What Is The Difference Between a Short Sale, Pre-Foreclosure, Foreclosure & REO?

There are a lot of 'catch phrases' that are being slung around in the media today.  Before you can consider selling your home as a short sale or purchasing a foreclosure, you might need to know what they are... or first, what the difference is between them.

Pre-foreclosure - Before a home is 'foreclosed upon', or even before a home is officially in the 'foreclosure' process, the Seller is deemed to be in pre-foreclosure.  They may only be one or two payments behind on their mortgage.  They may even be further along in missed payments.  Regardless, they have not yet been served, and neither the court nor sale date has been set.  In either case, the home is usually referred to as a pre-foreclosure, because it is BEFORE the actual foreclosure proceedings take place.  *As a side note, please know that the foreclosure process varies from state-to-state.  We are located in North Carolina, and thus when we speak of the foreclosures, we are speaking of the non-judicial process.

Foreclosure - Many people use the term 'foreclosure' as a general, catch-all word for distressed properties.  However, it is a little more specific than that, because as we just read, an owner may be behind on their payments, and they may be facing the possibility of foreclosure, but they may not have yet been served.  However, once the seller is served (receives notice of the default and is apprised of a court date to determine if a sale may be set) then the home may be more specifically referred to as a 'foreclosure'.  The problem with this term is that most people refer to homes owned by banks as foreclosures.  Now, read on...

REO - An REO is a short term for Real Estate Owned.  This is the term that I prefer to use when referring to what most people call foreclosures.  Typically, when a property is sold on the courthouse steps, if an investor does not purchase it, then it is almost always purchased back by the bank or lender.  When this is the case, it becomes part of the lending institution's inventory - and as such, it is called an REO.  It was a foreclosure, but it is now an REO.  And that is the difference.

Short Sales - Short Sales are becoming more and more popular, as more and more home sellers are in financial distress and find that their homes are not worth as much as they owe. So, let's spend a little more time and go into greater detail on short sales. Click below to REALLY get into short sales.

What Is A Short Sale?

A "short sale" is the sale of a house in which the proceeds fall short of what the owner still owes on the mortgage.

Why would you want or need to do this?  Some homeowners may have purchased their homes during the height of the real estate boom, but now, the same home may not be worth what it once was.  The solution: sell it for less than what is owed.  Some homeowners may have borrowed too much for their home (eg. 100% financing or refinancing). If the value of the home has not increased significantly since then, there may not be enough equity to pay all the costs associated with selling.  The solution: sell it for less than what is owed. 

However, in almost every short sale case, there must be a proven hardship on behalf of the seller.  It is not enough to simply say that you have to sell.  But rather, there must be some sort of extenuating circumstance that is preventing you, the seller, from selling the home and completely paying off the debt.

Many home owners who can no longer afford to keep mortgage payments current find that a short sale is the best alternative to bankruptcy or foreclosure proceedings. When lenders agree to a short sale in real estate, it means the lender is accepting less than the total amount due. Not all lenders will accept short sales or discounted payoffs, and not all Sellers will qualify for a short sale.  However, when lenders agree, they are betting that they can avoid a lengthy and costly foreclosure process.

While considering a short sale, sellers are always advised to seek sound advice from an attorney and/or CPA.  However, in any case, it it is imperative to contact a real estate professional immediately.  A Realtor who is trained in obtaining short payoffs will be able to lead a seller through the long process of gathering information, submitting the short sale request, listing the home, procuring and negotiating a bona fide offer to purchase with a Buyer... AND communicating that offer with the lender, all so that the seller may escape the stigma of a foreclosure as well as possibly save his or her credit report from more severe damage.

Short Sale Information For The Seller...

The short sale process has always been a very frustrating and lengthy one. There used to be a time when short sales could be resolved and approved within 2 weeks.  Now, they can take anywhere from 30-180 days to complete - if indeed they ever DO reach a resolution. They should now be called "long sales".  Today, many short sales are never even reaching a negotiator's desk at the lending institution.  Many files are stuck in limbo with unwilling, understaffed and simply uninformed lenders. 

While new legislation may soon help to resolve some of these issues and alleviate some backlog, the Home Affordable Foreclosure Alternatives Program (HAFA) still has some 'kinks' before it can be considered a success.  However, if successful, it could completely change the landscape of how short sales work.  The HAFA program is not intended to assist every homeseller, and as is the case with short sales in general, not every lender participates in the HAFA program.  So, for the purpose of our immediate discussion on short sales, we will continue with the traditional method.  Our main menu will offer additional information on the HAFA program.

