Foreclosure, Short Sale and REO Explained
One way to buy a property at a discounted price is to buy a Distressed Property. Generally speaking there are 3 types of Distressed Properties:
- Short Sale also referred to as Pre-Foreclosure
- Real Estate Owned (REO) also known as Bank Owned
The Short Sale is the first step in the distressed property market. A Short Sale occurs when the owner of the property, who for various reasons is not capable of making the mortgage payments and has not done so for an extended period, lists that property at a price that is less than the amount owed on the note (loan). The reason for listing the property at a price that is less than what is owned is to be competitive with similar properties for sale in the same neighborhood, get rid of the obligation to pay back the loan and prevent foreclosure.
For their part, the lenders are open to the idea of accepting a payment that is less than the amount owned because the foreclosure process is expensive and the costs of going through the foreclosure may even be more that the actual loss on the loan.
The Short Sale process can be challenging. First, the lender does not set the selling price. The asking price is set by the owner often in consultation with a Realtor®. That price may be lower than what the lender is willing to accept. A potential buyer contracts with the seller, not the lender. Once the contract is in effect, it is sent to the lender along with a letter of hardship from the seller explaining the reason(s) for the incapacity to pay back the loan. The seller must also furnish information about their assets, employment situation, paystubs (if employed), budgets, a list of creditors and other information that can help the lender make a final decision. The lender uses a Negotiator to review the owner’s personal and financial situation, the market condition, the property appraisal, the status of other liens and various other factors.
Therefore, the Short Sale process can take a long time, generally 3 to 4 months, but in certain cases, it can even take more than a year. All the while there is no guarantee that the lender will accept the original offer. I even had a bank foreclose in the middle of a Short Sale transaction.
Basically, Foreclosure is when the lender takes back the property from the home owner. The foreclosure process is a judicial process that is specific to each state. The process ends with a public auction at the county court house (some counties even have auctions online) where anyone with cash can buy the property.
A word of caution to wood-be bidders at those public auctions. Depending on the county where the auction occur, there are many people who specialize in buying these types of properties, so don’t expect to be the only bidder present, one would also expect the lender to bid on that property up to a predetermined price, so the chances of buying a mansion for $100 are more none, than slim. No one is allowed to visit the property before the auction. Besides the uncertain condition of the property itself, there are many potential legal, judicial and title problems that could surface after the closing. There could also be liens from secondary lenders and even ITS liens that would need to be satisfied. Therefore, buying a home on the steps of the court house should be left to experts with deep pockets.
Real Estate Owned (REO)
Normally when buyers refer to “buying a Foreclosure”, they really mean “buying an REO”. If no one buys the property on auction day, it reverts to the lender who will put it up for sale through a local Realtor®.
At this point the lender is interested in selling the property quickly as it is an asset that is costing them money to maintain and keep up to date with the insurance and real estate tax payments. Frequently, they will price it below the market value in order to rid of it quickly. Often times, the price is such that it attracts multiple buyers who have to bid the price up over the asking price.