Asking the dumb one: REO, short sale, pre-foreclosure, which is which

Question

I read closing documents for a living and I've somehow never had to learn the vocabulary on the distressed side, so I'm asking the dumb one.

REO gets used constantly and I've seen it expanded as real estate owned, which as a phrase tells me nothing, since every property is owned by somebody. Owned by whom, at what point?

And separately, I've seen short sale and pre-foreclosure used as if they're the same thing on two different sites, and used as clearly different things on a third. If the owner is behind on payments and selling, is that a short sale? Or does short sale mean something narrower? I'd rather have the strict definition than the way people use it loosely, because I'm going to end up reading a contract with one of these words in it.

Rena Guide · Accepted Answer

Fathom has the REO origin exactly right. Adding the strict line for the second half.

Pre-foreclosure describes a stage in time. The owner has defaulted and a formal notice has been recorded, but the auction hasn't happened yet. The owner still holds title and can still sell. That's all the word means. It says nothing about how much is owed or what the house is worth.

Short sale describes a price relationship. It's a sale where the agreed price is less than the total owed on the loans, so the lender has to agree in writing to accept less than full payoff and release its lien anyway. The lender is a required party to the deal, and short sale approvals routinely take months because the file goes through a loss mitigation review, sometimes with a mortgage insurer also needing to sign off.

So a short sale is usually happening during pre-foreclosure, and that's why the words get blurred. But a pre-foreclosure owner with $200k of equity who sells for $250k isn't a short sale at all, it's an ordinary sale by someone in trouble. And a short sale can happen for someone who's current on payments but underwater and relocating. The two words answer different questions: when in the process, and whether the price covers the debt.

The part that catches people reading these contracts for the first time is that in a short sale the seller's signature doesn't close anything. Every deadline in that purchase agreement is effectively suspended until the lender's approval letter arrives, and the approval letter often comes back with its own terms, a different price, a cap on seller credits, a required closing date. If you're reviewing one of these, the approval letter is the document that actually governs, and how much power it has to override the signed contract varies by state. Worth having a local real estate attorney read the first one you touch.

wendy_park48 · Answer

On the REO expansion: it's a bank accounting term. It means real estate owned by the lender, as opposed to loans owned by the lender. A bank's balance sheet is supposed to hold mortgages, and when a foreclosure doesn't sell at auction the bank ends up holding the actual house instead, which lands in an "other real estate owned" bucket. That's where the acronym comes from. It's a category on a balance sheet, not a description of a property.

Asking the dumb one: REO, short sale, pre-foreclosure, which is which

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