It’s true, you can usually find great deals on foreclosures or short sale, often well below market value. So what’s the difference between the two and what are the pro’s and con’s of each? Well, let’s tackle those questions!
First, the definition of a foreclosure is when the present homeowner is no longer able to pay the minimum payment on the mortgage. The homeowner typically has several months with the opportunity to catch up on the payments of this mortgage, however, if they cannot catch up, the mortgage company will move toward the foreclosure process. If no attempts are made to resolve the past due balances, a sheriff’s sale will be scheduled.
A sheriff’s sale is similar to a public auction, where the property is listed in a local paper or on local city or county websites depending on your location. After the completion of the sheriff’s sale the property is said to be in ‘redemption’ the redemption period is typically a 6 months period, however, if the property is found abandoned or vacant an expedited process can occur moving the redemption period up to 5 weeks.
The redemption period mandates an ‘Acceleration Clause’ which means the entire mortgage is due immediately (you cannot get another mortgage) and past due mortgage payments and any accrued interest must be paid now. Unfortunately, if a homeowner is already behind on the payments it’s likely the homeowner cannot fulfill the acceleration clause and, therefore, the home will go back to the bank and listed for sale (eventually) as a foreclosed property.
Pro’s of Purchasing a Foreclosure
- Homes can be purchased well under market value
- With work & fix-ups the property can be a great way to build some fast home equity
- Lower than average home prices means a good option for first-time buyers to purchase a starter home
Con’s of Purchasing a Foreclosure
- The property is often left unused or maintained for some time – this could mean an unknown condition.
- If you’re in the seasonable cold locations, it’s possible the home could have freeze damage or broken pipes
- Often the bank requires several extra forms you must agree to in order to proceed – “buyer beware” as-is where-is without any warranties
- Some banks will not allow any repairs to be made and/or negotiated during the inspection contingency time period
- Be aware of special assessments, unpaid water bills or unpaid taxes as depending on the bank, they may not pay these at closing
- Patience, as asset managers are reviewing lots of offers on several different properties, it can be tedious to wait through the offer acceptance period
- It’s likely that the property has been vacant long enough and may no longer qualify for the homestead credit. A portion of that year’s taxes maybe at a higher rate
Now, let’s compare the difference to a short sale. Unlike the name ‘short sale’ suggests, there’s really nothing short about this sale. The ‘short’ comes from the actual market value being short of what the outstanding balance actually is on the loan. In the last several years the market turndown caused a huge flux in property values. Several homeowner’s bought in 2007 and 2008 at the top of the market and have not been able to recoup the full value. If they’re in a situation where they need to sell (job move, health expense, etc.) they may not have a choice of waiting it out till the property gains a full value for them to be on the positive end.
Likewise, with the foreclosure process, the homeowner may have missed a payment or two, or they’re sure a late payment is expected in the near future. There really isn’t a pre-determined time for when a short sale can or cannot occur, however, it’s important for you as a buyer to know that the short sale process can take anywhere between 4-6 months or possibly longer to commence the agreement. If the sheriff’s sale has already taken place, the redemption period has started and unless you come to terms with the bank prior to the redemption period expiring the wait may be all for nothing. The important part is to know where in the process are they, have they missed payments or not, as the sheriff’s sale occurred or do they, at least, know when the sheriff sale will be? Knowing the answers to those questions are important to know if the sale will be worth the wait.
Here’s the process of a short sale (every scenario is different):
- The homeowner may miss a payment or be aware of a missed payment in the future
- They choose a Realtor to represent them with listing the property for sale
- In many states, it’s suggested that an attorney also represents the homeowner to protect them after the sale (tax ramifications can exist so you will want to check with an attorney and/or your CPA to know how this will effect you).
- The property price is reduced until an offer is received. Unlike a traditional sale, most banks will only look at one offer at a time. This offer will be signed by the seller and then sent to the bank to be negotiated.
- Then you wait…. market evaluations are conducted to verify the value of the home, research is done on the local market to make sure your offer matches the highest possible value for this home. It’s possible that the bank will counter your offer so don’t always expect to get the home at the original written offer price.
- It’s suggested that you submit your earnest money and complete a buyer’s inspection as you normally would (there are varying opinions on this, consult a Realtor in your area).
- The bank accepts, counter’s or denies your offer altogether. Keep in mind a lot of things are happening during this time and we’re typically 5-6 months in at this point.
Pro’s of purchasing a short sale property:
- Again you can purchase a property much less than the current market value
- You also have an opportunity to do fix-ups or remodels to gain quick equity
- Unlike a foreclosure, people are still typically occupying the home, which means the heat is on and there’s less risk of frozen pipes and/or extensive damage being done to the home
- During the short sale process, the bank will usually take care of past unpaid water bills, assessments and more in order to provide a clear title to transfer (consult with your Realtor to verify)
- Since typically the property is being maintained, the water, heat etc. are on so the inspector can easily inspect major home mechanicals before you fully commit to purchasing the property
Con’s of purchasing a short sale property:
- The short sale process is very slow and tedious
- After waiting through the process, you’re never guaranteed to actually end up with the property in the end
- There’s extra documentation you will sign as you will be purchasing the property as-is
- Once you’re engaged in a contract and have submitted your earnest money, that money is tied up and in most states you cannot look at other properties until this contract is fully canceled
- If you decide at some point to move on from the sale, you will be out the money you paid for the inspector. Make sure you have short sale contingencies set for specific timeframes, in the event you do cancel within those guidelines you will be able to get your earnest money back. If you don’t, you will loose your earnest money plus the expense of the buyer’s inspection.
So now that we have reviewed both options, I hope you have an insight as to if purchasing a foreclosure or short sale is a viable option for you. The biggest thing to know is to have a real estate agent familiar with the distressed property and how the banks work in order to protect you through the process.
You’ll also want to discuss the condition with the properties with your lender if you plan to borrow money as foreclosures and short sales can typically be in too poor condition to qualify for a regular federal loan such as FHA. Some conditions may also exclude you from a traditional conventional loan so you may want to have an idea of what you can borrow and at what down payment before getting your sights set on a foreclosure or short sale.