It is important to understand that not all sellers and not all properties will qualify for a short sale.  Yes, there is a qualification process.  It is not enough to say "Hey, I made a bad purchase, so let's just dump this home". 

First, there must be some sort of financial hardship.  Did the seller lose a job?  Did the interest rate adjust upwards, thus making the monthly mortgage payments completely unaffordable?  Is the seller trying to sell the home, but due to market conditions, it is no longer worth what is owed?  What are the specific circumstances surrounding the inability to 'keep' the home?  This is the 'hardship'. 

You do not necessarily have to be behind on your mortgage payments in order for a lender to qualify you for a short sale.  This used to be the case, and there are many people who say this is still the case, but not always.  It will all depend upon which route the short sale takes, who the investor is, who the servicer is, and under which program the short sale is accepted.  However, if you are already behind on your payments, there is no time to waste.  In fact, if you are already behind, we hope that you have already contacted your lender or mortgage servicer to see if 'something' can be worked out.  Many lenders would rather renegotiate the terms of your debt, than to write off a loss.  We HIGHLY recommend that all sellers in this situation first try a modification on their mortgage, as we are now seeing this to be the first requirement under the HAFA program.

Secondly, if you have plenty of cash reserves, other financial investments (lenders will usually not consider a 401k - so that may be safe), or if you have a positive monthly cash flow, the lender may not qualify the seller for a short sale.  This is not always the case, however. Therefore, all short sale cases must be explored on an individual basis as there is no ONE litmus test. 

And be sure that if you are trying to keep any part of the equity you already have in your home, you will not have success with a short sale acceptance.  If a home is worth $200,000 and you only owe $150,000, then there is $50,000 in equity.  Why would a lender take a loss when the Seller can take the loss?

So, if you can not keep up with your payments for a viable reason, if you don't have the cash reserves or sufficient income to pay your debt, AND your home is not worth what you owe... then a short sale may be in your future!

As previously mentioned, the landscape is changing with regards to how short sales work under the new HAFA program.  Be sure to read our new page with a brief review of the relief this program may bring to the short sale industry.

Consequences of a Short Sale

Since we are not attorneys nor a CPAs, we can not give legal or tax advice, and the following should not be construed as such.  Please understand that there may be credit, tax and legal consequences for the Seller in a short sale transaction.  We strongly urge you to seek other professional advice.

Sellers often ask which is better... a Short Sale or a Foreclosure?  Well, that depends, and it will always depend.  More often than not, a short sale is going to be 'better' because the consequences will be less severe than a foreclosure.  However, each situation is different, each Seller's needs are different, and each bank is different.

Regardless, there may be credit, legal and tax consequences to a short sale.

Both foreclosures and short sales will have credit consequences and both may stay on your credit report for 7 to 10 years.  However, whereas a foreclosure may prevent a lender from approving you for another home loan for 5 to 7 years afterwards, typically, short sellers may be able to purchase again within 2 to 7 years.  Alot depends upon how a short sale is reported to the credit bureaus.  If it is reported like the vast majority of cases as "settled for less than full value", then your credit will indeed take a hit, albeit still smaller than with a foreclosure.  Alternatively, we strive to communicate with lenders to report the sale as 'paid in full' which is not always likely, but still attainable in some cases, and a much better consequence on your credit report.

Another factor which contributes to one's ability to purchase again after a foreclosure, short sale or deed-in-lieu is whether or not there were extenuating circumstances associated with the default.  Did the owner simply 'walk away' from the home?  Or was there a job loss, loss of income, health issue?

Additionally, after a forclosure or short sale, lenders want to see that the borrower has not only re-established credit, but will be putting a little more 'skin' in the game with a 10%-20% down payment.  Again, this all varies by situation.  And it will all most certainly change in the years to come.

Many people think that if a home is foreclosed upon, the seller can just walk away, free and clear of any debt.  Not so fast!  While in some states, that may be true, in North Carolina, laws may allow a lender to pursue a 'deficiency judgement' against the seller for any amount of debt that was not paid (one of the deciding factors will be whether the shorted loan was a purchase money loan, refi, 1st or 2nd mortgage).  In the case of a foreclosure, the amount of debt not paid will be quite larger than the amount of debt not paid in a short sale.  Being responsible for part of a debt is much better than being reponsible for most of the debt. 

In many instances when short sales have been properly negotiated, the lender may release the entire debt.  Instead of just releasing the lien on the property, they may consider the debt 'Satisfied in full'!  This means that they will take no recourse against any debt unpaid after the close of the sale.  Of course, this will vary from lender to lender, seller to seller and case by case.  But in cases where the seller is insolvent, it is more likely to happen - but is never guaranteed! 

