A lot of my clients are not initially aware of the differences and advantages/disadvantages when comparing short sales versus foreclosures. This blog will be an attempt to explain in detail how the process works and the benefits and hassles associated with each. First I will describe and somewhat define both a short sale and then I will go in-depth about the disadvantages and advantages of each when purchasing a property.
A foreclosure is a property that is already owned by a bank. Typically a foreclosure is obtained by the bank when the past owner is in default and has not been making their payments. The bank files a “Notice of Default” and an auction date is set for the property to be auctioned off (in our case at the Sevier County Courthouse steps). In most cases the lending institution (holder of the mortgage note) ends up bidding and winning the property at the auction for the amount of the existing mortgage or close to the amount. There are exceptions to this scenario such as when the original owner in default had a large down payment or a substantial equity position in the property. In this scenario other bidders may take interest and bid against the bank. Once a property is acquired by a bank they typically hire an “asset manager” to deal with the sale of the property and obtaining a “Broker Price Opinion” or BPO which is basically an appraisal of the property value. The asset manager then selects a Realtor to market the property and offer it up for sale in the MLS. Large banks typically handle foreclosures in this manner. Most of the smaller, local banks skip the process of hiring an asset manager and list the property with a Realtor direct.
Short sales are more difficult to explain in a clear cohesive manner. A short sale occurs when the property owner is facing difficulties making their payments on the property. This could be due to a variety of reasons. The cabin may not be generating enough rental income, they could be facing financial difficulties, lost their job, facing health concerns, or any other reason they are not capable of continuing payments of their mortgage. A short sale boils down to the current owner is having difficulty making their payments, the price they could obtain for the property is less than the existing mortgage, and they are not capable of making up the difference (bringing money to closing). An owner of a home then consults with their lender, provides them detailed documents about their financial situation and the lender then decides if the property is eligible for a short sale. Sometimes, a lender will reject a short sale opportunity if an owner cannot show “financial hardship”. If an owner has substantial assets and can afford to either make payments on the loan or has the funds to make up the difference between the estimated selling price and the existing mortgage the lender will usually not accept the short sale scenario. Most often in this area with overnight cabin rentals this is not the case as many cabins have been going into a “short sale status” or deed in lieu of foreclosure.
A short sale can get very tricky when there is more than one mortgage on the property (by different lenders). The reason is that a short sale requires the cooperation of all lenders involved with the property. The first or senior lender has little reason to offer any of the proceeds to a junior lender (the second mortage holder), since all junior liens will be cleared if the senior lender forecloses. Therefore, the senior lender typically requires that it receive all of the net proceeds of sale or that the junior lienholder be paid only a token amount. If the senior loan has been securitized, the loan securitization agreement can prohibit the loan servicer from negotiating in this situation. However, if the junior lienholder will receive nothing from a short sale, it has no incentive to cooperate.
A short sale is advantageous to an owner because it would not have a foreclosure on their credit, but their credit is usually damaged substantially (80 to 100 points off the FICO score approximately for a short sale vs. 200+ for a foreclosure) by this point anyway. From a bank’s perspective it has a couple advantages. The cost associated with processing and going through a foreclosure is quite high for a bank with legal fees, filing, and things of that nature. Also, when the lender is in possession of the property they are responsible for its upkeep, taxes, HOA fees, and utilities (if they are turned on). So, a short sale has certain advantages to each side of the equation when considering the current owner and the lender. A seller especially as a vacation home or investment property must be careful about the tax ramifications with a short sale based on the “cancellation of debt income” (COD). Depending upon several different circumstances such as if the loan is a recourse or non-recourse loan the owner may take on tax liability for the “capital gain” of the cancellation of debt. The 2007 Mortgage Forgiveness Debt Relief Act of 2007 removed all liability on any debt forgiven on a personal residence, but not a vacation property/investment property.
A short sale is usually, but not always, listed within the MLS. Frequently the listing agents of these properties are random in nature – as they are decided by the seller/owner of the property, not an asset management company that deals with foreclosures and has a few selected Realtors to market the property. Sometimes a property can be a normal listing and then change to a short sale status if an owner’s financial position deteriorates. It is possible for an owner to list a property originally and have it classified as a short sale, but it is less common in our market. Usually an owner will “test the waters’ for a while to see if they can obtain a higher price for their property and after learning they cannot, go into a short sale status and begin lowering the price.
Now to the advantages and disadvantages to each from a buyer’s perspective. This information is based on experience and my perception of how each works. Each individual may perceive certain things to their advantage while others may see it as a disadvantage.
Foreclosures – Advantages
With a foreclosure you can receive a fairly quick response on your offer. While it may take a little longer than a normal real estate transaction to get a response, it is within a short manageable time. Usually two or three days is the time it takes for a bank to respond to an offer – whether it be to counter the offer, accept the offer, or reject it without a response. I have had situations where my clients have made offers and it only took one day to get a response, but two days is most common from my experience.
Prices on foreclosures are without a doubt lower than the average property on the market. Sometimes they are aggressively priced from the start, while at times they are somewhat competitively priced and come down in price once the market establishes the price is too high. This is dependent most on the BPO the asset management company receives and the recommendations from the listing agent. Some tend to list the property very competitively at the beginning while others hold out for a higher price and lower it over time. It is very important to look at other foreclosures in the development or comparable foreclosure properties (whether they be sold or currently on the market) and determine if the price has some room to decline in price further or if it is competitively priced currently. Foreclosures can be purchased at higher or lower prices that short sales, it just depends on the particular cabin.
