You may have heard about people being “upside down” on their mortgage. When people owe more than the value of their home it can lead to a short sale. If they cannot afford their mortgage payments anymore, it can lead to an REO (Real Estate Owned) sale.
A short sale occurs when a home is sold for less than is owed on it – for example, if the buyer owes $275,000, but the home will only sell for $250,000. An REO occurs when the property is already foreclosed on, and the lender (who now owns the property) is the seller. A short sale is preferable to a foreclosure for several reasons. I’ll explain both sales in more detail, and I think you’ll see why.
If you’re a seller, a short sale is better because it’s less damaging to your credit (and your privacy) than a foreclosure. Clearly, you won’t be too motivated to sell your home since you’re not making any money on the deal, but at least you’re not digging a deeper hole financially. Be aware that this must be an “arm’s length” sale – you can’t sell to your sister or son or best friend.
Another word of advice, don’t try to make an under-the-table deal with the buyer to get some cash. It’s called fraud, and it can get you in big trouble. Recently, a buyer agreed to buy an heirloom oriental rug for $60,000 (one that was worth about $500). The buyer and seller got caught and sent to jail. Sometimes the bank will allow the seller to get some cash out of the sale—as long as all parties agree, you’re good to go.
REOs are the end product of a foreclosure, which is a public process (must be published in the newspaper), and they are devastating to a person’s credit. If you’re a seller, try to avoid foreclosure if at all possible. Adding insult to injury, a foreclosure can result in a deficiency judgment against the seller, where they not only take your house but require you to pay the unpaid portion of the loan. Rough deal.
As a buyer, short sales are also preferable to REOs, generally speaking. In a short sale, the seller is obligated to complete a Transfer Disclosure Statement (TDS). This document discloses physical problems with the property as well as other known problems (e.g., a neighbor’s dog has bitten several people or a neighbor has been cited for several noise violations as a result of his garage band jamming until the wee hours of the night). In an REO, the bank isn’t expected to know about these issues and is exempt from the TDS requirement.
Again, looking at this from the buyer’s perspective, a significant downside to REOs is that buyers frequently must work with the lender’s escrow company and use the lender’s sales contract. Many of the lenders that have found themselves stuck with properties to sell are banks or federal lenders like the Federal National Mortgage Association, referred to as Fannie Mae. As a rule, these are bureaucratic organizations that are not customer-centric The process can get burdened with intractable inspection time frames, and doesn’t allow for contingencies.
Really, the only advantage to the REO is that anything that was going to get taken from the house has already been taken. Sometimes, when a buyer views a home before a short sale, they are horribly surprised later to find that everything that could be removed from the house has been.
Short sales and REOs often involve emotional trauma for the person who lost his or her home. As a result, I’ve seen houses with the following things removed – no exaggeration: wood stoves, “built-in” hot tubs, kitchen cabinets, wall-to-wall carpet, toilets, light fixtures and more. This goes way beyond taking the light bulbs to be frugal. This is an emotional response to the loss of a treasured home.
Apart from that, short sales are definitely preferable—whether you’re a buyer or a seller. Either way, I’d highly recommend going through the process with a Realtor by your side. In REOs, banks know the value of listing with a broker. They want to work with a competent Realtor that’s familiar with state and local real estate law. You should have a similar expert on your team.