Purchasing Bank-Owned Properties – The Good, the Bad, and the Ugly

Real estate owned (REO) properties are an excellent opportunity for investors to purchase homes at below market prices. But REOs have below market prices for reasons that require significant due diligence to make sure the property one buys truly is the property one expects to buy. While buying an REO has much in common with buying a regular home, all the moving pieces and the various participants make the process different enough to merit further investigation. After all, if you’re going to be making an investment you want it to be a wise one!

What is a REO Property?

An REO is a foreclosed property the ownership of which has been transferred to a bank or lender. The following steps take place before a property becomes an REO.

  • Loan Default: The homeowner or borrower is unable to pay their mortgage for a length of time that’s usually stipulated in the mortgage agreement.
  • Foreclosure: Legal proceedings are initiated against the borrower to foreclose on the property.
  • Auction: The property is offered to the public at a foreclosure auction and sold to the highest bidder. If the property is sold to a third party, the bank or lender recoups a percentage of the outstanding loan balance, interest, and fees associated with the sale of the property.
  • REO Status: If the property isn’t sold at the auction to a third party, then ownership of the property tends to fall to the lender and it becomes an REO property. The lender gets ready to sell the property, which is likely to entail evicting occupants and disposing of any outstanding liens.

What’s the Appeal of a REO?

  • Reduced Prices: Since the longer a bank holds onto a property the more money they lose, lenders are motivated sellers. As a result, you’re likely to get a discount.
  • No Outstanding Balances:  REO homes are usually sold without any title liens or outstanding claims. Delinquent taxes or HOA are also taken care of, which saves you money.
  • No Homeowners to Work With: A homeowner’s emotional attachments may complicate the negotiation process. Not so with banks eager to make their money back.

Things to Consider When Purchasing an REO

As a function of the popularity of Real Estate Owned properties, the following considerations must be made.

  • Depending on where you live, you’ll face significant competition, which drives up the purchase price.
  • You must be able to compete with others as opposed to being only able to make a first offer, which means being able to make counter offers for a potentially higher price.
  • If your offer is accepted but the price has been driven up due to competition, will the appraisal leave you with a price that makes the whole ordeal worth it? What happens if the appraisal leaves you with a loss? It’s important to remember that if the appraisal is significantly less than the purchase price that you may be unable to obtain a loan.
  • If your property is a part of a Homeowners Association (HOA), is the quality of the HOA sufficient to pass the criteria of the lender? The lender is likely to check if the HOA has any pending litigation and the HOA’s delinquency rates, which is the measure of how many HOA members pay their dues on time expressed as a percentage.
  • Will the lender be able to transfer the title? Some banks may find it difficult to transfer a clear title on some properties.

What it Takes to Buy an REO Property

Browse Available REO Properties

Scope out what’s available in your target market and price range. There are several avenues available to peruse REO properties.

  • Bank and Lender Listings: These are websites, like PennyMac REO listings,  that show every REO from a given lender.
  • Multiple Listing Service: Multiple Listing Service is often used by lenders and realtors to list REO properties.
  • Real Estate Agents: A real estate agent can find you REOs based on geography from a variety of lenders.
  • Online Services: Websites such as Zillow allow you to look up REOs by type or geography. Some of these websites are free while others charge a fee.

Find a Lender and Discuss REO Financing

After finding an REO you like, speak to a lender about financing opportunities. Being prepared is important because lenders are motivated to move their properties ASAP, so they are likely to operate on a first come first serve basis. You don’t want to miss out because you weren’t prepared!

For this reason, being pre-qualified by a lender is a wise decision. With pre-qualification, the lender that owns the property will have already marked you as qualified to make a purchase and, as a result, will be more likely to say yet to your offer. A step above pre-qualification is getting pre-approval from the lender that owns the property.

Get a Real Estate Agent Who Knows REO Properties

A real estate agent well versed in REO properties will help you find the best deals, using their expertise to lead you through the entire process. Your agent will also know whether or not you need to retain an attorney or an inspection service. An experienced agent will know how to negotiate with a lender, calculate the cost of repairs, and work quickly enough to not fall behind in the process and jeopardize your deal.

