What is the Difference Between Short Sales and Foreclosures (REOs)?

A client recently asked me this, so I thought I'd share: So here is a basic rundown of short sales: A homeowner/borrower is behind on their mortgage payments (in default of their loan). The property that the loan is on is not currently worth an amount that would pay off the outstanding balance of the loan (ex. Bought it for 200k, put 40k down, house is only worth 120k). What more banks/lien holders are doing nowadays are loan modifications. They will have their underwriters determine if it is a better deal to modify the loan to something the homeowner can afford, or if they should allow them to go through with a short sale. If they choose short sale, they will need to have a real estate broker list the property, and negotiate a price less than the outstanding balance of the loan for the bank to accept. A couple of years ago, it was not uncommon to spend 6+ months waiting on a response from the bank in regards to a new buyers offer (it only matters where the offer gets put into the stack on the bank's negotiator's desk). The longest I have had a client wait to hear back was 6 months, but the longest I've heard of is 1.5 years (in CO). Whether or not you want to stay away from them depends on your timeframe. Sometimes banks respond within days. Aside from that, the process is exactly like purchasing a "normal" (equity) sale. The headache is normally with the seller, and thus, listing agent. No reason to rule them out altogether because of the word on the street. It's a buzzword more than anything.

Foreclosures are where you're going to find the "deals" that are actively listed. These are properties that the owners have defaulted on, and either couldn't sell during the time allotted for the short sale, or didn't even try. Banks are not in the business of holding properties (much to a lot of people's dismay). They don't want the carrying costs, and they don't want negative cash flows. They are typically in rougher shape than a market value equity sale, but that is where you can get your savings and then apply those to renovations (keep in mind, I have had clients close on foreclosures that had been completely redone by the banks because they were in such bad shape no one would touch them). Banks only care about their bottom line, so there is no emotion involved, and unlike short sales, they respond very quickly to foreclosure offers (all of this paragraph also applies to HUD owned properties, as those are just foreclosures on FHA loans as opposed to a Wells loan, or Chase, BBVA, etc.).

Now, for equity sales. These include properties that have been flipped by professionals, estate sales, your neighbor's house who just wants to move onto the next part of their life, etc. These owners have enough equity in the property (either from paying down the mortgage, or from appreciation) that they can list it on the market and see what comes back. They are not "distressed" sales. What really makes some of these different than the distressed sales is the owners emotional attachment (unless you are buying from an investor/flipper, estate sale, etc.). People are not always rational when selling the home they have lived in for X years, and that can sometimes make deals fall apart (enter awesome broker that knows what they're doing).