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Foreclosures & Short Sales: Are You Buying a Money Pit?

Wednesday, 12 Aug 2009 | 1:39 PM ET

There are some great deals out there right now in the housing market — particularly with foreclosures and short sales — but let the buyer beware: You could be buying a money pit.

Rundown house
Rundown house

A foreclosure occurs when the homeowner can't make his or her mortgage payments and the bank seizes the home and re-sells the property, without giving anything to the homeowner.

A short sale is the Hail Mary pass of the housing market, where a seller, teetering on the brink of foreclosure, agrees to sell the house for less than the current mortgage on the house and the proceeds are used to repay the seller's lender.

Any way you slice it, you're dealing with people with big financial problems and you don't really know what you're getting. If you're going to make a six or seven-figure gamble like that, you’ve got to do your homework and go in there with your game face on. Put your trust in your spouse — seriously, you’re gonna need it — not in the listing agent.

It starts straight from the listing. At the bottom of every MLS listing of a house, there’s a disclaimer that says, “Information deemed RELIABLE but not GUARANTEED — ALL Room Sizes Are Approx.”

Did you just see what happened there? If you looked at it quick, all you’d see is: RELIABLE GUARANTEED ALL.

“It’s gotten to a point that there’s a joke: How do you know when a listing agent is lying? When their fingers are on the keyboard — or when their lips are moving!” said John Sullivan, president of the National Association of Exclusive Buyer Agents. The group represents buyers only — not sellers.

Some of the descriptions in home listings — particularly with foreclosures and short sales — are so comically deceptive, the NAEBA put out a tongue-in-cheek new-homebuyer's glossary breaking down of what some common terms could mean:

Cozy home = Too small for your big-screen TV.

Cozy condo = It is so small that it is difficult to turn around in.

Easy access to everywhere = The ramp to the beltway is half a block from your backyard — or IN your backyard.

Fixer-upper = Hasn’t been lived in for 20 years. If it’s a “fixer-upper” with “great potential,” the door may fall off the hinges when you open it and there may or may not be a stairway to the second floor.

Galley kitchen = A hallway with cupboards and appliances that two people could not occupy at the same time.

Grandma’s house = Hasn’t been updated since the 1930s — and it still smells like her.

Light and bright = Everything painted white. Looks like a hospital.

Light, airy basement = You may be able to see light through cracks in the foundation.

Lots of living space = If you include the garage, patio and utility room.

Low-maintenance yard = It's paved over with concrete.

Mature landscaping = A tree may fall on your house.

Total facelift = The seller just painted everything, but didn't do any substantial renovations.

Water view = You may only be able to see it if you lean off the deck — in the winter.

Both foreclosures and short sales bring a lot of risk and ambiguity but short sales are the most dangerous.

There’s something called a “bank addendum” that most people don’t realize with short sales. That basically means that nothing in your “contract” is assured and that everything in there “can be nullified by the bank,” Sullivan explained. That could mean taxes and fees that are much higher than you expected.

Plus, there’s the timing. It could take weeks for the bank to approve a short sale — or months. That means you could lose out on your first-time homebuyer credit and won’t be able to lock in your mortgage rate before rates start moving significantly higher.

And, with both short sales and foreclosures, you have to be prepared for higher-than-average maintenance costs for the first three to five years, Sullivan said. You may have to replace your furnace sooner than usual because the prior owner didn’t do regular maintenance. You may find your kitchen sink isn’t connected to the plumbing — it’s just a pipe into the backyard. There are any number of surprises.

What’s the biggest mistake people make with a short sale?

“I would say the biggest mistake people make in a short sale is even attempting it,” Sullivan said, citing the uncertainty — and potential for marital discord.

“It’s the waiting period,” Sullivan said of the strain a short sale can put on a marriage. It could exacerbate the feelings of one spouse who may not have been crazy about the house to begin with. Plus, “you’re hanging out there without a locked rate,” he said. “Let’s face it, money is still the largest reason for marital discord.”

Sullivan said it’s better to buy a foreclosure than a short sale because “there’s less ambiguity.” The bank has already determined what it will accept for the house, what the commissions are, etc.

For sure, either one is gamble. So, make sure you have a good inspector, who’s familiar with homes in the area. Make sure your real-estate agent has experience dealing with short sales and foreclosures. And, if your agent isn’t experienced, “make sure you have a real-estate attorney — not your cousin, Vinny, who's a lawyer — who can tell you the impact of the language in the bank addendum,” Sullivan said.

And when you're going through the inspection, turn on all the water, jiggle the knobs—make a Hot Pocket.

Act like a gorilla testing Samsonite luggage and jump up on and down on every floor.

But keep the focus of a ninja: Don't let the real-estate agent or anyone distract you. This is your last chance to not get screwed.

Remember: "Money Pit" was great movie because it was a movie, not your life.

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