Narrow Down Your REO List

The following are important considerations when picking an REO property:

  • Price
  • Repairs and their effect on the price.
  • Nearby schools, work opportunities, public transportation, entertainment, etc.
  • Number of bedrooms, bathrooms, and amenities.
  • The neighborhood and community.
  • Lender-specific criteria.

Use your criteria to refine your potential properties, then narrow your list down further with what matters to you, like a patio, number of cars that can fit in the garage, etc. Then send your list to your agent so they can arrange tours.

Get an Appraisal on Your Ideal Property

You need your property appraised because the means by which a lender determines the value of a property might not reflect its actual market price. The property may be in dire need of repair, be in a bad location, or be marked up because of the sale price of comparable homes in the area or as an attempt to recoup the lender’s investment. An appraisal will get to the bottom of your desired property’s true value.

Once you have the appraiser’s estimate, you can compare it to the bank’s asking price. The appraisal is based on the home’s major systems (HVAC, electrical, etc), its structural integrity, and the prices of comparable nearby REO units. You’ll also need an inspection, which will help you know the nature of the repairs and renovations your home demands. If your property requires too much of an investment to repair it may make it more difficult to get a VA loan.

Make an Offer

After you’ve determined which property you want, your agent will help you figure out what offer is most likely to get the a-okay. Your agent will also put the offer together and submit it. Some lenders require additional paperwork. It’s also not uncommon to provide an earnest money deposit check with your offer, which is usually 1-2% of the asking price that’s held in escrow until the purchase is finalized. It’s meant to communicate your seriousness about purchasing the home.

This is also where the results of your inspection may come into play. If you discover the home requires significant repairs, you can ask for a lower price. Your agent will be able to explain all your inspection contingencies. In some cases, the lender themselves may have conducted an inspection, in which case you should ask to see the documentation.

Banks tend to take longer to respond to offers on REO properties because of all the people the banks have to answer to, so patience is required during this step.

Negotiate Details

Bidding on an REO may take longer than the process of purchasing an privately-owned home because the offer is reviewed by numerous individuals and companies. Lenders must prove to shareholders and investors that they’re getting the best price for their property, so you’re likely to be met with a counter offer. If the lender is unwilling to budge on the price, request a lower interest rate or a reduction in closing costs.

The bank will be even more eager to sell the property or negotiate if it’s been on the market for over 30 days. Although, if an REO has been on the market for that long it may also be a red flag. So, make sure to not lose sight of due diligence if a deal seems too good to be true.

Finalize Your Loan

After putting in your offer, you’ll be negotiating with the bank and putting the finishing touches on your loan. This is also when you’ll be verifying the title. Banks tend to clear the title before selling a REO property, but you shouldn’t take the risk of not verifying it. If the title hasn’t been cleared, the bank should already have a company they use for doing so. If the onus ends up being on you, then you need to hire a company to run a full, insured title search before your closing.

If you have good credit, your bank may be open to offering a mortgage worth the full price of the REO plus more if extensive repairs are necessary. Somelenders banks ask for a 10% down payment if your property is going to be a rental.

Closing

Once everything is settled, it’s time for the closing. The process is similar to any other closing except for a few notable differences. If you’re unable to close before a predetermined closing date, you may incur a penalty for each day afterward. Getting pre-qualification or pre-approval for your loan and getting assurance that the funds will be available before your deadline is a way to avoid these penalties.

At the time of the actual closing, you and a representative of the lender will sign all the documents you need to transfer the house into your name and to finish the mortgage. Once everything is signed and the funds go where they need to go, you’ll get your house keys!

Bottom Line

REO properties have a lot going for them, which is why you’re likely to face competition in purchasing them. With enough patience and effort, however, you can end up with the REO of your dreams. Just make sure that if you think you’ve found your dream home you have it properly inspected so it doesn’t end up a nightmare.

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