Foreclosures versus short sale homes have been a longstanding debate in real estate investing.
Below is a comprehensive list of differences so you can understand better which option is suitable for your 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 payments by forcing the sale of the asset used as collateral for the loan.
This is typically the case with houses as they are often used as collateral for loans.
What is a Short Sale?
A short sale is just like a regular sale in that the seller lists his or her property on the market with the help of a listing agent but the only difference is that here a lender gets involved in the process as well.
You require 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 sales at a lower price, it does not involve any extraneous costs as opposed to foreclosures. A foreclosure has the additional costs for the lender such as those of a foreclosure suit, hearings and associated documentation, along with the possible task of selling a foreclosed home which is normally extremely hard to sell.
Waiting Period for a New Mortgage
As a house flipper, foreclosing on a property is not at all good. In the case of a foreclosure, the waiting period to obtain a new mortgage is higher as it has negative consequences for the property owner and the lender, along with the housing market in general.
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 demonstrated. However, in the case of a foreclosure, Fannie Mae requires a seven-year long waiting period which can be lowered to three years due to extenuating circumstances.
Looking at the definitions of foreclosures vs. short sales, it should be clear that foreclosures move along faster. With foreclosures, lenders are keen to recover the money they’re owed. Short sale homes can take longer to close and hence are undesirable for lenders.
Furthermore, another difference in timing comes in when looking at the property being resold. 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 as 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 for a home, car or any other purchase in the future.
This can lead to the former homeowner to be removed from the pool of large-scale purchase consumers for years. Banks, in particular, almost always lose money on foreclosures. A house flipper should see that the number of foreclosures on the market is a marker of the overall health of the real estate market. When the market is down, turning the property around and selling it quickly may not be realistic.
Effects on the Housing Market
Where short sale homes are beneficial for the housing market, foreclosures actually saturate the housing market. Property values drop in areas with several foreclosed homes and not in an attractive manner.
Short sale houses, on the other hand, can revive a neighborhood as the buyer gets a house on discount which is normally not in bad condition. So flippers should consider the number of short sales versus foreclosures in the area and if buying a short sale is a better deal.
When looking at foreclosures vs. short sales, it is important to keep in mind the matter of a deficiency judgment. 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 by placing a lien on the debtor until the money is recovered. 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 conditions as they may have been left neglected for a long time. Hence the implications for the flippers include an increase in the amount spent on the house overall 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. Banks are willing to short sale a property rather than opt for a foreclosure and are thus 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 agreed to the process mutually. 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 convenient 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 almost immediately buy a new house if his or her payments were never above 30 days late. Many foreclosures in one area could limit the number of recurring buyers for house flipper’s properties.
While foreclosures often require the court to be involved due to the legal proceedings necessary in the process, short sales are a more direct process – not involving any third parties. Also, while short sales are initiated by homeowners, foreclosures are initiated by the lenders.
Foreclosures reflect negatively on the borrower and if he or she has an employment status that requires security clearance, then the clearance may be revoked, along with the position being terminated. Short sale homes are not such a stain on the borrower’s reputation and thus do not affect security clearance.
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 short sales or foreclosures. In such a case, 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 position.
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 minimizes the negative impact overall.
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