Foreclosures and Short Sales: What You Need to Know

Foreclosures and Short Sales: What You Need to Know

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We’ve all heard it blasted across TV screens, on the covers of books about real estate deals, and of course in the break room at work where someone always has a friend of a friend who bought a foreclosure for next to nothing.

You think, "well, this is fantastic, I am going to run out and find a foreclosure or a short saleand buy it for half price right now!" That would be an amazing deal, right? Okay, duh . . . of course it would be an amazing deal if you snagged a house worth $600,000 and only paid $299,000.

So often homebuyers think they should focus all their shopping attention on so-called distressed properties, or what I call stressed-out properties—a term I’ll use loosely to describe any property in foreclosure, short sale, or one that has gone back to the bank and is potentially up for auction. All of us have heard anecdotally that these types of houses are good deals. The irony is that most homebuyers probably cannot begin to define a foreclosure or a short sale and don’t have any idea about the pros and cons of buying either one. However, because foreclosures and bank-owned properties are so abundant these days, they should be considered

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Good foreclosure and short sale buys are available, but you need to do your homework, understand exactly what you are getting into, be patient, and learn the foreclosure and short sale process before proceeding.

Don’t Focus Only on Foreclosures and Short Sales

You don’t need to pursue distressed properties exclusively to get a deal. Let me explain it this way. On the same block in Scottsdale, Arizona, are three identical houses. One of them is in foreclosure and on the market for $330,000. Another is a short sale and also accepting offers at $330,000. The third house is owned by a nice elderly couple who needs to move back east. At what price do you think they will have to list their house to get it sold? That’s right, $330,000. Why would you overlook their house—a much easier transaction to close—just because you mistakenly think that the best deals are only foreclosures and short sales?

First, however, we have to distinguish between a foreclosure and a short sale. These terms get thrown around a lot, but many people are confused by what they mean exactly. It’s important to know the difference because each comes with its own set of rules and challenges.

What Is a Foreclosure?

When a homeowner can’t meet his payments, or refuses to make payments for whatever reason, the lender takes the property back. The bank or lender will declare the borrower in default and provide a demand letter specifying a final date by which the borrower must become current. To become current the homeowner would have to catch up with his delinquent payments and be current with his monthly payments. During this process and until the lender has completed the foreclosure process and obtained title to the property, the property is said to be in “preforeclosure” and remains under the control of the borrower (current “owner”). Oftentimes these properties will be listed on the market for sale as the borrower attempts to sell off the house to avoid the financial and credit impact of a foreclosure action.

Once a property has hit the foreclosure stage, approval of a sale may involve the lender. This is often because the price at which the owner is selling is lower than what he owes. In essence, it becomes a preforeclosure short sale. In addition, once the foreclosure is completed many states provide the borrower with what is known as a period of redemption. During this time the owner, or “seller,” still has an irrevocable right to get back up to speed and pay off the default, including all foreclosure costs, back interest, penalties, and missed principal payments. He then regains control of the property.

See, I warned you it was a bit complicated.

Each state has different laws. Some procedures involve the courts while others do not. Once the property passes through certain phases, it’s eventually ready to be sold at auction to the highest bidder, or put on the market and listed as a “Bank Owned.”

What Is a Short Sale?

Anytime you buy a short sale, what you’re doing is asking to buy a property for less than what the homeowners owe on the loan. The big caveat to short sales: The current owners must get the bank or mortgage holder to agree to this type of markdown sale. Not all lenders accept short sales or discounted payoffs, especially if they feel they can recover more of the principal by foreclosing on the house. And not all sellers, or all properties, qualify for short sales. Generally, the borrower must have a legitimate “hardship” such as a loss of income due to unemployment or medical situation in order to be considered.

Also, all too often the lender won’t accept an offer from you until you’ve completed a full short sale package that entails providing all of your financial information and a fully signed contract with the seller. Your Realtor will be able to assess the likelihood of that short sale being approved at the beginning of the process.

Generally speaking, short sales can take an excruciatingly long time to close even once an offer has been accepted. I once heard of a short sale that took place in February and generated lots of bids, but it still hadn’t closed by June of the same year. If you’re the one with the winning bid and you can’t get the house to close so you can move in, it can be an arduous and frustrating process to endure—much more so than buying a home that doesn’t fall in the distressed category.

The Bottom Line About Foreclosures and Short Sales

When a property is in trouble or in distress, it’s critical to be far more cautious than when purchasing a traditional sale property. Know that it won't happen quickly (and maybe not easily), but you can buy a distressed property - just remember to keep your expectations about price and timing in check along the way.

More From Trulia

The Six Roadblocks To Buying A Foreclosure or Short Sale
4 Things You Must Do To Buy or Sell A Home This Summer Season
The Pros and Cons of Buying A Multiunit Property

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