Foreclosure and Short Sales

Short sales and foreclosures are two distinct types of transactions that share the common denominator of being distressed properties, which involve a mortgage lender. (They are not interchangeable terms — although most people don't realize it, there is a distinction between the two.)

Many home buyers start a search for short sales and foreclosures in the hopes they can buy a cheap house, either for investment purposes or to occupy as a residence.

They believe they can save a lot of money or buy a home for much less than market value.

When buyers call me to say they want to buy a short sale or a foreclosure, I give them the reality check. That truth is they probably will not save any money since banks tend to value both short sales and foreclosures at market value, with an allowance for the condition of the property. However, there are also exceptions, and every so often the situation will be just right. It's more the exception than the rule, though.

To get started, let's examine the differences between short sales and foreclosures.

Basic Features of a Short Sale Property

• A short sale house is a home that is not owned by the bank. However, in order for the sale to close escrow, the bank must approve the sale.
• The title is still in the name of the homeowners, and the owners often live in the property because they can't afford to go anywhere else.
• The homeowners may or may not be behind in their mortgage payments; delinquency is not always a requirement.

• There must be a documented hardship letter. That hardship may include a loss of employment or forced retirement, it could be health-related, or the sellers could be getting divorced or facing incarceration.
• Some short sales involve reverse mortgages signed by sellers who have died, or second loans that were discharged in bankruptcy but never released.
• Although the home is not necessarily underwater, most short sales involve paying less than the full amount to the lender. A seller can also qualify for a short sale if the equity is insufficient to pay all of the costs of sale such as commissions and closing costs.

Basic Features of a Foreclosure Property

• Foreclosures are homes that are owned by the mortgage lender or — if the mortgage was insured or guaranteed — by a government entity such as Fannie Mae, Freddie Mac, or HUD.
• There are various ways a lender can acquire title to a foreclosure property. The most common way is by foreclosing on the homeowners for non-payment of their mortgage. However, a bank is allowed to foreclose for other reasons, such as the procedures offered when a homeowner sells the home to another individual without paying off the loan. Subject-to sales are no longer allowed. Banks can also take title to a foreclosure property through a deed-in-lieu of foreclosure or a court action.
• When banks take title to a foreclosure property, they evict the occupants and secure the home. Generally an asset management company will shut off the water, and perhaps board up the windows and doors and change the locks. This is why foreclosures are often an eyesore in the neighborhood.

Terms of Foreclosures and Short Sale Transactions

Almost every short sale and foreclosure is sold in its "as-is" present condition.

Some banks will invest in fixing up foreclosure homes because the banks realize they can increase their profit by rehabbing, but many banks sell the home in the same condition the previous occupants left it, however deplorable.

There are sometimes extenuating circumstances under which a bank will allow a price reduction for a major defect, but that is typically rare. You may ask, for example, for a reduction or credit to replace a furnace or the roof, but if the market is hot and another buyer might pay cash, the bank will probably reject that request.

The main difference between a foreclosure property condition and a short sale home condition is the foreclosure's condition could be unknown. The foreclosure home could be vacant for months, even years, during which mold or water intrusion can occur. Sometimes owners trash the home or fail to maintain it properly when the home is in foreclosure. In comparison, short sale sellers tend to take better care of their homes, and they can provide disclosures to the buyer.

Another difference is a foreclosure property can generally close within 30 days. A short sale, which requires bank approval, can take 30 days to 3 months, on average, just to get the short sale approval letter, and then another 30 days to close, so twice as long at minimum.

Where and How to Buy Foreclosures

Unless the bank is small and local, it is unlikely to offer a foreclosure home for sale to the public. Banks generally dispose of their foreclosures in 5 ways. With the exception of the bulk sale method, most of the ways banks sell their foreclosures involve a profit to the bank.

• At a trustee's auction or sheriff's auction. This procedure is a bidding process that takes place on the steps of the courthouse or other public building. Typically the offers must be cash, and the bank sets a minimum reserve price. If there are superior liens, the buyer assumes responsibility for those liens. Buyers at an auction often do not work with a real estate agent.
• In a bulk sale to private investors. These can be homes that were not sold at an auction or homes the bank never put up for auction. The bank will package these homes in groups and sell the entire package to an investment buyer or company at a steep discount.

• Through an online auction company. Many of the online home auctions place a reserved bid at which the home will not sell if the reserve is not met. They often require the buyer to pay a premium bonus such as 5 percent over the offered price as a fee to the auction company. The original sales prices are often below the reserved bid price and can appear deceiving. Most of these websites allow your own agent to represent you.
• By listing the home with an REO agent and offering the home for sale in MLS. The REO agent works with the bank's asset manager and prepares a BPO. The agent assesses condition, and allows for a deduction for its AS IS condition, so the home is basically listed at market value. Your agent can represent you.
• By placing the home for sale on its own website portal and allowing electronic offer submissions. This is more common with government entities. The banks will also pay your agent to represent you.

Where and How to Buy Short Sales

A buyer or investor is not permitted to buy a short sale directly from the homeowner. In fact, many short sales require the buyer to sign an arm's length affidavit that states there is no pre-existing relationship between the sellers and buyers. I have had banks reject a short sale because the buyer was a neighbor who lived nearby.

(Further, some parties may object to this practice and they withhold that information from the bank. They might sign an arm's length but secretly fail to disclose a relationship with the seller. In states like California, that action could constitute short sale mortgage fraud, which permits the bank to rescind the release of liability offered to the seller.)

You should hire your own real estate agent to represent you when buying a short sale. That agent should not be the listing agent. You deserve your own representation. Besides, bank tend to reduce the commission to listing agents who practice dual agency in a short sale.

Your agent should determine for you how many banks and liens are involved in order for you to adequately prepare for the wait for short sale approval. Your agent might also want to verify the seller qualifies for a short sale. Although not every short sales require a seller hardship, most do.

Finally, a tip: Banks might present you with a counter offer and ask for a higher price. If the property requires repairs, you might be successful with closing on your accepted sales price if you present the bank with a couple of documented estimates and photographs.

At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.