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An Overview of Short Sales and Foreclosures for Buyers

by guardianrealtycenter-chime-me June 21, 2019

Foreclosed Home for Sale

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During this podcast for Getting Real with Real Estate, we will provide you with important information for buyers interested in properties listed as Short Sales or Foreclosures.  Do you know the difference between the two? What are the advantages and disadvantages of each?  When does it make sense to pursue a short sales vs. a foreclosure and vice versa?  What are their relative risks and rewards?  If you don’t already know the answers to these questions, then by the end of this podcast, you will have a much better idea of what you’ll encounter if you pursue short sales or foreclosures.

So let’s begin.

While short sales and foreclosures both offer tantalizing opportunities to the buyer interested in either a primary residence or an investment property, there are some notable differences between the two.  And this is precisely where the term, caveat emptor, buyer beware, applies!  To give you a better handle on short sales and foreclosures, we’ll discuss what they are, how they compare, how they differ, their relative advantages and disadvantages, and when it makes sense to consider them as an option for buying a property.

What is a Short Sale?

A short sale does not imply a quick sale.  In fact, it is anything but as we will discuss later in this podcast.  A short sale basically means that the homeowner is selling their property at a price below what is owed on their current mortgage.  The term “short” means that the homeowner cannot fully repay their original mortgage and is “short” by a specific amount.  Rather than a lender  going through the expense and trouble of taking ownership of the property because of the homeowner’s failure to pay the full mortgage, they work out a deal where the homeowner sells the property at a lower price that is “short” of the full mortgage so that the lender can recoup as much of the property’s value as possible and the seller will no longer owe any further debt to the lender.  Basically, a short sale is very much like a conventional sale with the exception that the mortgage lender of the seller becomes a very important part of the negotiation process. In fact, once the lender allows the homeowner to list the property as a short sale, the buyer can negotiate the sale price with the homeowner first, but ultimately cannot move forward without lender approval.

What is a Foreclosure?

A foreclosure means that the original homeowner can no longer make mortgage payments and has defaulted on their loan.  Generally, after three-to-six months of delinquent mortgage payments by the homeowner, the lender eventually repossesses the property, evicts the homeowner, often against their will, and puts it up for sale either through an auction or realtor.  A foreclosure sometimes is referred to on the market as an REO or real-estate owned property.  In some cases, a property can be listed as a pre-foreclosure.  The seller still owns the property and the lender or bank has not yet begun foreclosure proceedings.  A seller will be very motivated to prevent any foreclosure by either selling the property at the value of the original mortgage as soon as possible or resort to going through the short sale process, assuming the lender or bank agrees to accept less from the buyer than what the current owner owes on the mortgage.  But if the homeowner cannot sell the property within a specified time, the lender or bank will proceed with the foreclosure and take over the property.

How do Short Sales Compare with Foreclosures?

First, they both tend to happen when a property owner is having financial difficulty and cannot meet their mortgage payments. Needless-to-say, sellers are extra motivated to make a sale.  Consequently, both types of sale lure buyers with especially attractive prices, generally below what the market demands from other conventionally sold properties in the same area.  Both short sale and foreclosed properties can be found through a realtor and the Diamond Listing Team of the Guardian Realty Center are experts at assisting buyers to find those types of properties in Westchester and Putnam counties.

How do Short Sales Differ from Foreclosures?

The primary difference for the buyer between a short sale and a foreclosure is the actual seller of the property.  In a foreclosure, you are dealing directly with an unemotional bank or lender, whose primary goal is to sell quickly but also to recoup as much money as possible to cut their losses.  In contrast, during a short sale, you’re dealing with an emotional homeowner possibly on the verge of being evicted by their lender.  Sometimes those emotions can become a roadblock during negotiations when the homeowner is forced to accept that their property is no longer worth what it once was or what they think it should be.

