosure process.

Once the lender has access to the home, it orders its own appraisal and proceeds with trying to sell the home. Foreclosures do not normally take as long to complete as a short sale, because the lender is concerned with liquidating the asset quickly. Foreclosed homes may also be auctioned off at a "trustee sale," where buyers bid on homes in a public process.

In most circumstances, homeowners who experience foreclosure need to wait a minimum of five years to purchase another home. The foreclosure is kept on a person's credit report for seven years.