Janelle D. By Janelle D. • April 12, 2019

REO, Foreclosure, Short Sale: Understanding the Difference

Many times you'll run across clients interested in buying a REO, foreclosure or short sale home.  Is it a good idea to purchase these types of homes or is it more hassle than it's worth?  Let's take a look at each option so you can help them make the best purchasing decision.

REO

A REO (real estate owned) or bank owned, home has been taken back by the bank after a homeowner was unable to fulfill their financial obligation. The lender has not been able to sell this home, following the unsuccessful sale at a foreclosure auction.

  • Homeowner unable to pay their mortgage
  • Unsuccessful sale at foreclosure auction
  • Lender-owned
  • Little room for negotiation
  • Buying house "as is"

With an REO, the lender is responsible for paying property taxes and maintenance on the home while it's in their possession -- not something they favor. Lenders have little interest in managing properties so they work with real estate agents to quickly sell the home.

If your clients are interested in buying a REO, they need to be aware that they will be dealing with the bank, not the homeowner. The goal of the lender is to get their money back, meaning they will stay firm on their price. In addition, buyers need to know they're buying an "as is" house which could include major issues. Many of the time lenders won't be willing to make any repairs, leaving the home buyer with a laundry list of repairs and fixes.

Foreclosure

With a foreclosure, the home is in the process of being taken back by the bank and owned by the mortgage lender. In this case, the lender has seized the house because the owner has failed to make mortgage payments and may have abandoned the home.  Depending on which state you're in, a judge may have to give the lender permission to foreclose.

  • Owner failed to make mortgage payments
  • Lender-owned
  • Buyer bids at auction and pays on-site
  • Problems after the sale: title issues, IRA liens

The foreclosed home will go up for auction once the lender repossesses the property. The minimum price the lender will accept is most likely the amount the former homeowner owed on the mortgage, along with legal fees. The process of completing a foreclosure sale is quicker than a short sale because the lender wants to liquidate the asset quickly.

Because of the quick sales process, the buyer may be faced with problems that would have otherwise been cleared up in a traditional home sale which goes through escrow. Problems can include title issues, IRA liens, and structural problems, to name a few.

Foreclosed homes are auctioned off at the county courthouse. Buyers make bids and the winner will be required to present a cashiers check for the full amount while they're onsite.  Seasoned real estate investors typically purchase these properties vs. your average home buyer.

Short Sale

A short sale is an alternative to bankruptcy or foreclosure, when the amount the homeowner owes on the house is more than the amount the home can be sold for. In most cases, this is due to a fall in the housing market. It's unlikely that the owner will ever be able to catch up on their payments, but they want to avoid foreclosure.  In this case, the owner still owns the home.

  • Homeowner owes more on the house than it's market value
  • Homeowner still owns the home
  • Ultimately, the lender approves the sale
  • Lengthy buying process

With a short sale, the lender agrees to accept a payoff, which is less than the total amount due. This is why a short sale is so appealing to buyers -- they can get a great deal. On the other hand, there may be problems associated with the home, if the owner hasn't had enough funds to maintain it properly.  Make sure your client hires a home inspector so they're aware of any problems and the associated costs.

When a home is approved for a short sale, the buyer will initially negotiate with the homeowner and the real estate agent, unlike a REO or foreclosure, and then get approval from the lender. Both the homeowner and the lender must agree on a sales price which can lengthen the process. You should make your client aware that it can take months to get a response from the lender, making the process frustrating for many buyers.

A few things you should make your client aware of including whether or not the short sale has been lender-approved.  If the seller hasn't gone into default, the bank won't support a short sale.  Also, it's important for buyers to know that short sales require a lot of paperwork and the buying process may take up to a full year. If your buyer is in a hurry to get into a property, a short sale isn't their best option.

Conclusion

Whether your client is considering a REO, foreclosure or short sale, he/she needs to be aware that they may be buying a home "as is" which can lead to additional costs after the purchase, the approval process may take months or even a year, and they may have little negotiating power.  Help your client find a bank that is familiar with the type of home sale they're interested in so they have an expert in their corner. 

We hope you'll share this information with your clients so they will be able to make the best decision on buying a home that has been seized by a bank or lender, or from homeowners unable to pay their mortgages.

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