Information About Foreclosures and Short Sales

A lot of real estate buyers in search of a super deal ask me about bank owned foreclosures, and their related sibling, short sales. Both can result in some very good deals, but they absolutely aren't for everybody. Foreclosures, in particular, involve some very unique factors that make them appropriate only for a very small subset of buyers. I've put together the following overviews about buying foreclosure properties, and purchasing property involving a "short sale" to help potential buyers get a better understanding.

About Bank Owned Foreclosures

Lots of buyers asking about bank-owned foreclosures, the holy grail of super bargain hunters. Bank owned properties can be great deals, but they're seldom the type of houses that second home buyers are looking for. This isn't to say that second home owners have some magic talisman to avoid financial problems and get behind in their mortgage. (Although homeowners with the financial where-with-all to own a second home in the first place often have more financial resources to carry a house.) An owner of a house with good market appeal who's behind in his or her mortgage may be successful in going the short sale route rather than having the house fall into foreclosure. Short sales tend to be the more common distress sale mechanism for houses with significant appeal, and therefore fewer fall into full foreclosure.

Bank owned houses with factors that appeal to the second home buyers do sometimes come to market, but they're generally in poorer condition than their 'short sale' siblings. Freeze damage, pipe breaks, mold and trashed kitchens and baths aren't uncommon. They can be great deals, but they're not for the faint of heart.

A downside of purchasing a bank-owned home is that the buyer has much less opportunity for inspections and due diligence. When a bank takes over a house in this climate, they typically have it winterized, draining the heating system and all the pipes. They may also shut off the electric service. So it's not possible to test the water, or ensure that the plumbing and heating systems are operable. The house is sold "as is". (Some banks will permit a potential buyer to have the systems turned on and off — in a single day — at the buyer's expense to do an inspection, but this is done before submitting an offer, as banks won't include an inspection contingency in the purchase contract.)

Bank owned properties are also less suitable for buyers who plan to get a mortgage, for two reasons. First, the bank will set a firm time limit to close, usually 30 days, and that can be too short to get a firm mortgage commitment. Second, for a conventional loan, the lender wants the appraiser to verify that all systems in the house (heating and plumbing) are in good working order. Because the systems are turned off, that can be impossible, although there are some convoluted workarounds to that glitch. Given these hurdles to getting a mortgage, a bank is much more likely to accept an all-cash offer, even at a lower price, than an offer involving financing.

If you're an all cash buyer who is willing to do some (or often, a lot of) work and accept some risk, a bank owned foreclosure can be a great. But if you're planning to finance, and want a house in move-in condition that just may need some sprucing up, a foreclosure probably isn't for you.

Finding Foreclosure or Short Sale Houses

The MLS Search on this website doesn't have a search field for "bank owned" properties. The pro version of the MLS that I have access to does have the capability, so if you drop me an email I can run a search for properties coded as "bank owned" and email you the list.

Finding short sale houses is more involved. There isn't a "short sale" field in the Multiple Listing System. For a house that may go as a short sale, agents usually put the phrases "short sale" or "third party approval" in either the public remarks or broker remarks sections. I can run keyword searches on those fields. However, with short sales, it's better to start with the type of property you're interested in and then drill down to possible short sale candidates, rather than pull a list of every possible short sale in the county.

 

About Short Sales

"Short sales" are sales where the current owner of a house owes more on the property than it can sell for, and they look to the lender to accept a payoff on the mortgage at closing of less than the amount owed. Many sellers mistakenly believe that simply because they owe more than they can sell for the house that they are eligible for a short sale markdown of the amount owed.

That's simply not the case. A lot of prerequisites have to be met before a lender will even consider a short sale. Generally, the homeowner needs to be a certain number of months behind in their mortgage payments, and NFS (notice of foreclosure sale) lis pendens filed by the lender. (This is the first step in the foreclosure process, and is more a legal maneauver to protect the lender's rights.)

The house should also have been exposed to market for a good period of time (6 months seems to be the minimum), with periodic price reductions and no offers during that time sufficient to clear the mortgage. (A history of offers below the threshold to clear the mortgage, though, is good.)

The owner of the house should lack other resources sufficient to make up the pay off deficiency. Lenders are taking a much harder line with owners who have other resources and just don't want to fulfill their pay off obligation. This is less important than the other two prerequisites, and varies widely among lenders. But the likelihood of approval of the short sale is greater if the seller doesn't have other resources than if they're sitting on a stash of cash and have a couple of other vacation homes or investment properties.

A seller meeting these general guidelines doesn't necessarily guarantee a short sale approval. Lenders generally do not tell a seller what they are willing to accept as a deal price (although that is changing under new Fannie Mae guidelines that apply in some circumstances.) So once the buyer and seller agree on a sales price and contracts are executed (subject to third party, or short sale, approval), a short sale package, including the purchase contract and a lot of other supporting documentation, is submitted by the seller to their lender.

Short sale approval by the lender can take quite a long time once the package is submitted. Two to three months is common, although four to six months is not unheard of. The outcome may be the bank accepting the deal as is, putting a counter offer on the table, or rejecting the deal outright.

The short sale process is fraught with landmines. So it's imperative (which is a strong step above 'impotant' or 'recommended') that some of the professionals involved in the transaction have short sale experience — preferably at least one of the brokers and one of the attorneys. (And yes, I have quite a bit of short sale experience at this point.)

There are some downsides to a short sale. The first is the often lengthy time time between find the house and making the deal and actually closing on it, due to the added couple of months for the short sale approval. As a buyer, whether you actually get the house is largely out of your control, although working with a broker who understands the short sale process can give you a good feel for the odds. The second downside is that the buyer shells out quite a bit of expense at the front end, for home inspections and attorney fees, well before the short sale approval. And lastly, you can't lock a mortgage rate when you make your offer. The longest 'rate lock' a buyer can typically get is 60 days, which will likely expire before you can close on the house. So a buyer is more exposed on the mortgage rate side than in a traditional transaction