What’s the Difference Between Foreclosures and Short Sales?
Short sales and foreclosures were rampant a decade ago when the housing market crashed and millions of homeowners found themselves underwater on their mortgages. While the rate of foreclosures and short sales have certainly diminished since then, they still occur, giving buyers a chance to score a great deal on a home.
But before you start looking at these types of sales for a discount on a home purchase, it’s important to know the difference between the two.
Foreclosures
Foreclosures commence when a homeowner does not pay the mortgage for a certain period of time. In this case, a legal process known as “foreclosure” will commence.
More specifically, a “Notice of Default” will be issued to the homeowner informing them that they are at risk of losing their home through foreclosure if they do not settle their mortgage issues with the lender. Usually, this notice is sent out after three to six months of missed payments.
At this point, the homeowner has the opportunity to settle their mortgage arrears with their lender, either by paying what they still owe or by going through a short sale, which we’ll discuss shortly.
If the debt isn’t settled in either one of these two manners, the lender has the right to sell the home at a foreclosure auction in order to recoup their losses. If the auction does not result in a buyer for the property, the lender will then take possession of the home and become the rightful owner. At this point, the home will be classified as a bank-owned property.
These types of transactions usually don’t drag on for very long because lenders will usually want to cut their losses as soon as possible and get these properties off their hands.
It’s important for buyers to know that even though they may be able to snag a great deal, there is some risk involved with buying a home this way; namely, they could be buying a home with major issues.
While the average home purchase typically comes with a home inspection before the deal is sealed, foreclosure transactions don’t normally have inspections conducted before the buyer takes possession.
That means buyers could be getting their hands on a property that has major issues with it that could cost a ton of money to rectify, such as mold, termite infestations, structural issues, water damage, and others. In these cases, there’s really no deal at all after more money is spent making the necessary repairs.
Further, there could be liens on title that may not have been known about beforehand, which the buyer will have to be assumed once the transaction goes through.
Short Sales
A short sale can occur before the home ends up in foreclosure as a result of mortgage arrears. In this case, a short sale happens when the property is valued at less than what the homeowner owes on the mortgage. In this case, the homeowner is considered to be “underwater” on the mortgage.
During the short sale process, homeowners and lenders will negotiate a deal in hopes of the lender accepting less than what is currently owed. If an agreement can be reached, the home will sell as a short sale and the mortgage debt will be considered settled. The homeowner won’t have any further financial obligations with the mortgage or the home after the deal closes.
The lender will typically require documentation to prove why a short sale is the best route to take, considering the fact that the lender could be on the hook for covering more expenses than they care to take on. Short sales cannot occur without lender approval.
If a deal can’t be reached, that’s when foreclosure becomes the next step.
Short sale transactions can take much longer than the average home sale to complete because the buyer will typically be required to accept additional demands from the lender, such as covering closing costs and necessary repairs. In some cases, it can take up to a year or more to close on a short sale.
Usually, sellers would be responsible for covering the cost of repairs and closing costs, but lenders are liable for such expenses in the case of a short sale.
If you’re considering a short sale purchase, keep in mind that the lender will try to get you to cover these costs and that the transaction could take longer than it normally would with your average listing. Other than that, a short sale will still occur as any other type of real estate transaction would, with a real estate agent listing the property for sale and a home inspection allowed to take place.
The Bottom Line
There are certainly deals to be had with foreclosure and short sale transactions. But there’s usually a little give and take in order to get a good deal and save some money on a home purchase. Both of these types of scenarios can come with their own set of hassles and obstacles to have to deal with.
If you’re considering buying a home that’s being sold as a short sale or foreclosure, consider working with a real estate agent who is well-versed in these types of transactions to keep yourself protected at all times.
