Short Sale vs Foreclosure
Buying a short sale has its pros and cons, and so does buying a foreclosure. Not knowing the short sale process and how it affects you as a buyer, OR not understanding the way foreclosures are sold can lead to lost time, money, and headache. Take a moment to familiarize yourself with the processes for each, or suffer the consequences!
Which one is a better buy for today’s home buyers?
I did a similar post quite a while ago and thought I would update the subject since the market has changed over the past few years. I work with homebuyers that buy both foreclosures and short sales. I’m also a short sale specialist in my area and deal with lenders during these transactions on a regular basis. From my experience the more a buyer understands about the process for both types of transactions the better. There are also some buyers that will see the process and decide they’d like to NOT purchase a short sale or foreclosure after reading this. If that’s the case, they will do well and be able to narrow their focus on a property that will meet their needs and timeline.
Buying a Short Sale
There are several factors that home buyers must consider BEFORE they decide to enter into a contract on a short sale property.
Listing Price of a Short Sale: One of the main differences of a short sale vs foreclosure is, with a short sale, the listing Realtor is the one who determines the listing price with the homeowner. (This is true unless it’s a HAFA (Home Affordable Foreclosure Alternative) short sale where the lender does dictate the price, but 90%+ of short sales are NOT going to be HAFA).
This means that a property listed at a low listing price may not actually sell for that low price. This can be very frustrating since there are a number of Realtors who price homes much lower than similar homes in the area either out of ignorance, or to try and attract buyers for themselves. Both reasons are not good for the uninformed buyer and you can waste time thinking you’ll get the home at a unreasonably low price only to find the short sale bank wants more money than you offered.
The timeframe involved in a Short Sale: Another issue some buyers are not aware of is the time it can take for a short sale to get approved. There are several variables that can effect the time a short sale takes to get approved including who the lender is, how many loans/liens are on the property, and who is handling the short sale (do they have experience?).
If a buyer is thinking about making an offer on a short sale then these are the details they should know. It won’t give an exact time frame, but if there are 2 lenders that need to approve the short sale, it’s likely going to take around 90-120+ days to get the short sale approved, or longer in some scenerios. A buyer that needs to move by a definitive date may not like the idea of not knowing when, or if, their offer will be approved for 3 or 4 months, and may not want to move forward with the short sale because of this.
How many liens a Short Sale property has: Although mentioned above, I wanted to go into more detail about having more than 1 lender that needs to approve a short sale. When there are 2 lenders involved in a short sale they do not always agree to terms and don’t always work on the same time table. Many times the 2nd loan on the property will demand more money from the 1st lender than the 1st lender is willing to give. This can usually be worked out, but not always, and the going back and forth can add time to the short sale “waiting game”.
When there are 2 loans for a short sale you may also find that they may have different guidelines regarding how they handle the debt the seller is forgiven. Even though the buyer is not affected by this directly, if the seller is not happy with the terms offered to them, the short sale may never get approved and the buyer will not be able to buy the home. This is not only an issue when having 2 loans and can happen with a short sale that has only 1 loan, but there’s a greater chance of it happening with 2 loans.
This also has a lot to do with what a seller is expecting from the short sale and what their agent or legal professional has told them about the short sale process. There is no way for a buyer to know what the seller thinks, other than trying to feel it out from the listing agent, or unless you are able to speak with the seller directly at some point.
Short Sale Processing Fees for Short Sales: Although this is not always the case, there are a number of short sales that state that the BUYER must pay either the Listing agent, Title Company, or another 3rd party a “short sale negotiation fee” or something similar. This can be a fee that ranges from several hundred to several thousand dollars!
This can be a cost that buyers cannot afford if they don’t have a lot of funds available. There is also an ongoing debate as to the legality of these fees and whether they are ethical or not. Regardless, they are a real possiblity that a buyer may end up paying a fee like this on certain short sales and should be taken into account.
Benefits of Buying a Short Sale: Like everything there are pros and cons to buying a short sale, some of which were addressed above. Some of the benefits that buyers of short sales find is that many of the homes are still occupied by the homeowner and may be in much better condition than most of the foreclosures on the market. They are also usually priced lower than some “regular listings”, which can be a good way to find a good price on a nice home in an area that you may not otherwise be able to afford.
Buying a Foreclosure Property
When it comes to buying a foreclosure property, there are many things that buyers may not understand which can cost them money and problems during OR after the transaction is complete. By getting good legal advice and working with professionals this can be greatly reduced, so buyers should consult professionals when it comes to buying a foreclosure. Here are some of the issues that buyers need to understand to be successful when purchasing a foreclosure.
Title Issues, Code Violations, and Unpaid Utility Bills: When a property is foreclosed upon, more times then not, the previous homeowners have more than just a delinquent mortgage on their record. It is very common for unpaid utilities, property taxes, IRS taxes, and other such liens and liabilities to be part of their financial picture. With that said, buyers must be aware that these types of liens/liabilities may attach themselves to the property that has been foreclosed, and unless properly cleared, may be inherited by the buyer.
Many title companies DO search for these liens and get them cleared, but it is up to the buyer to have their legal representative review the title committment provided by the title company to determine that the title is not only clear, but marketable. It is common for unpaid utilities to come back to haunt a new buyer, and this typically happens when buyers are putting the utilities in their name so they can move into the home. Finding out a $500 water bill needs to be paid is a rude awakening, so doing a little due diligence is key.
