Short Sale vs Foreclosure

August 11th, 2008 categories: Real Estate Finance

What’s the difference between a short sale and a foreclosure? We’re all hearing about them in the news and I’m sure some of you have, or are currently dealing with one yourselves. As people’s Adjustable Rate Mortgages(ARMs) continue to adjust, more and more people are finding themselves in a difficult situation.

Basically, a short sale is is when the owner(Joe Smith) owes more money on the home than he/she can sell it for and is experiencing financial hardship. Maybe they bought the home a few years ago when the market was hot and paid $700,000 for it, financing all of it and now that the market has shifted and prices have dropped, that same home is only worth $500,000. Or maybe Joe bought the home for $500K, but pulled out some equity to pay off other debts. Joe Smith is still making payments on a $700K loan, but can only sell it for $500K.

At this point, Joe would hire a Realtor and prepare to sell the home like any normal sale. The Realtor would then work with the owner to submit a package to the bank(s), who has a lien on the home. The idea is to prevent the home from going into foreclosure and costing the bank and the owner more(short sales are less harmful to a person’s credit than a foreclosure).

The seller and the Realtor would work with a loss mitigator who would arrange for an appraisal, or a Broker Price Opinion(BPO) and then review any offers that come in. The process can take anywhere from a month, to more than 6 months – depending on who the bank is, if there’s a first and a second loan on the home, if the seller is still making payments or not, if the property is being rented or not, etc. If you’re looking to purchase a short sale, be prepared to wait it out.

If the bank has already done it’s BPO and has approved a sales price, then things don’t take as long. Often times you’ll see, “Offer accepted pending lender approval” on a listing. This simply means that the owner, Joe Smith, has accepted someone’s offer, but the bank is still reviewing the file to see if how much they’ll sell the home for(since they’re the ones who will eat the loss – the difference of what the seller owes and what it sells for). Remember, in a short sale, Joe Smith is still the owner and not the bank, but in the end it is up to the bank who has final say on the sales price.

In a foreclosure, the bank is the actual owner of the home. Joe Smith is no longer in the picture and you’re dealing strictly with the bank. Typically the list price is already below market price and it’s very common to have multiple offers. In some cases, you can purchase the home for less than asking price – it just depends on the home and the bank.

The biggest thing to remember about a foreclosure is that the seller is the bank and they have not lived there. This means that they’re not obligated to provide certain disclosures about the home and you have to do your due diligence. This is true in any home purchase, but even more so in a foreclosure.

Since the owner can’t tell you about the crazy neighbor down the street, or that the house flooded a year ago, make sure you spend some time in the neighborhood and to get a good home inspector. You’ll also want to be extra careful when reviewing the preliminary title report(PR). This is where you’ll see what liens are on the home and so forth.

Many banks will also take an all cash offer over a financed purchase that may be slightly higher in price. At this point, the bank is trying to get rid of this home as quickly as possible and that usually translates to an all cash offer. Again, it depends on the bank and the particular home for sale.