Thursday, February 4, 2021 / by Randy Durham
What is the difference between short sales, foreclosures, REOs, and traditional sales?
This is usually the most common type of sale, and the least complicated. Let’s say that the owner of a home wants to put his home up for sale for whatever reason. They may be going through a divorce, relocating, upsizing, downsizing, the neighbors built an ugly fountain in the yard and they’re sick of looking at it…or simply because they want to. The reason doesn’t matter. All that matters is they want to move. As a buyer who wants that house, you are most likely going to be getting a conventional or government-backed loan such as FHA, VA, USDA, or a state-specific loan like THDA or GA Dream. If this is the case, then your chances are very high that you will be involved in this type of sale. A traditional sale happens when you buy or sell your home with a realtor or on your own. As a side note, buyer agents work for sale by owners all the time. They are not limited to showing you homes on their MLS that are listed with other agents. Even though most people have to get financing for a traditional sale, cash buyers are still floating around. In this industry cash is king, so be aware that they can have more leverage in a bidding war and closings will happen sooner because you don’t have to deal with a lender. If you are a buyer getting financing, the lender will arrange their own appraisal to determine if the home’s value is sufficient enough to cover the loan amount you requested. If you are using gov’t backed lenders, the requirements are different. For example, if you’re using an FHA lender and the home has a septic tank but there is a sewer in the area, they can make you have the house hooked up to a sewer line before they approve the sale. So once you are approved for a loan, there is usually a bit of back and forth (boxing gloves) with negotiating repairs, making the title is clean, and everyone sort of gets along with each other, seller moves out, everyone smiles at the closing table when the deed is transferred to the buyer and the buyer moves in. End of story. That is a traditional sale. Another type of sale that is similar to a traditional sale but slightly different is called a short sale.
Short sales basically happen when a lender agrees to let you sell your house for less than what you owe on it to avoid foreclosure. This also happens if the loan on the property is not enough to cover what the house is worth at its current market value. This is called “short” of, which is where the short sale gets its name. This type of sale can also be called a “pre-foreclosure.” This type of sale HAS to be approved by a lender and there MUST be some type of hardship involved. During this process, the seller’s lender will request a short sale package detailing their finances. This includes their debts, assets, credit score, and their original paperwork to purchase the home. This was a win-win for people during the housing crisis because buyers sometimes got better deals on houses that were usually in a good condition, banks were taking a smaller loss, and sellers were able to keep the foreclosure off their credit history. Another plus is that as a seller, you will be eligible to buy another house in two years instead of five years. When I first started working as an assistant, the market was still recovering from the housing crisis in 2008. From my experience, short sales are anything but short. This is not always the case, this is my opinion only! While I’m talking about short sales—I cannot stress that enough. Almost every short sale in my experience has taken forever to close. There are a couple of reasons for that. Before I go any further, if you are a buyer that must be in a house within a certain time frame or you’re just not patient in general, please keep what I just said in mind. In contrast to traditional sales, the seller’s bank is another party involved in this transaction. Even if you have that golden ticket of pre-approval from your lender, the seller’s lender also has to approve and also accept your offer. This is where I normally saw most of the delays happen. As a buyer, you don’t have the same amount of control over this process as you would in a traditional sale where communication is more efficient between all of the parties involved in the transaction. Like if you make an offer and the seller has 24 hours to respond. With a bank that’s not always the case. Banks can require hundreds of pages in the paperwork involved in closing during a short sale. Most of these require signatures from every party, including buyers, sellers, lenders, and agents. Documents can be lost, pages come back missing, and other blunders can keep you on your toes and do nothing but raise your blood pressure. And if only one of these things happens, the documents simply won’t be processed. And depending on the bank, their response time can be like watching water boil. Oh the bank didn’t get that income statement I sent three times already before they could accept the offer and told me a month later and now the buyer lost their chance to lock in their interest rate? …Ok. Another issue that can cause delays is if the buyer has a lender and the seller’s lender doesn’t want to cooperate. Have you ever seen a boxing match between a seller and a buyer over repairs, closing costs, and clouds on a title, and by the time you get to the closing table you felt like you deserve a trophy because you just got put through one of those game shows with a crazy obstacle course? I’m not even kidding. Imagine that…only with banks that can take forever to respond to each other. It can get ugly. However, at the end of the sale, banks and sellers avoid saying the dreaded F word. Which brings us to our next type of sale…
