Foreclosures versus short sale homes have been a longstanding debate in real estate investing.
Below is a comprehensive list of differences that can help you better understand which option is most suitable for your real estate investment strategy.
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What Is A Foreclosure?
It is integral to know exactly what a foreclosure is when deciding on purchasing foreclosures versus short sale homes. A foreclosure is a legal process in which a lender recovers the balance of a loan from a borrower who stops making the necessary payments. This is done by forcing the sale of the asset used as collateral for the loan, which in most cases is the house itself.
What Is A Short Sale?
A short sale is similar to a regular property sale, but with one major difference. During a short sale, the seller lists his or her property on the market with the help of a listing agent, just like a regular sale. However, the process also includes the involvement of the lender.
You are required to have the approval of your lender for a short sale as you are attempting to sell the property for a lower price than the outstanding mortgage balance.
Foreclosure Vs. Short Sale – The Differences
Since short sale homes are essentially regular sales at a lower price, it does not involve any extraneous costs versus doing foreclosures. A foreclosure has additional costs for the lender, including:
- Foreclosure suit with hearings (and associated documentation).
- Selling a foreclosed home (which is normally extremely hard).
Waiting Period For A New Mortgage
As a house flipper, foreclosing on a property is not good. After a foreclosure, the waiting period to obtain a new mortgage will be higher due to the negative consequences for the property owner and the lender.
Some mortgage loan companies may require you to wait four years in the case of a short sale. This can be lowered to two years or less if extenuating circumstances are shown. However, in the case of a foreclosure, Fannie Mae requires a seven-year-long waiting period which can be lowered to three years if there are qualifying circumstances.
From looking at the definitions of foreclosures vs. short sales, it is important to understand that foreclosures move along faster. With foreclosures, lenders are keen to recover the money they are owed. Short sale homes can take longer to close and hence are less desirable for lenders.
Properties can also have differences in the timing of resale. Foreclosures take place when the homeowner has abandoned the house. Short sales, on the other hand, can take place even whilst the homeowner is residing in the house. Thus, it may be less troublesome for a house flipper to purchase a foreclosure rather than a short sale.
Credit Score Implications
A short sale is not as damaging to the homeowner’s credit score when compared to a foreclosure. In the case of a foreclosure, the homeowner receives a mark on his or her credit that can make it difficult, even impossible to borrow money to purchase a home, car, or other items in the future.
This can also lead to the former homeowner being removed from the pool of large-scale purchase consumers for years into the future. This is because banks, in particular, almost always lose money on foreclosures.
Effects On The Housing Market
A house flipper should see that the number of foreclosures on the market is a signifier of the overall health of the local real estate market.
Where short sale homes are beneficial for the housing market, foreclosures can actually saturate it. Property values will drop in areas with several foreclosed homes, negatively affecting local home values.
Short sale houses, on the other hand, can revive a neighborhood as the buyer gets a house on discount. These are normally not in bad condition, making them easier to rehab. Many foreclosures in one area could limit the number of buyers for a house flipper’s property. So flippers should consider the number of short sales versus foreclosures in their considered area and if buying a short sale is a better deal.
Also keep in mind that when the market is down, turning the property around and selling it quickly may not be realistic.
When looking at foreclosures vs. short sales, it is also important to consider the matter of deficiency judgments. Short sales often lead to deficiency judgments which is essentially the mortgage holder seeking to recover the money that was lost during the home sale.
This could be done through a court order placing a lien on the debtor until the money is recovered. However, in the case of a foreclosure, neither the borrower nor the lender has to worry about this process.
Implications For Buyers
Foreclosed homes are generally in shoddy condition as they may have been left neglected for a long time. This implies that flippers will have to increase the amount spent on house repairs to make it sellable.
In the case of short sale homes, the house is normally in tip-top condition given that the homeowners were planning to live in it for a long time. Due to this fact, banks are willing to short sale a property rather than opt for a foreclosure. They are also more willing to negotiate the price with buyers, potentially giving a flipper a good deal.
Consent Of Homeowner
When it comes to a short sale, both the homeowner and the lender (normally a bank) have mutually agreed to the process. However, with foreclosures, the lender may sell the house without the homeowner’s consent due to his or her inability to repay the entire mortgage loan. This could provide a flipper with a quick purchase.
Future Home-Buying Implications
Just as the foreclosures vs. short sales debate has different implications for the credit score of a borrower; it has equally important implications for borrowers when it comes to future home-owning. The borrower may not be able to buy a new house for about five to seven years if his or her previous home was foreclosed.
Following a short sale, the borrower can immediately buy a new house if his or her payments were never above 30 days late.
While foreclosures often require the court to be involved due to the legal proceedings necessary in the process, short sales happen more directly because they do not involve any third parties. Also, short sales are initiated by homeowners, while foreclosures are initiated by the lenders.
Foreclosures reflect negatively on the borrower and if he or she has an employment status that requires a security clearance. The clearance may be revoked, along with the position being terminated following a property foreclosure. However, short sale homes do not leave such a stain on the borrower’s reputation and thus do not generally affect security clearances.
In the case of a foreclosure, the tax consequences are less given that the full amount is generally recovered by the lender. Whereas, with short sales, if the lender forgives the deficiency (the amount owed not covered by the sale) a “Cancellation of Debt” form is submitted. The forgiven amount is now considered part of the borrower’s taxable income.
Which Option Is Best For You?
Sometimes financial circumstances force homeowners into placing their homes on the market as either short sales or foreclosures. These can provide enterprising flippers with buying opportunities. In such cases, the list above will help a house flipper to understand whether buying a foreclosure or a short sale is a better option.
If you’ve gone through the list, it should be clear that there are many factors that come into play when looking at foreclosures vs. short sale homes, especially depending on your situation as a flipper or real estate investor.
Even though foreclosures are more immediate and relatively easier options for the borrower, almost in every scenario – whether you are a homeowner, a lender, or a buyer in the market – a short sale or a short sold house is the option that most minimizes the negative impacts overall.
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