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Buyer Basics
Distressed Properties Overview
Short Sales, Foreclosures, and REOs
Unless you're a patient, submissive buyer willing to give into every demand imposed by a bank, you should steer clear of short sales. It usually takes a VERY long time to close a short sale, and many if not most, do not close before becoming a foreclosure.
Important Note: New "HAFA" legislation, effective April 5th, 2010, is intended to get banks to respond to short sale offers more quickly and make accepted offers close more quickly. However, there are little consequences for banks that do not comply, so it is yet to be seen if this legislation will have the desired effect.
Most ordinary buyers should also steer clear of foreclosures because, as with short sales, you risk assuming unknown liabilities. It's best to wait till it becomes an REO.
An REO is the safest, and although by no means easy, is the least difficult of the three types of distressed properties to purchase. See below for more information on all three of these distressed property types.
Issue |
Short Sale |
Foreclosure |
REO |
Non-Distressed |
Typical time till offer acceptance, rejection, or counter |
1 to 12 months |
1 to 2 months |
5 to 15 days |
2 to 5 days |
Time to close after acceptance |
3 to 6 months |
45 to 60 days |
45 to 60 days |
15 to 45 days |
You must assume liabilities, liens, outstanding HOA fees |
YES |
YES |
NO |
NO |
Who must approve sale? |
owner & bank |
owner & bank |
bank only |
owner only |
Likelyhood of ever closing |
low |
medium |
high |
high |
Short Sales
[The following is meant to inform you, not discourage you, about short sales. But we admit that it sure sounds discouraging...]
A short sale results when an owner wishes to sell their property, but the proceeds from the sale will not be sufficient to repay the lender for the unpaid debt still owing on the property. The seller can not legally sell the home without the consent of the lender. The deficiency must either be made up by the seller, or forgiven by the lender.
Note that you generally have to buy a short saled property "as is", meaning that the seller or lender will NOT make any repairs or replacements of missing or broken appliances or fixtures. These problems become your responsibility once you become the owner. You also will be assuming any outstanding liabilities on the property such as mechanics leans, home owner association dues, or other forms of litigation.
Banks are not anxious to forgive debt, and the seller usually does not have the funds to pay the difference. Once a prospective buyer learns about oustanding liens, litigation, or the cost of repairs, they often withdraw their offer. All of these factors often mean that a short sale will never close. During 2009, 87% of all short sale contracts DID NOT CLOSE, although it looks like for 2010 as of about March, it's improved to only 33%.
When you submit an offer on a short sale property, it must be first accepted by the seller, then it will be forwarded to the lender's loss mitigation department. Be prepared to wait for a reply. It may be weeks or months before they even acknowledge receipt of your offer, let alone accept or reject it. You may be asked to sign additional legal documents agreeing to lender restrictions, and you may have to submit a final "highest and best" offer.
Often a home owner sets a very attractive "low ball" asking price without first consulting with the lender to see if they will agree to accept that price. The lender generally will not agree to such a price, and will delay to allow numerous offers to pile up. When buyers learn that they are competing with many others, they tend to become involved in a bidding war, thereby driving the offers higher. If they go high enough, the bank may agree to sell. If they do not, the bank will eventually initiate foreclosure proceedings.
Whether it closes or not, the process will very likely be slow and challenging. Many of those that did not close took several months, a year, or more, before they ended in failure. For those that did close, it often took extraordinary and multi-month efforts on the parts of real estate, mortgage, and title professionals.
Meanwhile, if the seller is behind in their mortgage payments, the foreclosure clock is running. The lender may initiate foreclosure proceedings, at which point they are unlikely to accept a short sale offer. A foreclosure offers significant profit advantages to the lender over a short sale. For example, if there is a mortgage insurance policy, the lender cannot collect on this policy untill after foreclosure is completed. There are also several federal subsidies available to them once the complete the foreclosure process which unfortunately discourage banks from completing short sales, or modifying loans to keep owners in their homes.
If you need to close on a property within a reasonable or short period of time, stay away from short sales. But if you can wait, and are willing to concede to all demands made by the seller's lender, then short sales may be for you.
Don't take our word for it. Here are some additional articles from various news and real estate organizations with additional facts and opinions about short sales:
Foreclosures
Foreclosure is a process whereby a lender, usually a bank, takes ownership of a property away from a borrower because of a default in the terms of the mortgage, usually a failure to make payments.
In Nevada, this process takes at least four months, although it often takes longer. The process can be terminated if the borrower pays the overdue amounts along with any late fees. The process is stayed if the borrower files for bankruptcy. The owner may sell the home during the foreclosure process as long as the sales proceeds are sufficient to satisfy the outstanding debt to all lienholders, thereby stopping foreclosure. If sales proceeds are insufficient, the bank may agree to a short sale (see above), but usually this is not permitted once the foreclosure process starts.
Once the foreclosure process completes, the bank becomes the owner of the property, at which time it is called an "R E O." (see below). An sherriff's sale must be conducted to attempt to sell the house, but the bank does not have to sell the home to the winning bidder. The current trend is that they NOT sell at the auction, instead choosing to sell through traditional means such as a multiple listing service real estate broker.
Once sold, the proceeds of the sale are applied to the outstanding debt. Any unpaid balance is still owed by the borrower to the bank, and the bank has the right to file for a deficiency judgement to obtain the balance through such means as garnishment of wages. If the bank foregoes the deficiency judgement and instead opts to forgive the outstanding debt, they must issue a 1099 so that the amount forgiven becomes taxable to the borrower.
The Mortgage Forgiveness Debt Relief Act of 2007 temporarily exempted much of the debt forgiven from taxation, however, it is set to expire in 2012. You should consult a qualified accountant to determine the tax consequences for your particular situation.
The owner may also offer a deed-in-lieu of foreclosure to the bank, whereby the owner simply gives the property to the bank without completing the foreclosure process, but the bank must agree to accept this option in full satisfaction of the outstanding debt.
REO's
REO stands for Real Estate Owned. Owned by what? A lender, usually a bank. A bank may become the owner of a property after an unsuccessful foreclosure auction, or because a borrower gave them the property via a deed-in-lieu of foreclosure.
Once a property becomes an REO, the bank is responsible for all expenses involved with the property such as maintenance, home-owner association fees, taxes, etc. A bank will usually try to sell the property any way they can, but if they have an unusually large inventory of REOs, they may elect to limit the number they put on the market at any given time, thereby controlling the supply and preventing prices from being driven lower.
Banks sell property "as is", without any kind of warranty. A buyer must agree to accept the property with any defects or shortcomings. Nevada law requires that the seller provide an SRPD (Seller's Real Property Disclosure) which is intended to inform prospective buyers of any known defects, but banks never provide this form, instead requiring you to sign an NRS Chapter 113 Waiver which relieves them of that obligation.
Some banks have a habit of listing a low asking price which they have no intention of accepting. They do this to attract multiple buyers and cause a bidding war. They will ignore at least the first, if not several offers. Once buyers learn that there are multiple offers pending, they tend to make higher offers. It could be quite some time before the bank is satisfied that they've received as high an offer as they are ever going to get, and finally agree to sell.
Nevertheless, REOs are still the safest and best choice of the three distressed properties because:
- there is only one party (the bank) involved. The original home owner is out of the picture
- past due home-owner association fees must be paid by the bank before closing can occur.
- any outstanding litigation or liens must be satisfied prior to closing, and if they are overlooked during the title sarch, your title insurance policy should protect you.