The Differences Between a Short Sale and a Foreclosure (And What They Mean for Buyers)

Jan 29, 2019 | Education, How-To, January Roundup, Tips

For buyers looking at every possible home option in their chosen market, it’s important to understand foreclosures and short sales. Both foreclosures and short sales are types of distressed sales, meaning that a property is being sold urgently, and often at a significantly lower price than it might otherwise go for.

But how do these two types of sales work? How are short sales and foreclosures different? And what do buyers need to know before they start looking at short sales and foreclosures as an option?

Foreclosures Vs. Short Sales

Short sales and foreclosures are both avenues for homeowners who have fallen behind on mortgage payments and wish to, or need to, sell their home. But while they often get lumped together, these two processes are actually fairly different, and they work very differently for buyers on the market.

Broadly speaking, a foreclosure is the legal process by which a lender or bank reclaims a home, once a homeowner defaults on their mortgage payments. Once a homeowner falls significantly behind on mortgage payments, their lender will issue a notice of default, informing the borrower that they are at risk of foreclosure. After this, the buyer is given a chance to remedy the situation by making up payments. If the owner and the lender can’t settle the debt or reach another arrangement, the property goes up for auction. Often enough, a lender, such as a bank, then takes possession of the home, and lists the property for sale as a real estate owned property, or REO.

In many cases, a seller uses a short sale as an attempt to avoid the foreclosure process. A short sale refers to a home sale where the market value of the property is less than the outstanding balance of the owner’s mortgage. This type of sale is an attempt to help the lender recoup whatever they can on the property, and minimize their losses. At the same time, a successful short sale can allow the homeowner to move on, free from their liability and with less significant damage to their credit.

The Pros and Cons of Short Sales and Foreclosures for Buyers

As a buyer, it may be tempting to look into the short sales and REO listings available in your market. Short sales and foreclosures can offer some concrete advantages — for the right type of buyer.

For one thing, these listings, as distressed sales, often ask for a significantly lower price than comparable homes on the market. That potential for cost savings is enough to entice many buyers. Similarly, in markets with lower inventory, broadening your home search to include foreclosures and short sales may open up new possibilities, which you may have otherwise overlooked.

However, these types of sales are not going to be the right fit for all buyers. Even in “best case” scenarios, there are many potential risks to consider when it comes to both short sales and foreclosures, such as:

Stressful Timelines

For one thing, these types of distressed sales often come with tricky timelines for buyers. With foreclosures and bank owned sales, the current owner typically wants to make as much as they can, as quickly as possible, leading to an extremely accelerated closing. In contrast, with short sales, the timeline can often stretch on for months and months. The seller’s lender must agree to the sale, which often takes significant amounts of negotiation and waiting. Similarly, outstanding liens on the property may have to be resolved. Committing to such a drawn-out sales process may mean that buyers miss out on other opportunities.

Repairs, Renovations, and Other Hidden Costs

In many cases, homes being sold as short sales and REOs are going to be in need of significant maintenance or upkeep. Foreclosures often go unoccupied, meaning that the property may fall into disrepair due to neglect, or lack of utilities. In many cases, with bank owned properties, buyers are going to have to buy the property “as is” — meaning that you may be responsible for a lot of initial maintenance. Typically, with foreclosures, you will not get a chance to perform an inspection of your own. You may have to put pressure on the owner (the bank) to perform an inspection. Otherwise, you could be purchasing a home with significant code violations, or potentially even unforeseen liens and title problems that need to be addressed.

The Importance of Insight and Experience

As you weigh all of your options, remember that one of the most important steps you can take as a buyer is to bring on the right real estate broker.

If you’re considering pursuing a short sale or foreclosure, your broker is going to be one of your most important partners, and an absolutely invaluable resource. Your broker can help you understand market trends and conditions in your neighborhood of choice, making sure you don’t miss any great home opportunities. And at every step of the way, your broker can assist with negotiations, paperwork, meeting deadlines, and so much more — all with the insight and knowledge it takes to make this tricky process go as smoothly as possible.

Looking to buy? Start you search.

Written by Troy Pieper Baird & Warner