Buying Bank-Owned (REO), Forclosures, Short Sale and HUD Properties

If you're reading this page, no doubt you are aware of the recent downward swing in the California real estate market in the past months. This trend has left the current real estate market with a large inventory of properties at reduced prices, many of which are bank-owned, foreclosed, HUD and short sale properties.

Why the current influx of so many properties? A lot stems from the loan industry crisis; home owners who were otherwise not able to afford to purchase a home, did not have a down payment, did not have the income to make a large monthly house payment, and/or had questionable credit were offered "creative" financing terms from lenders eager to lend money. Adjustable-rate mortgages, known as ARMs, were especially prevalent in the subprime market. They are considered higher-risk loans because they typically draw borrowers in with an initial low "teaser" interest rate, which can spike upward after the first few years.

When the ARM (ususally with a two-year term) matures, the monthly payment skyrockets. Those who were struggling to make their ARM payments now found themselves facing payments that jumped hundreds of dollars a month. For example, a homeowner who takes out a $200,000 ARM with a teaser rate of 4 percent initially pays $954.83 monthly in principal and interest. But when the interest rate jumps to 7 percent, say, in the second year of the mortgage, the payment rises to $1,320.59 a month - a move that regulators call "payment shock." Change that figure from $200,000 to $300,000, $400,000 or more, and you can see how quickly payments can get unmanageable.

So why would you want to look into purchasing a REO, foreclosed, HUD or short sale property? The number one reason is simple - more value for your money.   

REO PROPERTIES

REO stands for "Real Estate Owned".  These are properties that have gone through foreclosure and are now owned by the bank or mortgage company.  This is not the same as a property up for foreclosure auction.  When buying a property during a foreclosure sale, you must pay at least the loan balance plus any interest and other fees accumulated during the foreclosure process.  You must also be prepared to pay with cash in hand.  And on top of all that, you'll receive the property 100% "as is".  That could include existing liens and even current occupants that need to be evicted.  A REO, by contrast, is a much "cleaner" and attractive transaction.  The REO property did not find a buyer during foreclosure auction.  The bank now owns it.  The bank will see to the removal of tax liens, evict occupants if needed and generally prepare for the issuance of a title insurance policy to the buyer at closing.  Do be aware that REO's may be exempt from normal disclosure requirements.  In California, for example, banks are exempt from giving a Transfer Disclosure Statement, a document that normally requires sellers to tell you about any defects they are aware of; in other words, just like the foreclosed property, the REO property is sold "as is".

Most buyers assume that any REO must be a bargain and an opportunity for easy money.  This simply isn't true.  You have to be very careful about buying a REO if your intent is to make money off of it.  While it's true that the bank is typically anxious to sell it quickly, they are also strongly motivated to get as much as they can for it.  When considering the value of a REO, you need to look closely at comparable sales in the neighborhood and be sure to take into account the time and cost of any repairs or remodeling needed to prepare the house for resale.  The bargains with money-making potential exist, and many people do very well buying foreclosures.  But there are also many REO's that are not good buys and not likely to turn a profit. This is where you have to do your homework to make sure the property you are interested in fits your needs. 

FORECLOSED PROPERTIES

When a property owner is no longer able to make their mortgage payments and defaults on their loan, the property goes through a process know as foreclosure. When this occurs, the lender initiates the sale of the property by auction through a third party; called a trustee. The trustee is required to advertise a notice of default of the property in the newspaper for four continous weeks; take a look in the classified section of your local newspaper and you'll see a list of foreclosed properties for your area. The owner of the property has until five days until the date of the intended auction to pay all money owed; if they can not come up the money within the alloted time period, the trustee conducts an auction for the property on the steps off a courthouse located in the county where the property is located.

As previously stated, when buying a property during a foreclosure sale, you must pay at least the loan balance plus any interest and other fees accumulated during the foreclosure process. You must also be prepared to pay with cash in hand.  And on top of all that, you'll receive the property 100% "as is".  That could include existing liens and even current occupants that need to be evicted. Foreclosure auctions are particularly attractive to all-cash buyers and investors who are familiar with the process and are looking to get the most value for their investment dollar.

HUD HOMES

A HUD home is a property that was financed with an Federal Housing Authority (FHA)-insured mortgage where the owner has defaulted on the loan. Two FHA divisions you are probably familiar with are Fannie Mae and Freddie Mac. The lender forecloses on the home, FHA pays the lender what is owed and the lender transfers ownership of the home to FHA/HUD. In turn, HUD then sells it at market value. As with REO's and foreclosed propeties, HUD homes are sold "as-is"; however, there are a couple of notable differences in the purchasing process when compared to purchasing a foreclosed property.

First, a HUD home can be purchased with cash or you can obtain financing; one benefit that's not available when purchasing a foreclosed property. Secondly, rather than holding a live auction, the purchasing process is conducting by submitting a bid to the agency holding the property. You could be the only one bidding on a particular property, or there could be numerous bids placed; you just never know. When I purchased my home (a HUD home) back in 1997, I was the only one who submitted a bid on it.

Most HUD Homes are initially offered on a priority basis to owner-occupant purchasers (people who are buying the home as their primary residence). Following the priority period, unsold properties are then made available to all buyers, including investors.

SHORT SALE PROPERTY

A short sale property is a property being sold by an owner that is heading to forclosure. The owners realize they can no longer afford the monthly payment and they try to sell the house before they default on the loan and the lender initiates the foreclosure process on the property. The term "short" means that the amount the owner has listed the house for is less than the amount owed on the loan; the listing price being a reflection of current comparable properties in the area.

As an example, let's say someone purchased a home two years ago for $480,000 in the middle of the hot real estate market. The home was purchased with an ARM; the ARM matures after two years and their payment jumps $1,000 a month. In the meantime, the real estate market cools down, driving down prices of homes in the area. The owner is no longer able to make the house payment and decides to put the home up for sale. After getting an appraisal on the home, the appraiser values the home at $399,000. The owner is now upside down, owing more on the home than it's worth, and has to sell it at the lower value of $399,000.

The short sale process is similar to the "normal" purchase of a property, only all offers are submitted directly to the lender. The lender has the authority to either approve, deny or counter the submitted offer.

If you're interested in finding out more about purchasing a REO, foreclosed, HUD or short sale property, I specialize in representing buyers who are interested in purchasing these types of properties. Contact me for a free list of properties in your area today!