That foreclosure is a bargain ... but will your bank finance it?

Beautiful house. 

A few drywall patches will cover the holes where the surround sound speakers were yanked out of the wall.  The sprinkler system is ready to go into the ground out back.  That dirt will green up in no time.  What’s that smell?  Oh, the water’s off.  Someone must not have realized that when they decided to test the plumbing.

There are downsides to entering the world of the bank-owned properties, of course, but buyers have little choice in many instances these days.  Banks are not only setting the market, banks are the market in many parts of Phoenix.  As the floundering institutions look to offload their liabilities, typical mom and pop sellers are having tremendous difficulty competing with the bargain basement prices.  Buyers are willing to look past a little ugliness if it means saving a couple hundred thousand dollars.

Where it gets interesting, though, is financing.  I’m not talking about the current credit crisis that has made it difficult on many would-be buyers to qualify.  This could involve someone with bulletproof credit and cash reserves so ample that Henry Paulson will be calling any day for “a little help here.”  The problems that can arise with financing an REO property often have nothing to do with the buyer, but rather the property.

Case in point, a client of mine purchased a bank owned home earlier in the year.  Steady, verifiable income.  Credit tighter than Chinese fingercuffs.  The deal almost blew up because of a leak at the kitchen sink.  The day prior to funding, I had to slip my handyman in to make the repair (banks don’t often make any repairs to their properties).  Only after I supplied the underwriter with the documentation of the repair (they would later demand a copy of the handyman’s business card, I kid you not) did the deal actually close.  Mind you, this was for a leaky sink.

See where I’m going with this?

With most bank properties, a leaky sink is going to be the least of your concerns.  There might be all manner of physical conditions which preclude your lender from giving you the loan for which you are approved.  Some lenders are demanding copies of inspection reports, and have charged appraisers with reporting observable defects.  Once an underwriter has knowledge of certain defects, your loan is imperiled unless repairs are made prior to the close of escrow.

Termite infestation, roof damage, non-functioning major components and systems … all of these things can torpedo your loan.  Lenders are fearful enough of handing out money for prime properties at this stage of the game.  A distressed property is far from ideal collateral.  I get the impression in some instances that an underwriter or funding department will look for any excuse not to risk depleting their coffers further.  Even if you want to move ahead with the purchase because you are getting such a smoking deal, you might not have the means. 

I showed a property the other day in which two of the three A/C units had been cannibalized for copper and parts.  Outside of paying cash or arranging private financing, this steal of a house (quite literally) would be difficult to buy through conventional means.

If the bank won’t make the necessary repairs, buyers can be left with the unenviable decision of either walking away from a dream purchase, or making the repairs themselves.  A buyer tackling such expenses prior to the close of escrow is fraught with risk for all parties.  The buyer risks losing that money if the deal goes south, and the seller risks the buyer gaining an equitable interest in the property prior to closing.  Bad juju all around.

There are deals to be had in bank properties right now, but it’s better to be aware of the potential pitfalls before you sign a contract .  Home inspections will reveal many of the non-glaring defects, but I find it’s better to address the obvious loan killers in the initial negotiations.  Why waste weeks of your life jacking around with a seller that has no intentions or repairing anything, regardless of whether it affects your loan or not?

Seem stupid of the bank that owns the property not to make the repairs?  Counter intuitive?  Assume they will do whatever it takes to offload the inventory that they desperately don’t want?  Believe me when I say that the depths of a bank’s stupidity can be an uncharted abyss, populated by the freaky, googly-eyed monstrosities that the Discover Channel tells me reside only in the deepest oceanic trenches and asset manager’s offices.

Be prepared for the eventuality that your lender might not be as keen on the property you wish to purchase as you are.  Lean on your mortgage professional and your Realtor to help you successfully navigate the purchase of a distressed property.

There’s gold in them there foreclosure hills, but someone needs to lend you a shovel if you don’t have your own.  And they’ll want to know what manner of muck you are planning to dig into before giving you the go ahead.