Short Sale Vs. Foreclosure: Which Is Better For Buyers?

Today’s market is fast-paced and competitive, finding a deal can be challenging. If you’re looking for a new home below market value and you have determination and patience, distressed properties might be for you. We’ll discuss which is better for buyers, short sale vs foreclosure.

Short sale and foreclosed homes are sometimes referred to as distressed properties. This doesn’t always mean the property is in physical distress, it could be financially distressed. Homeowners who have had a loss of income or major life changes can fall behind on their monthly mortgage payments and find themselves looking for ways to save or sell their home.

A short sale transaction occurs when mortgage lenders allow the borrower to sell the house for less than the amount owed on the mortgage. This helps the home seller by allowing them to avoid foreclosure. Short sales are less damaging to a credit report than a foreclosure. 

A foreclosure is when a home is seized and put up for sale by the investor or bank. Every mortgage contract has a lien on the property that allows the bank to control the property if the homeowner stops making mortgage payments.

Preforeclosure is the first step in a foreclosure proceeding brought on because the homeowner has failed to make 3 – 6 months of payments. Borrowers in preforeclosure have a few options to avoid foreclosure. Borrowers can pay the past due balance in full, work with the lender to modify the mortgage to reduce their monthly payment or sell the home through short sale or deed in lieu of foreclosure.

Preforeclosures and short sales are both sales conducted by the owner or a real estate agent. Short sales can be a little more challenging because the bank is involved and has the power to reject offers that have been accepted by the owner. Having a real estate agent with previous experience with distressed properties can be incredibly helpful and expedite the purchase timeline in some cases. Banks can be slow to respond and real estate agents familiar with the process can anticipate necessary paperwork and potential problems with lienholders.

Short sales can be beneficial for all parties involved. They provide greater investment opportunities for buyers and minimize the financial repercussions that both lenders and sellers would face if the properties went into foreclosure.

A preapproved short sale is when the lender approves the sale price of the home before it is marketed to the public. This is a great sign that the bank and borrower are eager and ready to sell the property. As the sale is negotiated, the bank can reject any or all offers. Banks are notorious for slow response times because there are a lot of moving parts to a short sale transaction. The bank’s main goal is to recover as much money from the sale as possible so offers below market value or below the amount owed on the remainder of the mortgage, will likely take some time for approval.

There are few ways to search for distressed properties. Social media is a great place to start. Facebook Marketplace and Craigslist have high traffic and visibility and can be used by homeowners and real estate professionals. You can also post an ad letting the public know you’re looking for short-sale opportunities. You could be the answer to someone’s financial misery.

Pros

• Condition: Short sales tend to be in better shape than foreclosures. Many people are trying to salvage as much of their credit as possible. They’ve likely maintained the utilities and general maintenance items.
• Price point: Short-sale homes are often a great bargain, selling sometimes below market value.
• Less competition: There is less competition for short-sale homes. A lot of home buyers are wary of the process and don’t want the hassle of working with a bank.

Cons

• Risk: There is an increased risk when buying a short sale because they are sold as-is. The current homeowner could change their mind and pay the past due balance and keep the home. You as a buyer would be out any money you’ve spent on inspections or due diligence.
• Time: Short sales can take longer than a typical home sale because there are several lienholders involved. If there are additional liens on the property, those issues will need to be sorted out and approved by the bank prior to any sale.
• Effort: Buying a home through a short sale may require a lot of additional documentation, fact-checking, and constant follow-up with the bank, realtors, etc.
• Property condition: Homeowners in a short sale situation are usually financially strapped and their property could have a lot of deferred maintenance issues that need to be addressed immediately.

Buying a foreclosed property isn’t for everyone. Lenders are looking to cut their losses and recoup as much of the balance owed on the property. The same is true for municipal auctions where homes are sold due to tax liens, they want to sell the property as fast as possible for the most value and move one. Banks and municipalities aren’t interested in being landlords.

More often than not a distressed property is being offered as-is. In most cases, you will not get a chance to tour the home or order a home inspection before you purchase it. Pay close attention to the listing details, most foreclosures require a cash payment at purchase.

Below are some of the most popular search engines for distressed property:

• Fannie Mae HomePath^®: Here you will be able to search for foreclosure listings (called HomePath^® properties) by address, ZIP code or MLS number.
• Freddie Mac HomeSteps^®: This is Freddie Mac’s answer to the Fannie Mae foreclosure site, with very similar functionality.

Pros

• Price: Foreclosed properties are usually sold below market value.
• Quick sales: Because most foreclosed homes are sold as is and will likely be a cash transaction, the sale timeline is faster than a short sale.
• Clean title: A homeowner may have back taxes due or liens on the home, especially when they are financially strapped. Once a bank forecloses on a home, the bank clears the title of liens and encumbrances.

Cons

• Cash buyers preferred: This can be the biggest hurdle when purchasing a foreclosed home. Buyers will likely need a large sum of cash available for the purchase of the home, as well as the costs of repairs.
• Condition: By the time a home has reached the foreclosure stage the homeowner has had some significant financial trouble and has likely neglected the maintenance of the home or abandoned the property altogether.

Buying a home under normal circumstances can be a challenge, but purchasing a distressed property is a whole other ball game. Short sales are great when the lender approves an offer and the homeowner can walk away knowing their credit won’t be destroyed and the new owner has a great home below market value. But we don’t live in a fairy tale, and short sales are rarely that easy. If you’re looking for a quick investment opportunity, then a foreclosure might be more ideal for you.

Foreclosed homes are sold by the bank. The bank has likely cleared the title and evicted any occupants residing in the home. If you have a significant amount of money at your disposal that can cover the cost of the home and repairs, you could make a significant profit by purchasing a foreclosed home.

If short sales and foreclosures are too risky for you, you could consider a HUD home. HUD homes are a type of foreclosed property that is up for resale. When a homeowner buys a home through an FHA loan and they default on the loan, the U.S. Department of Housing and Urban Development (HUD) buys the home back and attempts to resell it to the highest bidder. Check out buying a HUD home to learn more about the HUD home purchase process.