REO Property & Short Sales: Definition & Procedure

Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

Short sales and REO properties often offer great opportunities for potential homeowners and real estate investors. In this lesson, you'll learn about short sales and REO property transactions. A short quiz follows.

Short Sales Defined

A short sale is a sale of real estate where the sales proceeds are less than the outstanding amount owed on the property. A 'short' is an alternative to foreclosure where the lender and mortgagor (i.e., the borrower) both agree that it is better for each party to take a loss by selling the property on the open market than to sell the property through foreclosure.

Short Sale Eligibility

Not every homeowner is eligible for a short sale. A short sale requires that both the borrower and the lender agree to it. Generally speaking, a homeowner may be able to obtain a lender's agreement to a short sale if:

  • The property is worth substantially less than what's owed on the loan;
  • The borrower has defaulted or is about to default on the loan; and
  • The borrower has a financial hardship that makes them unable to make future payments or pay the remaining balance after the sale.

Some examples of hardship include unemployment, divorce, or severe medical illness. The lender will also want proof that the borrower doesn't have other assets that can be used to pay the balance owed.

Short Sale Process

Short sales usually take significantly longer than ordinary sales. First, sellers need to obtain a lender's consent for a short sale. This means filling out paperwork and providing the lender documentation supporting the seller's request, such as a hardship letter. The property will then be listed and marketed. Once an offer is made, the lender gets a veto. In other words, not only must the seller agree to the offer, but the lender must agree as well (since it's losing money on the deal). If an offer is close to the appraised value of the property, the lender will probably agree to it.

Further Considerations for Sellers

A borrower needs to understand the bank's position on deficiency with a short sale. A deficiency is the outstanding balance left on the loan after applying the sale proceeds to it. While many states prohibit deficiency judgments after a foreclosure, few states address the issue in the context of a short sale. Consequently, a borrower should try to obtain a waiver of a deficiency judgment from the lender as part of the short sale agreement. At the very least, you should try to obtain a discounted deficiency settlement.

There are a few other considerations as well. The forgiveness of the loan deficiency will likely be treated as recognizable income for income tax purposes. This means that the seller may have to treat the amount forgiven as income for tax purposes. Congress passed the Mortgage Forgiveness Debt Relief Act of 2007, which provided an exemption in some cases. However, the act only applies to debt forgiven in 2007 through 2014, unless Congress extends it. Finally, a short sale will probably negatively affect your credit rating since you didn't pay all the debt.

REO Properties Defined

An REO property is real estate owned by a lender. REO property usually occurs when a foreclosure sale is unsuccessful and a bank ends up buying the property at foreclosure for the price of the loan it holds on it, which is called a credit bid.

Purchasing REO Property

Banks are in the business of lending money; they don't want to hold real estate and they don't want to be landlords. Consequently, REO properties are often a good place for people who are looking to purchase a home or invest in real estate to find a good bargain.

There are similarities and key differences when buying REO properties as compared to buying in a normal transaction. REO properties are often listed and marketed like normal listings on the multiple listing service, which means you can hire a real estate agent to help identify REO opportunities.

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