Another difference for the buyer between a short sale and a foreclosure is the type of financing that you can use.  Short sale properties can be financed using conventional mortgages, but many foreclosed properties, especially those sold at auction, can only be purchased with cash.  In some cases, you may be eligible to finance a foreclosed home with a conventional repair loan.  Qualified buyers who intend to reside on the foreclosed home can obtain government-insured loans backed by the Federal Housing Administration with little to no money down.  But buyers who intend to re-sell foreclosed homes at a profit are often forced to secure a private loan having significantly higher interest rates and requiring a down payment of 30 to 50 percent!

One other difference for the buyer between a short sale and a foreclosure is the time it takes to close the deal.  Remember what we said about short sales not being quick sales?  A conventional sale typically takes 30 to 45 days to close after the offer is accepted. A short sale can twice or three times as long, and in some cases even up to a year to complete.

Why?  In a short sale, the mortgage lender must approve the negotiated sale price.  The back-and-forth among buyer, seller, and mortgage lender on the agreed-upon price plus all the paperwork that needs to be completed can add weeks to the closing process.  Plus, the mortgage lender is often responsible for any closing costs and wire transfers that the homeowner would have been responsible for if it were a conventional sale.  In turn, the lender will try to pass on these costs to the buyer, which adds another layer of negotiations and possibly months to closing.

In contrast, the time to closing for a foreclosed property can take as little as 30 days depending on the financing options that the buyer chooses.  Again, lenders want to sell quickly and will often respond directly to offers within 48 hours

Finally, a subtle difference for the buyer between a short sale and a foreclosure is the listing price for the property.  Almost always, a foreclosed property will be listed at a price well below the market value for similar homes in the area, often because of the condition of the property, which is typically vacant.  In contrast, a short sale property is still occupied by the homeowner, and the condition of the property may be better than an unoccupied foreclosed home.  While the short sale property may still be listed at an attractive price, it may not always be well below prices of similar properties.  Keep in mind that although a short sale property must be sold below the value of the original mortgage, it’s always possible that because many other properties in the neighborhood may have gone down in value from when they were originally purchased, the short sale can still be more competitively priced and not always offer as low a purchase price below market value as a foreclosed property.

What are the Advantages of a Short Sale for a Buyer?

The primary advantage of a short sale for a buyer is the prospect of getting a home at a bargain price.  The homeowner is pressed to sell the home and get out from the mortgage that is owed.  While the mortgage lender must still approve all negotiated prices, the buyer is more likely to have their low-ball offer accepted in a short sale than in a conventional sale.  Part of the reason for that is that there is generally less competition among buyers in a short sale because first-time buyers of property typically don’t have the patience to get involved with the extended delays and all the back-and-forth that a short sale can entail.

Another advantage to a short sale is that they don’t pose the same degree of risk as a foreclosed property.  Unlike a foreclosure, a short sale can move forward much like other sales, and a buyer can get a conventional mortgage and have the opportunity to get the property inspected  Also, most short sales are usually in a better condition than foreclosures.

What are the Disadvantages of a Short Sale for a Buyer?

The main disadvantage of a short sale is the length of time often needed to close.  The process can take anywhere from 2 to 6 months and conceivably as long as a year.  Unless the buyer is persistent and patient, more often than not, the long wait time becomes a deal-breaker.  The involvement of the mortgage lender as the primary approver in the process is another disadvantage.  A buyer and a homeowner may have reached agreement on a price only to have the lender squelch the deal, often making a counter-offer for a higher sales price and requiring that the buyer assume all or most of the closing fees, especially if the buyer is an investor.  All the interventions by the lender only add to the length of time to close the quote-short-unquote sale!  Plus, if the property has additional home-equity mortgages or liens, then expect an even longer outcome.

Another disadvantage is that unlike a conventional home if the short sale home requires extensive repairs, don’t expect the homeowner or the lender to pay for them as a condition of the sale.  Attempting to negotiate that stipulation will only add to the time to close and often result in a negative outcome

What are the Advantages of a Foreclosure for a Buyer?

