Things to consider before you buy a short sale or foreclosure home

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Ask a Lender
November 15, 2016 | Updated September 20, 2017


Key Points

The basics on foreclosures and short sales

  • Homes in foreclosure were repossessed after the borrower defaulted on a mortgage.
  • Short sales involve homes with distressed mortgages that are sold before foreclosure begins.
  • Foreclosure or short sale homes can be bought at attractive prices, but carry significant risks.
  • Getting financing is more complicated when purchasing a foreclosure or short sale property.

Even in the strongest housing markets, when seemingly every available home is being sold for more than list price, there are occasionally listings that seem too good to be true.

In the case of foreclosures and short sales, those listings are definitely real. It may, however, be safe to say that some of those listings are too good to be simple.

Homes that have been foreclosed on, or that are listed as short sales, can typically be had at lower prices than other comparable properties, which can make them attractive to potential homebuyers, or those simply doing some "window shopping" of real estate listings.

The basics

Foreclosures occur when a property owner stops makings mortgage payments, resulting in a lender repossessing the property and selling it to recover some, or all, of the amount still owed on the loan. Some states require judicial foreclosures, in which a court must approve initiation of the foreclosure process after seeing proof that the mortgage has gone into default. Others use nonjudicial foreclosures, in which the borrower typically signs a deed of trust that includes a power-of-sale clause. That clause allows a trustee to initiate foreclosure without going to court, so long as the loan is in default and the borrower has been appropriately notified.

Potential homebuyers can buy a foreclosed property at auction, or afterward, when it becomes a real estate-owned (REO) property, meaning it is owned by the bank or another lender.

Some foreclosures are listed as HUD homes, which means the U.S. Department of Housing and Urban Development (HUD) acquired these properties as the result of a foreclosure on a mortgage that was insured by the Federal Housing Administration.

Short sales essentially occur on properties that would likely be foreclosed on, but without a lender ever repossessing the property. When borrowers know they will be unable to pay off their mortgage, they can sometimes convince their lender to accept a short sale, in which the house will be sold for less than what is remaining on the mortgage. This allows borrowers to avoid having a foreclosure on their credit report, and lenders to avoid the costs associated with foreclosing on a property.

Pros and cons

One of the biggest advantages of buying a foreclosed or short sale property is price. Typically, these houses sell for less than other comparable houses on the market. Buyers also know they will be working with motivated, committed sellers.

There are several issues that can arise when buying one of these properties, however. The purchase, lending and closing processes, for example, typically takes longer, as lenders are even more careful that they won't get burned on another loan.

"The seller's mortgage lender needs to thoroughly review a seller's short sale request," according to Freddie Mac. Gathering the required documentation and doing bottom-line reviews can take significant time to complete before a short sale is approved." Compare lenders to see what financing options are available before bidding on a short-sale or foreclosure home.

Many of these properties will also be sold "as is" and sometimes without an inspection, significantly increasing the homebuyers' risk — and possibly causing the house to cost more than its list price would indicate. Sellers and borrowers may also be less likely to waive some fees associated with a purchase, as opposed to more traditional home purchases.

Because of the complexities associated with these purchases, Freddie Mac is among a large number of entities that "strongly recommends" that buyers work with professionals who have significant experience working with foreclosed and short-sale properties.

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