People often get confused between foreclosure and short sale. If you do not care so much about the details, perhaps they do mean the same thing. But if you are a real estate investor, especially a sophisticated real estate investor, knowing the (subtle) differences between foreclosure and short sale will give you a competitive edge.

Foreclosure

Foreclosure happens when the homeowner, a.k.a. the borrower, a.k.a. the mortgagee, is unable or unwilling to make the mortgage payment. Usually, the banks will first try to send the case to a collection agency to try to recover portions of the payment, or if they will work with the borrower on a payment plan to get the borrower back on track, but the most important point is the communication. But let’s just say the borrower simply refuses to communicate and refuses to pay the monthly payments, at some point (usually when at least 3 months of non-payment) the lender will decide “this is enough” and forward the case to the process of foreclosure, which is technically a legal process.

This is where the phase Pre-Foreclosure begins. The lender typically will issue a Notice of Default via the County Recorder’s Office. The notice gives the borrower the “final warning” and to inform them that the lender is no longer accepting your monthly payment and now demanding the borrower to pay off the entire loan amount.

Of course, in most cases the borrower really has no financial ability to pay off the massive loan amount, and when the borrower runs out of pay off options, the lender will come in to foreclosure, or take control, of the home. This is typically done by scheduling an auction of the house, and the highest bidder wins the house, pay whatever the bidding price, and take the deed.

If nobody buys the house at the auction, the house becomes a bank-owned property, or REO (real estate owned). As a real estate investor, you may think this is a sweet deal for the bank / lender; but keep in mind, the bank is in the business of making money by collecting interest. The bank has absolutely no interest to own properties, collect rents, manage tenants… etc.

Short Sale

Short sale occurs when a borrower owes more on the mortgage than the price of the house. There can be many financial or personal reasons to sell in such situation, but typically is to avoid a foreclosure. Unlike foreclosure, short sale is not a legal process and can generally be more flexible.

To short sale, you can list your house on the MLS with a real estate agent like what any seller would normally do. Based on the current market condition, or your motivation to sell, you may end up accepting at a purchase price that is lower than your expectation. But in a short sale situation, that price will need to be agreed by the bank / lender first. Upon acceptance, you proceed with the real estate transaction in the usual manner, and at the end of closing, the bank will take the proceeds, and basically write-off, or “forgive” the remaining balance.

Invest in Foreclosure or Short Sale

Remember earlier we mentioned the bank has no interest to become a landlord? To the bank, it is actually a losing proposition if it needs to owns the property! If you have a relationship with a bank, this is a very good source of leads to obtain the REO list from the bank, and often times the bank will work with you because it really wants to get rid of the properties from its book! This is a very good strategy to pick up properties at a lower value, little or none bidding competition, and purchase something free and clear!

Short sale is another strategy you may consider. Although short sales are often listing on the MLS, just like foreclosure it is beneficial to have a relationship with the real estate agent, and the agent can give you “pocket listing” information when a short sale comes up for him, or through the agent’s brokerage. There is a good chance you can pick up the short sale with little or none bidding competition, and you can deploy good negotiation tactics to pick up the property at a potentially below market value.

These strategies are all great and we encourage you to learn more about Building Wealth with Foreclosure by clicking on the link.