Should I Buy a Foreclosure or Short Sale?

It's more complicated than you think.

I’m looking to buy a new home, and I’ve noticed that there are a couple of “short sale” and foreclosed homes in the area where I’m interested in living. These homes are priced substantially lower than others, and I’m wondering what the catch is. I’ve heard that short sales or foreclosures often need repairs. What else do I need to know to decide whether to invest in one of these properties?

Purchasing a home through a short sale or a foreclosure process can be a way to get a good deal on a property. But it isn’t for the faint of heart. Both processes are likely to be more complicated than purchasing a home on the open market.

First, make sure you understand the differences between these categories. Both are used when a property owner is in financial distress and can no longer afford mortgage payments.

In a short sale, the proceeds from the sale will fall short of the debt owed on the property. Such a sale can only occur if the mortgage holder (usually a bank) has agreed to accept less than the amount owed on the loan.

In a foreclosure, on the other hand, the mortgage holder has repossessed the property and is trying to recoup its losses by selling the house for the amount still owed on the loan. That amount is typically still less than the market value of the home.

Here are some of the common issues you may encounter when buying a foreclosure or short sale.

Purchasing Delays

If you’re considering buying a property listed as short sale or foreclosure, keep in mind a few things, experts say.

“The process for purchasing this kind of property may not be as easy as purchasing a home directly from a seller who is current on their mortgage,” says Colin McDonald, real estate agent with Berkshire Hathaway HomeServices Blake in Delmar, N.Y.

For instance, it typically takes six to eight weeks to close on a normal home, McDonald says. But with a short sale or foreclosure, the property may not close for six months or even a year.

“[W]hen a property is being listed as a short sale or foreclosure, you’re no longer just dealing with the seller,” McDonald says. “A bank is now involved, and unfortunately, they only care about getting what is owed to them. They will drag the process on for as long as they like.”

Short sales can also take months to get lender approval. “The seller’s bank can make things very difficult, making the borrower jump through many hoops — hoops that can take a long time to navigate,” warns David Reiss, a professor of law at Brooklyn Law School who writes and teaches about real estate.

And in the end, the bank may respond with a counteroffer that doesn’t meet your budget or terms. “So you might wait for a long time only to be disappointed,” says Sep Niakan, owner of Condo Black Book, a leading condo search website in Miami and broker of HB Roswell Realty.

Additional Risks

Foreclosed properties may be purchased through the open market with a real estate agent or at a sheriff sale or county auction. In many cases, you will not be able to view the inside of the property before the purchase. “[Y]ou are essentially buying a property sight unseen,” Niakan cautions.

In addition to buying the property, you’re also purchasing any liens (or unpaid bills relating to the property), code violations, or title issues, Niakan adds. Do your research to find out what other costs may be associated with the home, and factor all those costs into your bid.

If you’re purchasing a foreclosure or short sale on the open market — rather than at auction — you’ll typically get a clear title or a warranty deed that guarantees that no other lienholders have claim to the property. You can also buy title insurance to protect yourself from any future title issues.

Extra Work

When you purchase a short sale or foreclosure, you will likely need to reserve funds or energy for home repairs or improvements once the sale is completed.

“Keep in mind when you buy any foreclosure or short sale, these people were in financial distress, so expect to inherit a property that has had some sort of deferred maintenance, even if it looks good on the surface,” Niakan explains.

In most cases, foreclosures are sold “as is,” which means the owner or the bank does not plan to make improvements before the sale.

“The bank will typically allow you to conduct inspections, but that doesn’t mean they’re going to make any improvements to the red flags called out in the report,” McDonald says. “As it is, they feel you’re already getting the property for a great price.”

With short sales, the sellers usually still live in the property, so even if they’ve let some things go, it shouldn’t be in complete disrepair. With a foreclosure, the risk is higher that the property could be vandalized or trashed, McDonald says.

Potential Additional Fees

While the price of the home may be low, a foreclosure or short sale often comes with additional transaction costs. With a foreclosure, you may have to pay transfer taxes as well as any superior liens on the property. You may also have to pay an additional fee to the foreclosure company.

Typically, in a short sale, there is a negotiator involved who will require a fee, such as 2.5 percent of the purchase price, McDonald says. The buyer is usually required to pay this fee.

You also may have to pay back taxes or other past dues associated with the property. If you buy a condo-foreclosure, for instance, “there may be many years of past due condo association fees that may not appear anywhere in public record, and you might end up inheriting a very large debt,” Niakan says. “Some local and state laws limit the amount you would be responsible for in those cases, but do your homework.”

Purchasing a home at a price that is significantly below market always sounds like a good thing — and it can be for the right person. But keep in mind that if the property is really great, “there will be others who will also be interested in it,” McDonald warns. “This includes veteran investors who have deep pockets of cash.”

If you hope to get a great home for a low price through a foreclosure or short sale, be sure to do your homework and be aware that it may take a long time and come with extra costs and repairs. And at the end of the day, buying a short sale or foreclosure isn’t for everyone.

“While you may get a good price, you will be paying for the house with uncertainty, delay, and frustration,” Reiss says. “You’ll need to determine for yourself whether it is worth it.”

  • Arrow Aim True

    Spot on with guidance I wish I’d had 5 years ago when I bought my short sale.

    I ended up with a great deal and a home I love, but it took NINE MONTHS to close and the I dealt with three different banks that all dragged the process out to a ridiculous and frustrating degree.

    It worked out for me, but I doubt I will pursue a short sale ever again.

    • Colin

      Happy to hear you did snag a good deal but unfortunate to hear about your experience. Hopefully you were being represented by a reputable and experienced agent who did prepare you for this.