What are distressed home sales?
The term "distressed homes" refers to the value of the home and the financial situation of the owners, not necessarily the condition of the home. While a home in disrepair may seem "distressed", the owner may be in good standing with his lender and may not need to urgently sell his property. Usually, distressed homes refer to homes that are listed as foreclosures, short sales, or REO's, although sometimes they may be sold below market value to settle an estate or so that the owner can free up funds for other projects. An investor or home buyer looking for a good deal may focus on distressed homes because they will usually be listed at a lower price in an effort to move them off the market quickly.
The reasons behind a distressed home sale can be as different as the homes themselves. In the case of a sale because of the death of the owner, the family may desire a quick sale and may feel that the extra money they might make from pricing the home competitively won't be that much when divided between them. If a house might sell in 3 months priced at it's market value of $225,000 but might sell in 3 weeks at $200,000, and if the profits will be divided between 5 beneficiaries, the beneficiaries may decide that the extra $5000 a piece is not worth the trouble of holding on to the property until it sells at a normal price. There are people who actually watch the death notices so they can keep an eye out for a possible sale of property at a "fire sale price".
One category of distressed home sales is called a short sale. A short sale means that the mortgage amount owed on the house is higher than it would be able to sell for in the market that the home is in. This can happen if the housing market experiences a recession as it did in the last decade. Someone who bought at the height of the market may not be able to sell their home when housing prices go down because no one wants to buy a house that is over valued. So the seller may try selling their home as a short sale, meaning that they accept an offer that is lower than they owe on the house and then apply to their lender to be allowed to sell it at that price. The difference between the sales price and the loan is then either forgiven by the bank or arrangements are made for the seller to pay back the difference. This is usually a very lengthy process and can be very difficult for the seller as the application process can be stressful and time-consuming, and it can affect credit scores. It can also be difficult for the buyer as they may have to wait months before finding out if they will actually be allowed to buy the home for the price they offered. While short sales often take place when the seller is in arrears with their payments, that does not necessarily have to be the case. For a buyer who is willing to be patient, buying a short sale can make good financial sense.
An REO, or Real Estate Owned property is a property that is already owned by the bank, usually acquired through a foreclosure auction. The banks acquire the property when there aren't any bids at the auction to cover the amount owed on the property. The banks then take back title to the home and put the home on the market. This can be a great way to buy a distressed property because the buyer only has to deal with the lender, not the seller and lender. Sometimes a buyer might be able to purchase the REO directly from the lender. While often these properties may be purchased below market value, the lender is also interested in getting as much out of the home as they can so it may not be possible to get a "steal".
Foreclosed homes are the most common distressed home sales and the most familiar term to most people. Foreclosure is the process of foreclosing on a home. It starts when a homeowner falls behind in their mortgage payments usually 2-3 months. The lender then gives the homeowner notice that unless they bring the payments up to date, the lender will sell the home at auction to the highest bidder.
The leading cause of foreclosure is negative equity, meaning that the owner owes more on the house than it is worth. However, there are many other reasons that a homeowner might find themselves in the position that they are being foreclosed on. Some of these are:
- The death of the head of household or the major breadwinner. The sudden reduction of income can make mortgage payments impossible for the survivors.
- Medical bills from a catastrophic illness, chronic disease, or lack of health insurance can impact the homeowner's ability to make their mortgage payments.
- A divorce, even if it is amicable can cause homeowners to miss payments. Sometimes it is a problem of one spouse refusing to pay and the other refusing to leave.
- Sometimes it is just a matter of financial irresponsibility where the homeowner is either unwilling or unable to meet their financial obligations because of the lack of fiscal responsibility. It is, unfortunately, not uncommon for people to spend more than they make, leaving them with a cash flow inadequate for paying their bills, including their mortgage.
When a house is worth more than is owed, the homeowner can sell the house no matter their personal issues. But when there is a downturn in the housing market, even the most fiscally responsible can find themselves with a distressed home in need of a buyer.