What normally pops up in someone's head when you mention a foreclosure is actually called a Judicial Foreclosure. A judicial foreclosure happens when a buyer misses payments and defaults on their mortgage. Some banks have what is called an acceleration clause, which means that if you miss payments the bank can declare the entire amount on the loan balance due. Yeah, kinda shady. But I don’t make the rules. After this happens, the bank can begin the foreclosure by filing a lawsuit in court or a process that still requires legal steps outside of court called a “nonjudicial” foreclosure. Because of federal laws that protect homeowners, banks usually can’t file a lawsuit until you are at least 120 days behind on your payment. They also must notify you by phone and in writing to discuss any options to avoid the inevitable from happening. After this happens, the bank must post a notice of foreclosure 30 days before the sale takes place. The bank must also notify the owner of the home of a notice of the sale. The state of Tennessee actually has a law that allows them the chance to buy back their property after the foreclosure happens. This is called the “right of redemption,” and can only happen if the foreclosure takes place outside of court. After thirty days, the property is priced based on the home’s market value and its condition. The sale doesn’t always happen at the courthouse, but one thing is certain is that whoever buys the foreclosed home will be doing so without seeing the inside of the home beforehand. If you ever watched "Flip or Flop", that is an accurate depiction of what happens.
I also want to mention a lot of first-time buyers still want to see foreclosures. This is seriously one of the most common trends I have seen from buyers that need usually need some type of financing to get their home. My advice is to look into traditional sales, short sales, or REOs that I will discuss in a minute that qualify for financing. Foreclosures are an ugly world if you are a typical home buyer. Most of the foreclosures that I have seen and that you will probably see need a lot of work! I’m not talking about dated cabinets or bathrooms that still work or shag carpet you can still walk on without falling through a hole in the floor or a door with some scratches that don’t break off as soon as you open it. Some of these houses have a lot of structural issues that can be both expensive and mind-boggling if you are not a general contractor or someone with experience in renovating homes. Also, if you are looking at foreclosures, you will typically need cash. That is the general rule when buying a foreclosure at auction. While it is possible to get a loan for a foreclosure, banks have different standards that can vary widely depending on the condition of the property. Some banks won’t finance them at all. The bottom line is that you will need cash because most foreclosures go straight to auction. This means that bidders are lined up and they already have funds to purchase the house that same day. And if it’s a good property, it will sell auction. If not, you have a type of sale commonly referred to as REO.
If you have cash or enough for the standard downpayment that most conventional loans require—but not always because every lender is different and not all lenders do REOs—not going into that either, then another alternative to foreclosures is houses that do not sell at auction and are called REO properties, or Real estate owned. These properties remain under the ownership of a lender or investor if they are not sold at auction. Despite what you think, most banks will do anything to avoid foreclosure, and this is the reason why short sales gained popularity during the last housing crisis. This is the same concept with attorneys doing whatever they can to keep you out of court in a lawsuit. The reason is that court costs are expensive and so are the legal fees associated with foreclosures. Lenders also know they face a big chance they won’t recover the actual amount of what they financed the home for when the owner first took out the loan. So, if short sales are a win-win for lenders and homeowners because they are taking a smaller loss, then foreclosures and REOs are typically a lose-lose situation. And this is because the previous owner has a foreclosure on their credit history and banks are risking taking an even bigger loss if they have to take ownership of the property. As a buyer, this can actually work in your favor if you are willing to put a little bit of work into the home after you buy it. These homes are typically priced lower in comparison to short sales and traditional sales, usually to stay competitive while it’s on the market. The downside to this is that lenders are already taking a loss, and these homes are sold as-is. No exceptions. Bad toilets, spiders, and mice that may have moved in, foundation issues, roof leaks, dirty toilets, and peeling wallpaper. All of that will be yours. So do your homework when looking at the condition of REO properties.
Which type of sale is best for you? That depends on your personal preferences and the complete financial picture.