Buying A Foreclosure vs Short Sale | 2021

Buying A Foreclosure vs Short Sale | 2021

Short Sales versus Foreclosures. This is a topic that I’ve done a few videos on relative to the foreclosure side of things. I’ve been seeing a lot of people ask about them again, especially since it’s such a competitive market and everyone wants a “deal.” They probably still remember how it was back in the day when short sales and foreclosures plentiful and cheap. Back then, you might have to do some work, but you can definitely get those houses for a lot cheaper. Now that some of the laws have recently changed, let’s talk about short sales and foreclosures again, how they differ, and why that matters.

Definition of Foreclosures or REOs

First and foremost, for clarity’s sake, when we’re talking about foreclosures, you might see or hear them being referred to as an REO, which stands for real estate-owned. Real estate-owned (REO) is just how the bank classifies this asset when they take the property back after the foreclosure occurs and no one buys it while it is still available at auction. The bank will then hire an agent and have the property sold to recoup their investment in it. To read more about what happens during each step of the foreclosure process, click here.

Definition of Short Sales

On the flip side, the short sale is a situation where the house is underwater, meaning its value is below what is owed on it in total.

By definition,  a short sale is a type of distressed sale that happens when a homeowner owes more than what they can sell the home for on the open market.  In this case, the homeowner is essentially asking the mortgage lender, typically a bank, to accept a lower amount than the total amount owed. So, if you’re this owner, even if you sold the property at fair market value, you still couldn’t pay off all the debt. Therefore, this sale is upside down or underwater.

A short sale is something you can apply for with your bank in order to get out from under your debt. Generally, the bank will come up with a number that they’ll accept. Then once they have an acceptable offer for them to take, they’ll receive the pay off, and then they will report a loss on your credit. Doing this really hurts your credit, but that’s for another post. 

The main differences between Foreclosures vs. Short Sales

We can see the difference between REOs and short sales in three categories—process, timing, and damage on credit score.

Process. Unlike a foreclosure, a short sale is voluntary as the owner can seek the approval of the lender to sell the property at a lower amount than the amount owed on the mortgage. On the other hand, a foreclosure is involuntary as this is the final step in the process. Typically all other option have either failed for one reason or another. 

Timing. Although there are exceptions to this, in general, foreclosures move along much faster because lenders are intent on recovering the money they are owed. Short sales, meanwhile, can take up to one year to close.

Damage on Credit Score. A short sale is far less damaging to your credit score than a foreclosure, as people who opt for a short sale can usually buy another house within a few years. However, it will likely make the process for securing another mortgage more challenging. In contrast, a foreclosure will stay on your credit report for seven years, and you’ll have to wait five more years before you can buy another house.

So, in a nutshell, a short sale is when the owner is taking action in selling, while a foreclosure is when the bank takes action and sells the property.

Why you should care and what it has to do with our local real estate market

Now, let’s talk about why you should care and what it has to do with our local real estate market. Well, as of today, April 2021, when I’m recording this video, there are not a lot of foreclosures on the market.

As you can see on the image above which I pulled out of the MLS, right now, there are only a total of six for both REOs and short sales (ACTR and ACTS) in the entire greater Bay Area. It’s a teensy tiny fraction compared to some well over 9000 units for sale for condos, multifamily, and single-family houses, and all of that stuff on this day when I recorded this video.

And that’s because, generally speaking, equity is at an all-time high because values are at an all-time high. So most people, even if they’re in financial trouble, can sell the house and still be upright and not have to go through a short sale, which is why you see this the way that it is—so few of them.

Bay Area vs. Southern California

Now, historically, there have not been nearly as many short sales or foreclosures here in the Bay Area as, say, for example, Southern California. For whatever reason, the two markets just have that in common.

When I was doing more of those short sales and REOs, I remember looking at San Diego County and the number of foreclosures they had at any one month was more than what the other six Bay Area counties have combined at that time. Now, of course, I’m sure that’s changed a little bit. But if you’ll look historically, Southern California has always had notoriously more than Northern California, for whatever reason. But this relates to our conversation today between that difference and why you should care.

How foreclosures and short sales affect the comps

Typically short sales sell for less than comps because they’re often not well taken care of. It’s the same thing too with REOs. Most of the time, the bank is not going to do inspections upfront. You’re kind of buying the property as is, and you have no idea what’s going on. In addition, because the foreclosure process takes so long, there is a lot of deferred maintenance also.

In both cases, they sell for a little bit less, so you end up getting a bit of a discount. But ultimately, right now, there’s not going to be a lot of those opportunities out there for you to get a good deal. Right now, those opportunities just don’t exist.

What happens when the market starts to correct

Obviously, we don’t know what’s going to happen in the future. When prices cool off, and the market starts to correct or flatten or go back down, inevitably, there are going to be people who bought their houses at the tippy top—just right before it tipped—who may end up underwater. If those people have to sell for whatever reason, you might see some short sales come up.

However, again, as I’ve talked about in a bunch of past market updates, there’s a lot of cash flying around. This means that there’s a big equity cushion. There are a lot of people who are putting 30%, 40% down. Therefore, even if the market dips 10%, their value could still absorb that.

Now, of course, no one wants to lose 10%, especially on a million-dollar purchase. However, if they really had to sell, they’ll most likely wouldn’t immediately go to a short sale. They would probably still go on the open market because they still have that large equity cushion.

Why we need to talk about this???

So why are we even talking about this, then? Well, number one, it’s a popular topic of conversation. A lot of folks are asking about it, and it’s something to be aware of. It’s not something that I’m predicting or seeing any reason that it will pop back up in a big way here, locally. However, this is with the sole exception that it’s possible (with an asterisk) that all of the forbearance payments and all of the late payments from COVID may eventually catch up with folks. Consequently, this may force them to sell. Some may also end up getting foreclosed on or resorting to a short sale because of all of these late payments they’ve accrued over the last year or so.

We can also recall that the current administration under President Biden has said that they don’t want to see a wave of foreclosures hit. So presumably, there will be policies in place on a national level and probably also at the state level to prevent some kind of massive wave of foreclosures from happening in the short term. That’s not to say that if the market corrects, interest rates go up, buying power goes down, and equity starts to squeeze a little bit, you might see more of these REOs and short sales pop up, as opposed to just the six that we see as of today. With all these possible outcomes for short sales and foreclosures, they’re definitely something to be aware of.

What you need to remember if you're planning on buying a short sale or a foreclosure

If you think that you might want to buy one of these properties, put it in the back of your mind that it is not a quick process. Whether it’s a foreclosure or an REO, it takes a long time to do anything, frankly. When you go to make a bid on a short sale, as an example, you have to go through one and sometimes two layers of bank underwriting. You need to get approval from the first lender and then the second lender, too, if there’s one. That process alone can already take an awful, long time. It’s not for someone who needs to move in immediately, and it’s definitely not for someone who wants to be able to buy a house really quickly.

However, if you’re patient, you might get that opportunity to find that diamond in the rough. If you’re patient, you can definitely make a good purchase and score even in such a hot market. But as a disclaimer, I don’t think that is where you should put your energy and time right now. After all, at the moment, it’s not even something that is a significant portion of our inventory. That could change, though, and I think it might, which is why you should know what it is and be aware of it. But right now, you should still probably put your energy somewhere else.

I hope my blog on the things you should know about short sales and foreclosures has helped you.

If I can give you more context on the process of buying or selling your home, please do not hesitate to reach out. My information is below. 

Here’s to all your success!

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