Short Sale vs Foreclosure: Which One Should You Buy?
Most people purchase homes that are newly-made or were sold by the owner willingly. However, a market exists for real estate-owned (REO) or bank-owned properties – houses that were sold by the homeowner because they defaulted on their mortgage. Boasting lower prices compared to the current market value, these properties can be made into a new home or used as investment properties.
In this guide, we’ll discuss short sales and foreclosures in-depth. We’ll explain why mortgages default and what makes short-sale and foreclosure properties different. We’ll also touch on the benefits and caveats of buying REO or bank-owned properties as well as share tips on how to get the most value out of them.
Understanding Short Sales And Foreclosures
In most cases, a mortgage defaults because the homeowner is unable to make their monthly payments. Whether it’s because they lost their job, rising interest rates made the loan unaffordable, or any other reason, not keeping up to date on mortgage payments causes it to default.
There are also other causes for a mortgage to default, such as if the homeowner breaks the home loan contract. If it happens, the bank may demand them to pay the remaining mortgage balance – otherwise known as accelerating the debt.
Once the bank sends a notice that they’re accelerating the debt, the homeowner must pay it off. If they can’t, they have two options: put the home on a short sale or let the bank foreclose on their real estate.
Putting a home on short sales is a voluntary act where homeowners sell their properties for less than what they owe on the mortgage. Generally, homes put on short sale feature prices well below the market value for similar real estate and need to be pre-approved by the lender.
For example, a homeowner decides to sell the home for $180,000 even though they still owe $200,000 on their loan. This means they have a deficiency of $20,000. If the sale goes through, the bank will waive the remainder of the loan balance, considering it to be fully paid off. Short sales are often seen as more favorable because they impact the homeowner’s credit score less than a foreclosure.
Aside from being a method to settle mortgage debts, a short sale works almost like a regular home sale where the seller works with a real estate agent to find a buyer. However, different from a regular home sale, the lender is the one who has the final say to approve the winning offer from buyers to minimize their losses. Due to this more rigorous approval in the short sale process, it can take up to a year to close a short sale.
Benefits And Caveats Of Buying Short Sale Properties
Short sales sound like a good deal for everyone involved. You can get a home affordably, the homeowners are free of debt, and the lender can recoup their losses.
However, these benefits also come with some caveats. In this section, we’ll break down the advantages and disadvantages of buying short sales.
Properties Are In Better Condition
Generally, short sales are kept in good shape because they’re sold voluntarily. Because they want their house to be sold, they’ll likely keep the property in more presentable condition compared to a foreclosure. Due to this, you can save by not having to pay for extensive renovations.
Straightforward Purchase Process
Because the process of purchasing short-sale properties is similar to the traditional homebuying process, you won’t have to learn much if you’ve bought a home before. Just like other homes for sale, you can seek a mortgage to finance it as well as get an opportunity to inspect the home before making the purchase.
Purchasing Process Takes Time
You should remember that the lender has the final say for the property’s sale because they’re trying to recoup as much of their losses as possible. Therefore, it may take a large amount of time to close on your sale – the approval of your offer may take three months or even one year. If you plan on buying a home quickly, it’s not recommended to seek a short-sale home.
More Competitive Market
You’re not the only one looking to get a property at a cheaper price by looking for short sales. Other people will also be putting in their offer, and you have to compete with them to purchase the property. Due to this, you may not be able to get the house at your initial offer price because you need to appeal to the lender by offering the best price.
A foreclosure is an involuntary act where the lender seizes the house after a significant period of nonpayment. Generally, the lender will send a notice of default to homeowners after three or six months of missed payments. This notice contains information that the house is at risk of foreclosure and the homeowners will be evicted if left unpaid.
Once the homeowner receives the notice of default, they can try to settle the mortgage debts by either providing the owed payments or performing a short sale in a period called pre-foreclosure. Generally, this period lasts one to four months after the homeowner receives the notice of default.
Most people don’t want to undergo a foreclosure on their house because it has a negative impact on their credit score. Foreclosures stay on a credit report for at least seven years.
If homeowners fail to pay off the loan, the bank will begin the foreclosure process. To make back the money they lost on the mortgage, the bank will usually organize a foreclosure auction for third-party buyers to participate in. However, if nobody buys the home, the bank will become the homeowner and it will be considered an REO (real estate-owned) or bank-owned property.
In contrast to short sales, the bank usually works quickly to sell the home in a foreclosure process because the bank wants to liquidate the asset as soon as possible.