There is also new legislation which may allow participants in the Home Affordable Foreclosure Alternatives Program (HAFA) to be fully released of further debt repayment obligations.  This is on a case-by case basis, and is not available to everyone. FHA also sponsors a pre-forclosure program which eliminates the debt repayment obligations.

Short Sales - Information For The Buyer...

By purchasing a property for less than what is owed, you may get that deal you were always looking for.  Many homes that are within the pre-foreclosure process are nice homes in nice condition. Other times, these homes may need a little TLC to make it habitable. Regardless of the condition of the property, to you as a Buyer, the end-result of the short sale is that you own a home, free and clear of all encumbrances of record. It will be no different than if you purchased a home at fair market value from Tom and Susie Homeseller, without the pre-foreclosure stigma.  The only difference is that the process may take a little longer to complete.

For the reasons stated above, make sure that if you are considering purchasing a home in which the seller is attempting to short the payoff amount, you give yourself plenty of time and maintain a contingency plan in case the process takes a turn to the left - or simply does not 'turn' at all.

Be aware that the short sale process is not an exact science. If you see a home that is 'listed' as a short sale, the list price you see may or may not be the price at which you can purchase the home.  I know this may sound strange... why can't you purchase a home for the asking price?  Many times, the seller or "Realtor' does not know at what value the lender will accept by the time the home is initially on the market. Remember, the whole reason to short a mortgage is to sell it for less than what is owed.  The only number the seller or Realtor may know at marketing time is what is owed. If the full balance owed is more than the home is worth, (which is the real reason for this entire process) then the seller may never obtain an offer.  Therefore, in many instances, the seller or Realtor markets the home at their best 'guestimate' of what the lender may accept. Once an offer is received, whether it is more or less than the list price, the seller or Realtor will submit it to the lender for approval, counter-offer, or flat refusal.

Having said all of the above, changes are slowly being made to the entire short sale arena.  The US Treasury's new HAFA program may allow sellers to understand the exact price for which the lender or servicer will accept on a short sale.  Additionally, they will even pre-approve a seller for short sale acceptance, pending only a viable contract.  However, before we get excited, we must mention that the HAFA program is not available to all short sale sellers. 

So, before bidding on a short sale listing, you need to inquire with the seller or listing agent as to how they arrived at the listed price.  Is it the fair market value of the home? Is it a shorted payoff amount that the lender will accept, or is it an estimate of what the borrower and/or Realtor hope the lender will accept? Is this loan part of the new HAFA program?  Many questions, so little time.

In any case, there are two main points that need to be stressed and need to be fully understood by the buyer:

1) There may be rare exceptions, but neither sellers nor lenders are looking for extraordinarily low offers. Despite what you may have read in the blogosphere, from your neighbor, or on TLC... buying short sales are not going to make you rich.  We have rarely ever encountered a short sale that has been sold for more than 10% to 20% of its market value. 5% to 10% is much more likely, and 20% is only likely if there are severe deficiencies such as mold or foundation problems.  If you are looking to pick up 'foreclosures' at 50 cents on the dollar, you can unplug your computer right now.  "Flippers" or wholesalers need not apply.  Because of increased lending regulations, it is nearly impossible to 'flip' nowadays.  There may be cities such as Las Vegas or Florida in which this may happen, but not here in the Triangle Region of NC.  Remember, however, that most times, lenders will discount off the market value and not the value that is owed.  So, a 10% discount is definitely a deal - one that you most likely wouldn't get if it were not a short sale.  I'll take a 5% to 10% discount, wouldn't you?  Moreover, we even see many 'shorted' homes not go any lower than current fair market value.  At current FMV, it may be a large discount in the lender or servicer's eyes since they loaned a heckuva lot more than the new purchase price.  But in the eyes of the Buyer, it really is not a discount because it is the same sale price that the other homes in the neighborhood are going for.

2) If you are going to make an offer on a short sale, please make sure you have the ability to wait a long time.  Short Sales can take as little as 30 days, but more likely, they take up to 4 months to a year.  You would be doing a dis-service to yourself, your family, the seller and everyone involved if you chose to 'bail' before you saw your offer continue through the entire process.  Be patient and know that this WILL take time and there are no short-cuts. 

Why Do Short Sales Take So Long?

