Question #1: Short Sales versus Foreclosure Sales – What is the difference between a Short Sale and a Foreclosure Sale?
Answer: Foreclosure – “The legal process in which a mortgagee (lender) forces the sale of a property to recover all or part of a loan on which the mortgagor (borrower) has defaulted.” (The Dictionary of Real Estate Appraisal)
Short Sales are not Foreclosure Sales but they are sales which have some duress involved. In Short Sales, the owner often owes more on the home than it is worth, and is generally behind on the payments (also referred to as being in an “upside-down” position). The lender, hoping to avoid the expense and time involved in a foreclosure, allows the owner to list the property, with the condition that the lender can approve the sale price. The agreement may relieve the owner from an obligation to pay for the loss, or it may leave the owner open to a deficiency judgment, depending on the agreement. As a result of a Short Sale, the borrower may also face additional tax consequences as the forgiven debt may be considered as income.
In contrast, a true Foreclosure Sale is one that is generally auctioned off at the courthouse steps, and the buyer has to produce a cashier’s check for the full amount to purchase it.
Since Short Sales are advertised in the MLS, just like any other sale, they affect the market much more than Foreclosure Sales, which are available only to those who have cash and the time to research the properties they want to buy. The research is important because buyers can purchase a second trust deed instead of a first trust deed by mistake if they do not know the lien history.
So, should an appraiser use Short Sales as comparables in an appraisal? If they are common, many believe they should be included because they have become the market. Some argue that they may be in substandard condition, and if this is the case, adjustments can be made just as they would be for any other sale. Another consideration is that if Short Sales are relied upon, conditions of sale verification with the lender can be difficult if not impossible. In addition, the Short Sale sales price may reflect the lender’s motivations and business needs (i.e., number of potential loans in default) rather than “market value.”
If the appraiser decides not to include Short Sales, it is highly recommended they be noted in the appraisal with an explanation as to why they were not used. Short Sales may also be a predictor of where the market is going, for once buyers see the latest Short Sale prices, they often do not want to pay more.
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