"Foreclosures" Explained: Short Sale, Auction, Bank-owned…

Do you want to buy that foreclosure?

Lately, potential home buyers have been asking me a lot about foreclosures. Various websites list homes for sale labeled as foreclosure. What are those? The information is often so vague and misleading that not only first time home buyers but many of those who’ve bought before are puzzled.

I wrote before about RealtyTrac foreclosures featured on Trulia website. I really recommend that you review that post.

On any given website the term foreclosure may be used for a number of different stages of the general foreclosure process. (Good luck reading the small print :)

So I thought I would take a few minutes to review the stages of foreclosure in Washington state.

Deed of Trust

Let’s say John wants to buy a home but doesn’t have enough money. He can go to the bank and ask them to lend him some funds. However, homes are quite expensive, so to give him the loan, the bank will need some guarantee that they will get their money back.

Yes, they check his credit and employment history but the ultimate security for them is the home he is buying.

Here’s the way it’s done in the state of Washington. When taking a home loan John signs a document called a Deed of Trust. By doing this he gives powers to a third party (the trustee) to take the home away from him (foreclose) if he doesn’t stick to the agreement he signed with the bank (to make regular payments).

Notice of Default

So, John got his house. But soon John loses his job. Since he doesn’t have lots of saving he can’t make his house payments.

At this point the bank will send him a letter called a Notice of Default. It’s essentially a warning, “You didn’t stick to the agreement. Now, we can ask the trustee to take the house back from you!” This is not what they want, though. They want John to live in his house and make regular payments. So they give John another chance, “Pay this balance by this day!”

Notices of Default may also be publicly recorded (depending on a lender and local laws). So third companies may access the data and potentially list the John’s home on their website as “foreclosure”. (This doesn’t mean that John is selling his house. He may land a job, cure his debt, and continue enjoying his house.

Short Sale

John may also choose to sell the house. However, if he owns $300K but the house sells for only 250K, John has a problem. If he can’t find 50K to cover the difference, John has to ask the bank to accept whatever the house sells for.

Will the bank agree it? They may or may not. But usually they don’t start thinking about it until John has a buyer lined up.

So John may hire a Realtor and put his home for sale.

In the state of Washington (NorthWest MLS),  when you list a home for sale, you must indicate whether the home is a short sale or not.

Trustee Sale

If John doesn’t pay-up after the Notice of Default, the bank will send the file to the trustee. How long before they do it? It depends.

The trustee will then send a Notice of Trustee Sale, which essentially says, “The bank says you’re not paying. Is that true? Make sure you pay everything (including trustee’s fees) by this date or we’ll have to sell your house on auction”.

If John ignores that, the home will be auctioned by the trustee. If someone decides to buy John’s house on auction, they must have cash for it. You can’t take a regular home loan to purchase a house on public auction.

Buying a home on auction is risky because you don’t have a chance to inspect the house and may even have to evict John (take legal action to have him kicked out).

REO (Real Estate Owned) or Bank-owned Homes

Many homes don’t sell on auction. If the house doesn’t sell the trustee passes it on to the lender. At this point John’sa house becomes what they call REO or a bank-owned home.

Bank-owned homes usually sell in the same way as private home sales. However, because the seller is a company, more paperwork and hassles are involved.

Also, conditions of bank-owned homes vary. Much depends on John, the previous owner. The bank will usually send the home “as is”, meaning that there are not guarantees or repairs will be done.

I’ve seen websites that label bank-owned homes as “foreclosures” as well.

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