We get this question all the time!  Sellers want to sell their home quickly so that they don't do any further damage to their credit report. Buyers want to know, simply, if they can buy the home or if they have to look elsewhere. Buyer agents (Realtors representing their buyers) need to understand where in the process they are so that they can counsel their buyer.

Remember, when dealing with lenders, there is red tape, red tape, red tape. A Buyer and their Realtor are dealing with a person sitting behind a desk in some far-away land who has no real interest in the home that is being sold.  All they know is that they are to submit specific information to their boss.  Furthermore, they are being paid an hourly wage and sometimes a small bonus to do so.  They simply don't care for expediency.  Especially since our economy and housing sector has taken a turn for the worse, the amount of paperwork that is sitting on these desks is mounting and mounting and mounting. Many times, the initial paperwork that is submitted gets lost in a pile, never to be uncovered again.  So, after weeks of waiting, the process begins again.

In addition, most often, lenders will not do ANYTHING until the complete short sale package (along with all offers and addenda) are received.  Then, they perform their due dilligence to make sure a short sale is warranted.

Moreover, some 'lenders' are simply servicers of loans and thus they have no real authority to accept a short sale amount.  So, just when you think you won the process (because they escalate your offer to the next level), it gets struck down by yet another figurehead. What's more is that your offer can be approved by the servicer, but denied by any private mortgage insurer or guarantor who has the last say.

Another reason that the process takes so long is that there is a plethora of materials and documentation to gather, before and during the short sale process.  Some of these items include:

• A signed copy of the listing agreement with your Realtor.
• A signed copy of a sales contract with all addenda and attachments.
• A commitment letter from your Buyer.
• A written hardship letter stating the circumstances for your missed payments and default. 
• Your last two bank statements (checking and savings)
• Your last two paycheck stubs
• A HUD-1 settlement statement (net sheet) indicating the allocation of all sale proceeds.
• Your two most recent state and federal tax returns
• Your most recent summary satements for any 401k, retirement or investment accounts

Once all these items are assembled, your Realtor or agent will then submit them to the lender for review. It is at this point that the waiting begins.  The lender must then perform their own due dilligence, some of which may include:

• Re-assembling the materials the seller just submitted.
• Sending them down the line to the department head for further review.
• Sending them once more to yet another department head.
• Submitting them to their board.
• More red tape.
• Performing a BPO (Broker Price Opinion) to determine the fair market value of the home.
• Losing all the documents your Realtor submitted.
• Reassembling them again.
• More red tape.

If everything goes well, the lender may approve your short sale and the seller will be free to complete the sale of the home to a Buyer at a lesser amount than what is owed. It is never this simple, though.  Remember, we are dealing with a person sitting behind a desk in a city far removed from yours.  This person has very little empthay for your situation, and they certainly do not understand your market. Many times, the short sale process is more painful than a thousand papercuts on your tongue. Seriously!  Other times, it can go so smoothly that you wonder what is around the corner, and what have you missed.

Please be patient! We have seen short sales completed within a couple weeks, and we have seen them take as long as 180 days before the lender calls to accept, counter or reject the offer.

Now that all of this has been said, remember again that we are talking about the traditional method of doing short sales.  There are some new advances in the short sale process which is available to some sellers and some lenders.  The US Treasury's new Home Affordable Foreclosure Alternative Program (HAFA) is being extended in order to speed up and standardize the entire short sale process.  Be cautious though... this program is only available to those who qualify under the HAMP program.  Please read on...

Why Are Some Short Sales Not Successful?

I know... banks are not in the business of selling homes.  All they want to do is lend money and make profits.  So, 'why will they not allow me, the seller, to proceed with a short sale?'  Or the buyer may ask, 'why won't they just accept my offer?'

As previously mentioned, not all lenders participate in short sales.  In addition, not all homes and not all sellers will qualify for a short sale.

A few other reasons a lender may not approve a Seller for a short sale:

1. The Seller makes too much money (positive cash flow)
2. The Seller is not yet behind on payments
3. The Seller has excessive assets
4. There is equity in the home
5. The lender simply does not participate in short sales as a matter of policy
6. The mortgage is insured
7. The Seller has not yet received FHA counseling
8. The planets have not yet all aligned

OK... so the Seller and the home qualify, and there is a bona fide offer on the table.  Why will the lender not accept the offer?  Oh boy, there are many reasons.  Too many to list.  However, here are just a few:

1. The lender feels the home is worth more than your offer
2. The lender still feels the home is worth more than your low-ball offer
3. The lender really still feels that the home is worth way more than your ridiculously low offer

(Starting to get the point?)