Some of the not so obvious issues can be code violations against the property which some banks require the buyer to take care of on their own after closing. Code violations are usually not on record so its wise to check with the city the property is located in to determine if such violations exist, and if they do, how to correct them and what the cost will be to do so. This can also be a source of extra money and effort wasted for buyers of these properties.
Stringent Timelines and Extra Expenses When Buying a Foreclosure: In addition to the above, a buyer must be aware that once a buyer’s contract is accepted by a bank, there are very stringent timeframes that need to be followed such as escrow deposits, inspection periods, loan application, loan commitment, etc. These timelines are typical when buying any property since they are usually always included in a purchase contract, however in a short sale or regular sale situation, you are dealing with other people who typically are emotionally motivated to work with you. Some banks are not so gracious since they have asset managers handling these transactions who may have hundreds of other properties and have never even seen the home or met the buyer. Buyers may not get extra time needed if they are late on a contingency.
With some foreclosure properties there can be additional costs that must be paid by the buyer. For example, Freddie Mac and Fannie Mae owned properties require a buyer to pay the doc stamps tax on the deed and many other costs which can range from hundreds to thousands of dollars and have to be paid at closing. For a buyer who doesn’t have a lot of cash on hand, this can be a disasterous situation. The amount a buyer will have to pay will vary and has a lot to do with the price point of the home, but it will usually be AT LEAST several hundred dollars.
Bank Contracts and Addenda: When a buyer purchases a home, the bank will always have their own contract or addenda that must be signed by the buyer. This contract usually protects the seller and places more responsibilty on the buyer for certain things involved in the purchase. For example, the banks will not provide a seller’s disclosure and typically will mention again and again in their contract that they make no representation to the property’s condition, zoning, or being up to code with local building standards. This is something a buyer needs to be aware of and be ready to deal with through good inspectors and/or contractors. Many bank contracts will also prohibit a buyer from having the city inspector view the property at all, without written consent from the seller. This is to protect the bank from incurring fees if there is a problem and the buyer backs out, since they are left holding the bag.
There are also some stipulations in bank contracts that obligate a buyer to turn on utilities for the property in the buyer’s name and at their expense for inspection purposes. This in not always the case, but can be a headache to get done. It is also a problem if there are delinquent utility bills against the property as the utility company may not allow them to be turned on unless the balance is paid. This will not happen until closing, so a buyer might not be able to do a thorough inspection of the property OR may need to pay more to have an inspection with some alternate source of electricity to the home (i.e generator, etc).
The important thing is for buyers to be prepared for these types of stipulations in bank contracts, to understand what will need to be done, and when, and if they will incur any additional costs. Having a good legal professional at a buyer’s side during this process can be very helpful and they can guide buyers through the “legaleeze” in these lengthy contracts and addendums.
Property Condition and Financing Issues: Many foreclosures are in disrepair and buyers can have problems getting a bank to loan them money to purchase a foreclosure. Problems like this range from simple things like no kitchen appliances present in the property, or larger issues like roof leaks and illegal additions. If a buyer is not aware of their lender’s requirements when financing a home that needs repairs this can be another pitfall waiting to happen. Many times the decision as to what repairs must be made prior to closing will be determined based on the appraisal for the property. If there are repairs that are required then it is usually up to the bank that owns the property to repair them if they choose. If they elect not to repair anything, the contract will usually be cancelled and the buyer can be out the money spent on the inspection and appraisal.
One work around for getting a loan on foreclosures (or any property) that needs work is to get a renovation loan such as the FHA 203K loan. This type of loan differs from a traditional mortgage in that the property repairs that the lender finds necessary to correct in order to be financeable, will be done with money from the buyer’s mortgage. Buyers can also have other repairs done with these funds that they would like.
For example, if there is a house that NEEDS a roof in order for it to be financed, and the buyer also wants to repaint and change the kitchen (which are not required by the lender) then with a renovation loan the mortgage company will loan the purchase price of the home PLUS the money to have these repairs completed right after closing. This is done by having estimates for the work to be done submitted to the mortgage company prior to closing and the repair money being held in escrow to ensure it’s completion. There are also other details about the process that are not mentioned here.
These types of loans are great if a buyer has money to purchase a home and can afford the payments, but doesn’t have the money to do repairs to the home. Having the repair money included in the mortgage is usually much less expensive than taking out a personal loan or using a credit card to buy materials and pay for labor. These loans also open up opportunities that would otherwise be unavailable to some buyers due to needed repairs. It may also help a buyer find a great home for much less if there is considerable work to be done and no other buyers can buy it.
Conclusion-Which is a better buy? Short Sale or Foreclosure?
In the end there is not one that is better than the other. Every buyer has a different time table, stomach for risk, level of patience, etc. It is up to a buyer to determine for themselves if buying a short sale, or buying a foreclosure makes sense for them. In some instances buyers have decided to buy neither of these types of homes because of the potential pitfalls they might face.
With the information provided above, a buyer can have a pretty good idea of what they will be facing with either of these options. Both can be good and, although it may seem like there are a lot of negatives to both types of purchases, there are many buyers who get great deals on great homes and have not had to endure most of the issues above. It is up to a buyer to do their homework and due diligence and get competent professionals around them to give them guidance and advice. If they do that correctly, they will have success in either buying a short sale or foreclosure property.