“Confusion” is the watchword when most consumers hear the terms “foreclosures” and “short sales.” Most consumers don’t understand their definitions and even more don’t understand how different their purchase processes are.
So, here goes:
Short Sale, Defined.
A short sale happens when a homeowner still occupies the property (even if foreclosure proceedings may have begun) and the property is sold for less than the amount of the mortgage on the home.
For example, a home sells for $100,000 but the amount owed on the mortgage balance is $120,000. Obviously, the lender(s) (primary mortgage holder and secondary mortgage holder) must approve the sale and taking less than they are owed as a settlement.
Although homeowners usually walk away with no money in their pocket from a short sale, a short sale tends to damage their credit less and for a shorter period of time than a foreclosure. That is the major (only?) benefit to the homeowner in attempting a short sale but that one benefit is significant and worth the effort.
Foreclosures, Defined.
Foreclosures are properties that have completed the foreclosure process. The Sherriff Sale has occurred, the Redemption Period is over, the lender has taken possession of the property, changed the locks and hired a property management company to manage the sale of the home.
The Difference.
While both are “distress sales,” their purchase process is very different.
Of the two, foreclosures are the easier. The lender has acquired full rights to the property and is actively marketing the home. The lender has hired highly-qualified, market-savvy Realtors to provide an estimate of value, called a BPO (Broker’s Price Opinion). Some banks will rely on one BPO while others will order them from two or three different Realtors. Once the lender has a fairly accurate idea of value, they will typically not move from their list price for at least 30 days, often longer. Only after considerable market time has elapsed will they begin to reduce the price, usually in increments of about 3% of the asking price.
A short sale is a much more complicated and time-consuming process, in most cases. While I have had a few short sales approved within a couple weeks, it is far more normal for short sale approvals to take months.
The first step in the short-sale process is for the homeowner claims hardship – spouse(s) lost his/her job, now they can’t make the payments, owner was transferred out-of-state and they can’t sell for what they owe, adjustable-rate mortgage payment has increased to the point they can’t make the payment, etc.
To allow the homeowner to make their case for hardship, the lender will send them a short sale “kit.” Typically, it will include an application form or list of questions, including an explanation of their situation.
Once the hardship letter is received by the lender, the lender may tell the homeowner to put the home on the market and bring them an offer to consider.
There is no guarantee, however, that a buyer who offers the asking price will get the house. It all depends on whether the lender approves the sale.
So, a home worth $100,000 in today’s market (with a mortgage balance of $120,000) could get an offer of $100,000 and the buyer may wait months to find out if they bought the house … until the lender gets around to looking at and approving (or declining) the offer.
Adding to the delay are conflicting policies of FHA, Freddie Mac and Fannie Mae. Lenders don’t have a much incentive to write off any portion of a loan when the loan is insured by FHA. All they need to do is get the home into foreclosure and then FHA will “make them whole” by paying the lender the insured-mortgage amount of $120,000.
Recommendation
If you are going to buy “distress sale” properties, focus on foreclosures. They are easier and usually cheaper but may not be in quite as good condition and short-sale homes.
If you disregard my advice and write an offer on a short sale property, be prepared to wait … and wait … and wait … and wait to hear an answer on your offer.
My Opinion
It is sad that those homeowners who are truly trying to do the right thing – to cooperate with the bank and avoid making the bank foreclose and wait 6 months or more to get the house – are the ones most hurt by the delays lenders take in evaluating a short sale.
If banks were more responsive and flexible on short-sale requests and offers, fewer homes would be winding up on the foreclosure auction block.