It all comes down to the numbers.  More often than not... if a Seller has been approved for a short sale, but the offer is not accepted, then the lender feels that they could get more money if they foreclose and resell on the open market than if they allow a short sale to proceed.

As strange as it seems, not ALL lenders are willing to accept peanuts for vacant or underperforming homes.  It's a numbers game.  And if you are in the game of low-balling offers - or if you think you are going to find a short sale and make tons of cash, you may want to reconsider.

More recently though, we have seen a large number of short sale requests go unanswered.  Since the recent announcement of the 'Government Bailout' package, lenders are simply waiting. Waiting to see what THEY are going to get.  Waiting to see what everyone else does.  Waiting until something.  Most recently, it may even take an act of Congress (literally) to get your short sale accepted, completed and out of escrow.

In 2009, the Treasury Department introduced the HAFA program to provide a viable option for homeowners who are unable to keep their homes through the existing Home Affordable Modification Program (HAMP). The HAFA program takes effect on April 5, 2010—although some servicers may implement it sooner, if they meet certain requirement--and sunsets on December 31, 2012.

HAFA provides certain incentives to servicers and sellers, attempts to standardize procedures and shortens time frames, but only on loans eligible for modification under the HAMP program.

HAFA Provisions

• Complements HAMP by providing a viable alternative for borrowers (the current homeowners) who are HAMP eligible but nevertheless unable to keep their home.
• Uses borrower financial and hardship information already collected in connection with consideration of a loan modification.
• Allows borrowers to receive pre-approved short sales terms before listing the property (including the minimum acceptable net proceeds).
• Requires borrowers to be fully released from future liability for the first mortgage debt (no cash contribution, promissory note, or deficiency judgment is allowed).
• Uses standard processes, documents, and timeframes/deadlines.
• Provides the following financial incentives:
  • $3,000 for borrower relocation assistance;
  • $1,500 for servicers to cover administrative and processing costs;
  • Up to $2,000 for investors who allow a total of up to $6,000 in short sale proceeds to be distributed to subordinate lien holders, on a one-for-three matching basis.
• Requires all servicers participating in HAMP to implement HAFA in accordance with their own written policy, consistent with investor guidelines.

So, what does this mean?  It means that if you need to sell your house short, and you don't know what HAMP is... you are behind the 8-ball.  Contact a short sale professional immediately! But, if you have already applied to HAMP, you might have a chance.

Let's break it down further:

If you can satisfy the following criteria, you may be eligble for HAMP (remember, this is a loan modification program):

• The property must be the borrower's primary residence. No investment property can qualify here.
• The mortgage lien/loan must be in first position and originated before 1/1/09.
• The mortgage must be in default or imminently delinquent.
• The current, unpaid balance is less than or equal to $729,750.
• The borrower's monthly mortgage payment is more than 31% of the borrower's gross income.

OK... so you can satisfy the above criteria.  GREAT!  You are now eligble for a loan mod (HAMP).  But let's say that you have gone through the entire HAMP eligibility program, but one of the following criteria is now in your way of saying that it was the best thing since sliced bread:

• You do not qualify for a Trial Period Plan
• You do not successfully complete a Trial Period Plan
• You become delinquent on the mod by missing at least 2 consecutive payments
• You request a short sale

Alright... you and your loan are HAMP eligible, but the alternatives that HAMP provides can not be met or are not 'good' for your situation.  You then may request a short sale under the HAFA program.  Beleive it or not, but the servicer or lender must now consider your short sale request within 30 days!

Once the servicer receives and responds to your request, you have 14 days to respond to them.  As part of this new program, the servicer will begin their due dilligence process immediately.  Remember, in a standard short sale, the lender rarely does anything until an offer is received on the property.  Additionally, the lender or servicer won't even give you an idea as to what price they will accept. They make the borrower and the Realtor figure it out by trial and error.

But under the new HAFA program the borrower/servicer will pre-populate a Short Sale Agreement, one of a few new standardized forms to be used with the Realtor's standard paperwork. 

Some of the best 'stuff' is that under the HAFA program are that paperwork and procedures are now standardized across the board.  Banks are now willing to help, willing to tell you information and willing to cooperate.  They, along with the Seller, will receive cash incentives for their troubles. And did I mention that once an offer is submitted under the HAFA program, the lender has 10 days in which to respond?  Hallelujah!

Of course, this is only a brief synopsis of the new short sale procedure.  And as mentioned, it is only available to those who qualify under the HAMP program - which is not available to loans insured by FANNIE and FREDDI.  We do hear, however, that F & F will have their own foreclosure alternative program perhaps later this year.