As you’ve been on the hunt for great deals on houses, you’ve likely heard of short sales, pre-foreclosures, and foreclosures. But what are they? And how can they benefit you?
These types of purchases can be great opportunities for you as a real estate investor or as an agent that is looking to build an investment portfolio. The appeal of buying short sales, pre-foreclosures and foreclosures is that you can secure a property well below market value and wholesale, fix-and-flip or flip to rent the property for a more significant profit.
All three options are appealing to a home buyer that has a DIY streak and doesn’t mind putting in the work. Home buyers can save a bundle and get to style the house to their tastes and lifestyle vs. trying to modify the home to meet their needs.
The confusion sets in because there are more similarities between these categories and it feels like they sort of blend together at times. The big difference between a foreclosure, pre-forclosure and a short sale is that each one is set up based on the homeowner’s situation. Who is selling the home, the terms of the sale, and how it is sold can vary with each.
These differences are what will ultimately determine which is beneficial to you, given your interests and goals for the property. To help you determine which would work best for you, let’s take a look at purchase types.
The similarities and differences between short sales, pre-foreclosures and foreclosures.
|Ability to Inspect Property Prior to Purchase||✔||✔||✖|
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|Repairs Should Be Expected||✔||✔||✔|
|Reasonable Time to Close Purchase||✖||✔||✖|
|Bank/Lender Approval Required||✔||✖||✔|
A short sale is when a lender accepts a payoff that is less than what is owed. This helps an owner who is experiencing financial hardship sell the property.
Those who take this route aren’t always behind on payments or at risk of losing their home. Instead, it is typically a preventative measure taken to avoid foreclosure.
They ask their bank to sell the home for less than what they owe and to forgive the remaining balance. Despite taking a loss, banks may allow this option as it is easier to deal with than a foreclosure.
A pre-foreclosure is when a lender files a default notice on the property because the owner is at least three months behind on their mortgage payments.
The owner has three options: pay off the owed amount, sell the property, or face foreclosure.
A pre-foreclosure sale is when the homeowner opts to sell the home to pay off the remaining debt. Often they sell the house for less than market value to remedy the issue quickly.
A foreclosure is a home that has been taken back by the lender because the owner did not keep up with payments.
Homes purchased with a bank loan will go to a sheriff’s auction, where it will typically be sold at a fraction of the market value. If the home doesn’t sell, it will remain in the bank’s name, and the bank will list it as an REO (Real Estate Owned) property.
If the home was purchased with an FHA loan, the federal government would reclaim it. A government-registered broker then sells these homes.
Risk Vs. Reward
Which type is worthy of investment? That depends. There is no clear cut answer, but knowing more about each and how they compare can help you.
One major factor is that homes in any of these categories will be sold “as-is.” This does not always mean the homes need extensive renovations, but some repairs should be expected.
Keep in mind that a homeowner who is unable to make mortgage payments likely put off needed repairs and updates. As you look around, give yourself that extra cushion in your budget to back these finances.
With a pre-foreclosure and a short sale, you can get a look at the home before purchasing and will know what to expect. Furthermore, the homeowner can fill you in on any partially completed projects or hidden flaws that will need to be addressed.
This is not the case with foreclosures sold at an auction. In this case, the property will be bought sight-unseen. It’s best to consider Foreclosures if you are ready to purchase a fixer-upper because of this aspect.
If you decide to purchase a pre-foreclosure or a short sale in place of a Foreclosure, be prepared to absorb some of the seller’s costs at closing; they likely do not have the funds to cover them. Also, because the property is listed below value, negotiations will likely lead to you taking over some fees that are typically the seller’s responsibility.
Pre-foreclosures are also often in the same condition as Foreclosures but will take less time to acquire than a short sale. Both are sales conducted by either the owner or a real estate agent. The difference is that with a short sale, the bank is involved and may reject offers accepted by the owner.
While banks have increased their efficiency with this process, it still can take several months or more than a year to process. This balances out as the home is generally going to be in better condition; you’d just better be ready to wait.
Does this mean that pre-foreclosures and foreclosures are always going to be project homes? Or that short sales are the only way to buy a home that is in livable condition below market value?
No. It’s just a general rule of thumb to work into your investment tactics. Again, there are a lot of variations to take into consideration, and it ultimately boils down to the seller’s ability to keep up with repairs.