The primary difference between a short sale and a foreclosure is in who is selling the property. With a short sale, the bank allows the borrower to sell the home for less than the outstanding loan amount. Foreclosure is when the bank seizes the property from the borrower and attempts to sell it to satisfy the outstanding loan amount.
When a bank is unable to sell the property during the foreclosure auction, it becomes a real estate-owned (REO) property. Prices for REOs can be better than short sales because the bank is not in the property management business.
Learn more about the differences between short sales and foreclosures.
How Short Sales Work
A short sale happens when a property's lender agrees to accept less than its unpaid balance of the outstanding mortgage to facilitate a sale.
The bank holding the outstanding mortgage usually takes a long time to decide if it will accept the short sale offer. Waiting for an answer on a short sale can be frustrating. Some short sale buyers wait months for a response.
Beware of Pricing
Buyers gravitate toward short sales for two reasons: the list price is attractive, and they believe the seller is desperate. However, neither of those beliefs is necessarily true. Since not every short sale home is in foreclosure, not every seller is desperate. Moreover, sellers often set the listed price unrealistically, hoping that buyers will flock to that listing like moths to a flame.
Preapproved Short Sales
If you're thinking about buying a short sale, consider looking for a preapproved one. The way a listing agent finds out how low the bank will go is if an offer has already been accepted and the buyer walks away. Only then is the agent free to market the listing as an accepted short sale because banks rarely disclose a bottom-line price upfront.
With a preapproved short sale, the new buyers' wait is dramatically shortened. Typically, about the time the first buyers walk away, the sellers' documents have already been submitted to the lender, and the lender may have been close to issuing the short sale approval letter. The missing documents at this point are the new buyers' offer and loan qualifications.
Short Sale Negotiations
The sellers can agree to any type of purchase offer, but it's not binding unless the sellers' bank approves the offer. It doesn't matter what stipulations are in the offer if the bank won't accept them. Your true negotiation isn't with the seller; it's with the bank's negotiator.
Banks rely on desktop appraisals and third-party BPOs (broker price opinions) to determine a home's value. Although banks don't want to foreclose, they also want a fair market value. It is up to the listing agent to provide comparable sales and to substantiate the price submitted by the buyer.
Short sales are voluntary for the seller, while foreclosures are involuntary. For buyers, either can result in a good deal on a home, but short sales can take a long time to close.
How Foreclosures Work
Foreclosure is a bank process where they try to recover as much of the unpaid mortgage balance from a property as possible. They do this by forcing the sale of the property, usually at an auction.
Should you wait out a short sale and see if the home goes to foreclosure? Whether a buyer should wait for the property to go through foreclosure and be deeded to the bank depends on whether the home has multiple offers. If more than one buyer has submitted a short sale offer, the highest and most qualified offer will most likely win.
If the buyer is the sole offerer and the bank is responding negatively to the short sale or, worse, not at all, it might be in the buyer's best interest to wait out the foreclosure. There is also no guarantee that a bank won't reject multiple offers, particularly if none is high enough.
When Foreclosures Become REOs
Sometimes banks aren't reasonable and end up shooting themselves in the foot. Banks may refuse to accept short sale offers only to get title to the home through foreclosure, which they ultimately sell for tens of thousands less.
You can get a clue as to what the bank might do by looking at the opening bids posted in the event a home is in foreclosure. Often banks will post a minimum bid for the auction. If that minimum bid is the amount owed to the bank, that tells a reasonable person that the bank does not expect to sell the home to anybody at the auction. A reasonable person does not want to pay the balance due on the mortgage, or that person would just pay off the mortgage and buy the home from the seller.
The Bottom Line
Don't get discouraged if the bank rejects your short sale offer. Be smart. Submit that offer again, and you might get a different negotiator. The listing agent might be able to submit revised documentation on the seller's behalf that could alter how the bank will look at the short sale file.
If no one else submits a higher offer, eventually, the bank will put the home up for sale as an REO. Watch for it to reappear on the market as a bank-owned home. If the price is reasonable at that point, buy it from the bank. At least buyers of bank-owned homes are relatively assured their transactions will close within 30 days or so, and most likely at a much lower price.