The biggest advantage of a foreclosure for the buyer is price.  Foreclosed properties can be sold well below the market value of similar, conventional properties and provide the option to buyers to find a home in neighborhoods that they otherwise couldn’t afford.  In some cases, the price for a bank-owned foreclosed home can be as much as 30% less than comparable homes sold at market-rate prices.

The time it takes to close on a foreclosure is much shorter than that for a short sale.

Of course, the buyer has the option to buy a foreclosure at an auction, where the transaction can be very quick especially if the buyer has cash on hand.

But if the buyer pursues an REO, the advantage is that the lender or bank that now owns the property is responsible to ensure that it is lien free and the title is secure, which is one less headache for the buyer.  But if you try to buy a foreclosure through an auction, you may not have the same protection against liens or unpaid taxes as you would if you decided to buy an REO.

Fannie Mae and Freddie Mac have special loan programs from government-sponsored lenders for foreclosure buyers who qualify.  The loan process doesn’t require a home appraisal or mortgage insurance, which can save the homeowner hundreds of dollars.  Plus down payments can be as little as 3%.

The FHA also offers a “203k” loan which will cover some repair costs for foreclosed homes needing lots of work.

What are the Disadvantages of a Foreclosure for a Buyer?

The largest and most critical disadvantage of a foreclosure is the condition of the property.  Buyers typically purchase a foreclosure in “as-is” condition because banks will not pay for or repair any condition-related issues unlike sellers of conventional properties.  The foreclosed property has often been vacated by the original, evicted owner, who may have neglected the property because of financial hardships or worse yet, damaged the property on their way out.  Depending on how long the property has been vacant and neglected, its condition may have deteriorated and even subjected to vandalism.

Unlike an REO, if you are looking to buy a foreclosed property at auction, you may not have the opportunity to have it inspected beforehand.  Plus, you may have to deal with any liens and unpaid taxes in foreclosed properties bought through auction.  Therefore, always factor in the condition of the property, the potential for liens against the property, and the likely repair costs into your decision to buy a foreclosure. Unlike with a foreclosed home bought at auction, you do have the right to a home inspection before closing on an REO.  If you find problems with the property that are structural and foundational, then it may not be worth the cost and headaches to renovate it.

The other disadvantage is that multiple foreclosures in a neighborhood do tend to drag down the sales prices of the homes surrounding them, even if those homes are not in foreclosure.  This could negatively impact an investor attempting to resell the property at a desirable profit after any necessary renovations.

When does it make sense to consider a Short Sale vs. a Foreclosure?

Obviously, you’re going into this with the mindset of getting a property at a bargain price.  So when should you consider pursuing a short sale as opposed to a foreclosed property?  Part of your decision should be based on whether you intend to live in the property or rent or sell it as an investment.

The main question I would ask upfront is are you in a hurry to obtain a property?  If the answer is yes, then avoid pursuing a short sale, which can take months before a closing date is set.  If the answer is no and you can exercise a degree of patience and persistence, you can find good deals in short sales, which are generally in better condition and often carry less risk than foreclosed properties.

But if you can’t afford to wait for the two to six months it takes to complete a short sale, then consider foreclosed properties that are owned by a bank (REOs) and are presented by the Diamond Listing Team of the Guardian Realty Center.  Our realtors can provide you with the needed expertise and guidance to navigate the sometimes murky and risky waters that characterize foreclosures.  Make sure to have the property inspected and work with the realtor to develop an initial offer that reflects the issues with the property and its relative risks.  Finally, the realtor can give you information on available financing options, if relevant.

Bottom Line

There is likely a bargain just waiting for you out there in the marketplace of short sales and foreclosure.  But caveat emptor! Buyer beware – make sure you first come armed with facts and information especially from your realtor from the Diamond Listing Team of the Guardian Realty Center before you chase down that great deal.

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Joann Perna

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