I've gotten a lot of questions about the difference between REOs vs Short Sales. I have an extensive description of what an REO is on my website - but in summary, it is a piece of real estate that has already gone through the foreclosure process, did not get purchased at the trustee sale, and has gone back to the bank.
When a bank forecloses on a home it becomes a non-performing loan. This affects the amount of money a bank can borrow from the Federal Reserve. Since banks only make money by borrowing from the Fed and lending to the public, they must borrow as much as they can. Every non-performing loan reduces the amount the bank can lend to the public, affecting their bottom line profits.
A short sale on the other hand, has not gone through the foreclosure process. During the short sale process, the owner or owner representative is negotiating with the bank who has the first, second, etc trust deeds to take a loss because typically the amount owed, is more than the value of the house. The banks will normally not negotiate, if the owner has not missed several payments and gotten a notice of default. Sometimes, listing agents get a little anxious and list a house a "short sale" even before the owner gets a notice of default. As an owner/seller, if the bank does agree to the short sale, there may be tax consequences. Speak to a tax professional to find out if you qualify to be excluded from this tax. As a buyer, it can be frustrating offering on short sales because often times, the process is long and there's very little communication from the seller or their agent because they are waiting on the bank.
You can get deals from either REOs or a short sales; however, you need a lot more patience when it comes to short sales - and be prepared to not get any response at all...
*The NATIONAL ASSOCIATION OF REALTORS® has been working to change the tax laws and eliminate this "phantom tax" on income. Currently NAR is supporting the passage of S. 1394, the Mortgage Cancellation Tax Relief Act, which would repeal the law that requires home owners to pay taxes on forgiven debt for their principal residents as part of a short sale or foreclosure.