Forbearance, Foreclosure, and Short Sale
Forbearance, foreclosure, and short sales are all common terms in the world of real estate. While these terms are being used with more frequency of late, it is important to understand what they mean and their unique differences.
Forbearance is a legal term defined as, “refraining from asserting a legal right.” In real estate, forbearance, or a forbearance agreement, refers to an arrangement between a property owner and their lending agency or mortgage company to temporarily cease payments for a fixed amount of time. In other words, the lending agency is refraining from asserting their legal right to collect payment. After the agreed upon duration of frozen payment obligations, the property owner is required to resume regular payments and pay back the deferred amount, including interest.
In May of 2020, it was reported under the CARES Act that nearly 4 million borrowers had entered into forbearance agreements—nearly 7.3% of all active mortgages in the U.S.—and accounted for $841 billion in unpaid federally backed mortgage loans. By April of 2021, that number decreased by 55% to 2.2 million borrowers.
A foreclosure is an official legal proceeding where a lending agency, like a mortgage company, files to take property ownership. In a foreclosure situation, the borrower may still be required to pay the lending agency any outstanding loan amount after the foreclosed home is sold. A borrower has the option to surrender the property and forfeit all legal rights to the lending agency via filing for Chapter 7 Bankruptcy, at which point the property is foreclosed upon to clear title. However, the borrower is not required to pay an outstanding loan amount.
Foreclosure is the last step before a borrower loses ownership of their property. If a borrower is aware that making payments to their lending agency may be problematic or impossible due to financial difficulties, it is always best that they contact the lending agency as soon as possible. Payment plans and forbearance are two options to be considered and discussed with the lending agency and may prevent foreclosure proceedings.
A short sale occurs when a property owner sells the property, with permission from the lending agency, for less than the outstanding loan amount. The lender receives all proceeds from the sale, if there is a secondary mortgage the only first lender receives the proceeds. After the sale, two options arise for the remaining value of the loan: it can be forgiven, or a deficiency judgement is ruled by a court that the remaining amount be paid. It is important to note that the lending agency determines if the loan will be forgiven or if a deficiency judgement should be pursued.
When a lending agency is determining if a short sale will be an acceptable remedy for a property owner in a difficult financial situation, two critical factors are assessed:
- Is the property worth less than the outstanding loan amount?
- Is the seller (property owner) able to prove their financial hardship?
While a short sale of a home is not ideal for any property owner, the prospect of the remaining balance on the loan being forgiven is generally viewed more favorably than a foreclosure. A short sale may also impact the borrower’s credit score less than a foreclosure or filing for Chapter 7 Bankruptcy. When considering a short sale, it is wise to speak to a real estate professional that specializes in short sales. Though a valuable resource, real estate professionals are unable to provide legal advice, so if foreclosure or bankruptcy is being contemplated, consider consulting with a lawyer.