Careful preparation, professional guidance, and patience are the keys to success when it comes to a short sale or foreclosure property purchase. Remember that, while a distressed property can offer great value, you need to be both financially and emotionally ready for what will likely be a more complicated path to homeownership.
The Differences between Foreclosure and Short Sale
A foreclosure is the legal process by which a lender reclaims a property when a borrower defaults on their mortgage loan. This process begins with what’s called pre-foreclosure – when the borrower has fallen behind on payments and receives a default notice. If the debt isn’t resolved, the property could proceed to auction, where it’s sold to the highest bidder, often on the steps of a courthouse or virtually. If that home doesn’t sell at auction, the lender takes ownership and markets it as a real estate-owned (REO) property via traditional real estate channels using agents and brokers.
A short sale, by contrast, occurs when a homeowner owes more on their mortgage than the property is worth and attempts to sell that property for less than the outstanding mortgage balance, with the approval of the lender. Once an offer is received on the property, the lender must review and approve it. Short sale steps include the seller applying for a hardship, lender review, negotiation of the purchase contract, and final lender approval.
“Unlike foreclosure, ownership in a short sale never shifts to the bank,” explains Carl Holman, director of marketing with Foundation Mortgage. “Rather, the lender agrees to take a loss to avoid foreclosure proceedings.”
Foreclosures often close relatively quickly once the property has hit REO status. Short sales tend to close much more slowly because every decision involves lender approval.
“During foreclosure auctions, the timeline is extremely short. Upon winning a bid, you must typically pay immediately – often in cash or within 24 hours,” real estate agent Eric Fernwood notes. “When a bank takes ownership and lists the property as an REO, the purchase can typically close within a standard 30 to 45 days after the contract is signed. But buyers have minimal negotiation leverage. At auction, sales are final with no contingencies, and REO properties are sold as is.”
After making an offer on a short sale property, the lender’s approval can sometimes take three to six months or longer. The property will close only after the lender issues formal approval. The good news is that you can have the home professionally inspected and appraised and include financing contingencies in your offer. But remember that the lender can counter your offer, reject it outright, or even increase the asking price before approving the sale.
Why First-Time Buyers Consider These Properties
The primary benefit of pursuing a foreclosure property is the opportunity to purchase below market value, often significantly. Also, depending on where the property is located, it could present an opportunity to enter a desired neighborhood on a lower budget. However, foreclosure properties can be riskier when it comes to home condition and title issues. The property may also garner lots of competition from other buyers, and you could have a limited ability to negotiate.
“Short sale properties offer potentially good value and better disclosure of the property condition, but it’s still an arms-length purchase with a lengthier approval timeline, where the lender controls negotiations and there’s a good possibility of the deal collapsing,” says attorney Neil Cohen.
According to Fernwood, good foreclosure home candidates include experienced investors with risk tolerance and readily available cash. Due to their fast timelines, the possibility of no inspection allowed, and minimal negotiation flexibility, foreclosures are usually better suited to experienced or cash-ready buyers.
“Short sale properties are more ideal for those who are not on a tight timeline and can wait months for lender approval while also dealing with the uncertainty of whether they will actually get the property at or near the contract price,” Fernwood says.
Getting Your Finances in Order
Whether it’s a foreclosure or short sale property, the lender/seller prefers a financially secure purchaser who won’t disrupt or delay the transaction. That’s why having your financing in order is crucial. Get preapproved for a mortgage loan and have sufficient down payment funds ready to demonstrate that you are a serious buyer candidate, the experts agree.
“If you buy at auction, prepare to have sufficient cash. Generally, no financing is available,” Fernwood adds. “If the property is habitable or when it becomes habitable, you may be able to pursue a cash-out refinance.”
Purchasing a bank-owned home or short sale property involves a similar financing process to buying a normal property: You’ll still need to obtain financing in advance (unless you are paying in cash). If the property is distressed, some loan programs can even provide down payment assistance.
“However, financing using FHA, VA, or USDA loans can be tricky if the property needs major repairs,” cautions Holman.
Building Your Team
You don’t want to go about this process alone. Partner with an experienced real estate agent skilled in foreclosures and/or short sales for better results: an expert who can anticipate lender delays and help you set realistic expectations.
“A trusted attorney is also important, as they can flag contract risks or title issues that are more common in foreclosure sales,” continues Holman, who notes that a real estate attorney may be required in judicial foreclosure states. “And enlisting a professional home inspector and contractor is also smart. These experts can assess whether the property needs repairs and if those repairs fit within your budget and capabilities.”
Inspection & As-Is Risks
Be forewarned: Most foreclosure and short sale properties are sold “as-is.” That means the lender or seller will not make concessions or repairs. You, the buyer, are responsible for all defects and problems uncovered after purchase. For example, you may discover mold, pest problems, a leaky roof, a malfunctioning furnace, or other issues after moving in.
That’s why having the home professionally inspected is essential, if allowed. Even if the seller/lender will not ameliorate any issues discovered by the inspector, it’s better to know ahead of time what you’re getting into so that you can prepare properly and budget for repairs accordingly.
Government Foreclosure Sales
Government-backed programs can provide special opportunities for buyers to claim foreclosure properties. Check out these resources:
HUD Home Store (hudhomestore.gov): Foreclosures on FHA-insured loans
Fannie Mae HomePath (homepath.com): Properties foreclosed by Fannie Mae
Freddie Mac HomeSteps (homesteps.com): Freddie Mac’s foreclosure listings
VA Foreclosed Homes (va.gov or linked listings): Homes foreclosed on VA loans
Many of these can also be found on the MLS through local real estate agents.
“These homes often come with added protections, such as priority access for owner-occupants before investors. For first-time buyers, this can be an appealing way to compete in a less crowded environment while still accessing financing options,” Holman points out.
Financing Tools & Assistance
Unfortunately, there are no financing options or assistance available for auctioned foreclosure properties. But when it comes to short sales or bank-owned properties, it’s worth exploring different financing choices, including:
Hard money loans or renovation-specific funding if standard loans are not available.
The good news is that purchasing a short sale or foreclosure property should not negatively affect your credit; instead, it’s the seller’s credit that takes a hit.
“As long as you close successfully, there should be no direct credit impact from purchasing a distressed property,” says Cohen.
However, when you have a mortgage loan, your debt-to-income ratio is impacted, which could restrict your ability to get additional loans.
Closing & Making It Home
Before heading to closing, it’s important to have a home inspection, appraisal, and title search completed. Also, remember to budget for unpaid back taxes, liens, and HOA dues (if you are purchasing in a homeowners association) that could transfer with the property.
“After closing, be prepared to make immediate repairs if necessary, reconnect utilities, and possibly secure the home against further damage,” Holman recommends. “Long-term planning is essential here. Distressed homes can be rewarding, but only if you budget correctly and understand the scope of ownership responsibilities.”
The Bottom Line
Careful preparation, professional guidance, and patience are the keys to success when it comes to a short sale or foreclosure property purchase. Remember that, while a distressed property can offer great value, you need to be both financially and emotionally ready for what will likely be a more complicated path to homeownership.
“Buyers who approach this process with strong finances, the right team, and a long-term plan can succeed, but never underestimate the hidden risks or the need for expert guidance,” says Holman.