Some foreclosures may help with closing costs. This is typical only of a couple companies such as “Homesteps” and other government agencies such as Fannie Mae and Freddie Mac.
Foreclosures – Disadvantages
There are a few disadvantages to purchasing a property as a foreclosure compared to a short sale. Usually a cabin is not furnished if it is a foreclosure. There are exceptions to this though and it varies on a case by case basis. Rental history of the particular cabin is not available on a foreclosure cabin through the owner (lender) so it is more difficult to analyze the rental potential and do a financial analysis of the property. There are other means to obtain this information and while it may not be exact and as detailed as the information you can obtain in a short sale it is still valuable nonetheless. You can contact the past rental management company and they MAY provide you with an indication of how the property has performed on their rental program. If it has fared well, they will usually be happy to give you an idea that it did well because they want you to place the cabin back under their management so it can generate income. Also, I have access to the past listings in the MLS if it has sold recently or been on the market and expired. Sometimes the listing agent will provide the rental information on the MLS sheet and I can retrieve the information.
The bank/lender of a foreclosed property will make no repairs and it is sold “as-is”. This does not keep you from getting a home inspection to determine a home’s faults and things needing to be repaired. But once you have a home inspection do not expect the bank to remedy any of the problems. The home inspection in a foreclosure is just a discovery process where you find the faults with the home and if they are not substantial then you move forward and if they are difficult to overcome or substantial problems then you have the option of getting out of the contract and having your earnest money deposit returned.
Short Sale Advantages
Short sales, like foreclosures can be obtained for some incredibly good values – at times 60% to 70% of the existing mortgage or what the current owner paid or less. A short sale will typicallly have its furniture until the near end and they are very close to facing foreclosure. In a short sale furniture is typically included or at least negotiable in a contract. Short sales, since they are still owned by someone usually renting out the property will be able to give a past rental history for the property so you can get the past performance of the cabin and an indication of the type of income it will generate in the future. Also, sometimes on a short sale property the owner will agree to make some repairs in order to “save” the sale after a home inspection. This is not always the case, and they will usually not pay for big ticket items, but something is better than nothing which is what you nearly always get as far as remedies by the banks with foreclosures. Sometimes, in both foreclosures and short sales prices can be lowered after finding something substantially wrong in a home inspection, but the owner typically will not take on the responsibility for doing substantial repairs themselves.
Short Sale Disadvantages
The disadvantages of a short sale is probably the most prominent of all the differences between a short sale and foreclosure. In a short sale you will normally end up waiting a VERY long time before getting third party approval from the lender. The current owner may sign the contract in short order, but it will be contingent upon the lender approving the conditions of the sale (whether it be price, contingencies, etc.). I have had my clients have to wait anywhere from 45 days to over 3 months to obtain a final third party (lender) approval of a short sale. The problems associated with this are while the bank has your offer in hand they are slowly processing things such as obtaining an appraisal, receiving financial documents from the owner, and various other things. During this time of waiting, the bank likes to have other offers presented so they can decide which offer is in their best interests. It is not uncommon for a short sale to have several offers and you will not know if yours has been accepted for months. This is a very frustrating process for a buyer. While not knowing if your offer has been officially accepted is frustrating and takes patience, it is normally not as vital in the cabin investment market than if you were purchasing a property as your permanent residence and had to schedule moving, furniture, etc.
It is not only frustrating from a buyer’s perspective, but mine as well. Once a seller signs the contract it is out of my hands. I can do very little if anything to speed up the process when representing a buyer or make the other side work faster. Patience is vitally important when dealing with a short sale, but usually pays off with an exceptional deal if the bank accepts your offer.
Sometimes you will not know if the deal is finalized until a couple days to closing – and the closing date is a moving target. In my opinion, the best way to approach a short sale is to assume there will be no other offers and make your highest and best offer at the start. In a short sale situation they will very rarely if ever present a counter offer. It is also important to not let your emotions take control and offer too much. Make a decision based on what the value of the property is after doing research, not what you think other people may be offering on the property (if there is substantial activity and other offers). Sometimes it can almost get into a situation like a bidding war if the cabin is in an ideal location and priced very competitively – this is not an ideal situation to be in usually as emotions get involved.
In a short sale situation the negotiator and bank will be working on one side with the offers presented, but commonly they are not working in cohesion and having contact with the side of the lender dealing with the potential foreclosure proceedings. It is not uncommon to have a property have foreclosure proceeding processed and have a date for an auction at the courthouse steps, while at the same time an offer may be existing as a short sale property. Frequently, it seems, one side of the bank is not aware of what the other side is doing. So you may have an offer existing, only to find the lender has ended up foreclosing on the property and it being auctioned off at that courthouse.
To summarize, patience is the most important thing when dealing with a short sale because it can take a few months to close on the property. I have seen some incredible deals on short sales and obtained some excellent bargains for my clients, so it can be well worth the wait. If I had my choice and was buying a property though, I would be more apt to purchase a foreclosure rather than a short sale, which I personally have.
Short Sale Versus Foreclosure Summary
- Offer Acceptance Time – Advantage: Foreclosures
- Best Bargain/Deal – Advantage: Tie (Depends on the individual property circumstances)
- Cabin Furnishings – Advantage: Short Sale (slight advantage depending on circumstances)
- Rental History For Financial Data – Advantage: Short Sale (slight advantage)
- Overall Ease of Transaction – Advantage: Foreclosures
- Chances of Getting an Offer Accepted – Advantage: Large advantage for Foreclosures