Benefits And Caveats Of Purchasing Foreclosed Properties
While it may seem riskier, purchasing foreclosures can be an even more affordable option if you need to purchase real estate at a deep discount and get the process finalized fairly quickly. In this section, we’ll break down the major benefits and caveats of purchasing foreclosed homes.
Property Prices Are Far Below Market Value
Your main advantage when looking for a foreclosed property for sale is that these properties are offered at deep discounts. This allows you to save up much more compared to purchasing a home traditionally. These low prices usually stem from the bank wanting to sell the property as quickly as possible in order to recoup their losses.
However, you should keep in mind that your mortgage lender might not provide loans on foreclosed properties. If you’re looking to buy foreclosures, you’re likely going to need to pay in cash.
Fast Closing Process
Stemming from the bank’s need to sell the property as quickly as they can, you can expect your home purchase to be finished faster than usual. Typically, foreclosed property sales are finished in just 30 days, in contrast to the average 54 days it takes to close a traditional home sale.
Property Might Not Be In Good Condition
A foreclosed house is sold ‘as-is’. This means that you might not be able to have the property inspected or even check it yourself before putting in your offer.
Because properties are often put on foreclosure by force, the previous homeowner may not have taken care of the home before the lender takes it – you may even see some damage to the property when you move in. You may need to spend much more on renovation compared to a home bought through other methods.
Potential Of Informal Settler Problems
When you buy a foreclosure, you may find informal settlers occupying the home. While some can be evicted simply by calling the police, some may have forged documents to appear like they have a legal right to live in the house. Because legal eviction procedures cost a large amount of time and money, they might add more expenses to this seemingly good deal.
Why Purchase Foreclosed And Short Sale Real Estate?
Because foreclosures and short sales are usually sold well below market value, they can be a more affordable option for homebuyers and investors. Additionally, buying and renovating a foreclosed house to sell can be a lucrative choice for flippers. Investors can also use the house as an investment property of their own to rent out.
However, purchasing an REO property also requires you to be patient and do your due diligence, especially for investors. Buying homes on short sale may be cheaper than buying homes sold regularly, but they may take longer to close.
You should also keep in mind that foreclosure properties may not be in the best condition, and you may need to spend a considerable amount of money to renovate them. Investors will need to check whether they profit from purchasing a foreclosure below market price.
Short Sale Vs Foreclosure: Which Should I Buy?
Short sale or foreclosure properties are often cheaper compared to traditional purchases. However, you may encounter more hurdles because of the circumstances surrounding the home sale.
If you’re not in any hurry to find a home and are willing to pay slightly more, you can consider buying a short-sale property. The lower price can still allow you to save and the condition is often better compared to foreclosures, but you may have to wait longer and compete with other potential buyers who may offer a higher purchase price.
However, if you want your property closed quickly and don’t mind putting in the work, you can look into foreclosed homes. Keep in mind that there are invisible costs to foreclosures like the effort and expenses to renovate as well as the potential cost of having to deal with informal settlers.
Tips For Purchasing Short Sale & Foreclosed Properties
Here are some tips that make purchasing a home owned by real estate or the lender a less daunting process.
Work With Experienced Real Estate Agents
To help you navigate the paperwork and contact the sellers, buyers can enlist the help of a real estate agent. Because a mortgage lender often passes off foreclosed homes as REO properties, they may have a list of foreclosed properties you can consider.
In addition to that, foreclosure specialist agents can also help buyers negotiate prices and arrange home inspections if possible.
Secure Your Finances Beforehand
While you can apply for a mortgage if you want to buy a short-sale home, you’ll need to be more prepared to buy foreclosed homes. Since most foreclosure properties are sold in an auction, your mortgage lender might not provide you with any loans – you need to have the amount of money you’ll be offering in cash.
Prepare For Inspection & Renovation
When you buy an REO property, it means that you’re purchasing a second-hand home. Even if the property you’re purchasing is sold on short sales, you should always do your due diligence and hire professional inspectors to ensure that the building is up to standard.
If you’re purchasing a foreclosed home, inspectors are even more important. You should have contractors ready to go once you close on the property because most foreclosed homes are left in poor condition.
Purchasing a short sale or foreclosed property can help you find a home for less than market value. Investors in real estate can also consider purchasing these properties to later rent out or sell.
But while REO homes are usually sold at a discount, there are many hidden costs due to their condition. You may need to pay for an extensive renovation or wait a long time to close the sale.
Looking for a short sale or foreclosed properties to buy? Contact Wesley Mortgage, LLC today! Our team of financial professionals can help you find affordable properties in your area for your home or investment property. Contact us today for more information!