Short sale vs. foreclosure: Which is better for buyers?

The market for buying a new home is often fast-paced and competitive, so finding a great deal may require a bit of effort.

Looking for a new home that’s below market value and you have a little determination and patience, a so-called “distressed property” might actually be just the property for your situation.

Let’s take a close-up look at two of the most common types of distressed properties – short sales and foreclosures – so you can determine which would be the best fit for your potential investment.

The difference between short sales and foreclosures

Homeowners who’ve suffered a loss of income or experienced major life changes can fall behind on their monthly mortgage payments and find themselves looking to sell their home short to avoid default. If the financial hardship the homeowner is facing becomes too great, their property may become “distressed” – meaning it’s under foreclosure, preforeclosure or bank/lender control.

Let’s take a closer look at short sales and foreclosures and how these two types of distressed properties compare.

Short sales

A short sale occurs when a mortgage lender allows the homeowner to sell the house for less than the amount they still owe on the mortgage. This helps the home seller by allowing them to avoid foreclosure, which is typically more damaging to a credit report than a short sale.

Foreclosures

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

Now let’s take a look at what preforeclosure is and how it differs from a short-sale transaction.

Preforeclosure vs. short sale

Preforeclosure is the first step in a foreclosure proceeding, which often happens after a homeowner has failed to make 3 – 6 months’ worth of payments. Borrowers in preforeclosure can avoid foreclosure in one of three ways:

• Pay the past due balance in full
  
• Work with the lender to modify the mortgage terms and reduce their monthly payments
  
• Sell the home through short sale or deed in lieu of foreclosure.

Preforeclosures that go to market and sell and short sales are similar in that they’re both conducted by the owner or a real estate agent. A real estate agent who has previous experience with distressed properties can be incredibly helpful and expedite the purchase timeline in some cases.

However, short sales can be a little more challenging because the bank is involved and has the power to reject offers that the owner has accepted. Banks can be slow to respond, and agents familiar with the process can anticipate the necessary paperwork and potential problems with lienholders.

Short-sale buying process

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

A preapproved short sale is when the lender approves the sale price of the home before it’s marketed to the public. This is a great sign that the homeowner and the lender or bank are eager and ready to sell the property. As the sale is negotiated, the lender or bank can reject any or all offers.

You can search for distressed, short-sale properties in a few ways. Let’s take a look at a few of them.

• Brokerages: A brokerage will likely provide you with a list of short-sale properties if you express your interest in them.
  
• Through the multiple listing service (MLS): You can easily access short sales through the MLS which lists and sometimes even flags them. If the listing doesn’t explicitly say “short sale,” you might notice other related language such as “headed to auction” or “subject to bank approval.”
  
• Through an agent: You can also access short sale properties through a real estate agent who specializes in them. Agents who specialize in short sales usually list these properties in bulk on behalf of lenders, so it’s likely a good idea to have a buyer’s agent represent and protect you as you pursue a short sale home.

Pros of a short sale

Let’s take a look at some of the pros of a short sale.

• Property condition: Short-sale homes tend to be in better physical shape than homes under foreclosure. Homeowners generally try to salvage as much of their credit as possible, so they’ve likely maintained the utilities and general maintenance items.
  
• Price point: Short-sale homes can be a great bargain, because the seller has incentive to sell as quickly as possible.
  
• Less competition: There’s usually less competition for short-sale homes than homes being sold in a more traditional fashion.

Cons of a short sale

Let’s take a look at some of the cons of a short sale.

• Risk: Because some short-sale homes are sold as-is, they come with increased risk. The current homeowner could change their mind about selling, pay the past-due balance and keep the home. If this happens, you, as a home buyer, would be out of any money you’ve spent on inspections or due diligence.
  
• Time: It can take longer to close on a short sale than a typical home sale because several lienholders are If the property has additional liens, they’ll need to be sorted out and approved by the bank or lender 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, real estate agents, etc.
  
• Property condition: Although we already discussed the property’s condition as a potential pro of a short sale, the flipside is also possible. Homeowners in this situation are usually financially strapped, so their property could have a lot of deferred maintenance issues that need to be addressed immediately.

Foreclosure buying process

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 as possible. The same is true for municipal auctions where homes are sold due to tax liens and municipalities want to sell the property as fast as possible for the most value and move on. Lenders, banks and municipalities aren’t interested in being landlords.

Often, a distressed property will be offered as-is. In most cases, you won’t get a chance to tour the home or order a home inspection before you purchase it. Pay close attention to the listing details, because foreclosures may require a cash payment at purchase.

Below are some of the most popular online tools for finding a foreclosure property:

• Fannie Mae HomePath^®: The Fannie Mae HomePath^® website lets you search for foreclosure listings of Fannie Mae properties by address, ZIP code or MLS number.
  
• Freddie Mac HomeSteps^®: The Freddie Mac HomeSteps^® website offers similar functionality but features Freddie Mac properties.

Pros of a foreclosure

Let’s take a look at some of the pros of a foreclosure.

• 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 or lender forecloses on a home, they clear the title of liens and encumbrances.

Cons of a foreclosure

Let’s take a look at some of the cons of a foreclosure.

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

Short sale vs. foreclosure FAQs

Below are commonly asked questions pertaining to short sales and foreclosures in real estate.

How long does a foreclosure or short sale process take?

According to the Department of Housing and Urban Development, the mortgage lender will start the foreclosure process 3 – 6 months after the first missed monthly mortgage payment. After that, it could take up to a few months or even years to get the house sold.

The short-sale process from start to finish can also take anywhere from 3 – 6 months, and possibly longer, depending on the situation.

Which is better for a home buyer: short sale or foreclosure?

Short-sale homes are typically in better condition than foreclosed homes. Although short sales might have better bones, you’ll almost always save more money on the home price buying a foreclosed home. It’s important to consult with your real estate agent when thinking about buying a short sale versus a foreclosure.

Does buying a short sale or foreclosure home hurt my credit?

Going through a short sale or foreclosure can affect the homeowner’s credit score and credit report as a whole, but buying one of these homes doesn’t hurt your credit.

Are short sales and foreclosures good investment opportunities?

If you have a significant amount of money that can cover the cost of the home and repairs, you could make a large profit by purchasing a short sale or foreclosed home and reselling it.

The bottom line

Purchasing a distressed property comes with advantages and disadvantages. When a lender approves an offer for a short sale, the homeowner can sell knowing their credit won’t be destroyed and the new owner has a great home.

Foreclosed homes are typically sold by third-party trustees on behalf of a bank or lender that’s likely cleared the title and evicted any occupants residing in the home.

Buying a short-sale home or a foreclosure can be a great way to get into a house while likely paying less than market prices for the property. However, unless you’re paying for the property with cash, you’ll need to finance the purchase with a mortgage. Take action and start your application today with Rocket Mortgage^®.