Monday, May 18, 2009

So What's the Deal with those REOs?

Although most buyers are excited about the opportunities REOs (REO stands for Real Estate Owned by the beneficiary/lender that foreclosed) present in today’s real estate market, I find that many are also concerned about purchasing a home that can have many unseen problems which may not show up until long after escrow closes. This post is dedicated to addressing some of those concerns. 

How Does a Home become an REO

An REO is a foreclosed property. In California, when you buy a home, unless you pay cash for it, chances are you will have to finance the purchase. A home is financed in much the same way a car is financed - you sign legal documents called “a note” for a loan. The lender gives you the money which you agree to pay back with interest over a term of (usually) 30 years. If you default on the loan, the lender can then take the home back and sell it to someone else. The legal process of taking the home back for default on a note is called foreclosure. Although the process in California includes a trustee (a neutral third party-typically a title or escrow company) who is given the note and who is notified by the lender to begin foreclosure proceedings in the event of non-payment the basic idea remains the same: don't pay the mortgage (or property taxes or Homeowner's assessments) and lose the home.

In order to begin the foreclosure process, the lender is required by law to send a homebuyer who has defaulted on the loan a Notice of Default. The lender notifies the trustee in writing that the trustor (borrower) is in default, and instructs the trustee to initiate foreclosure proceedings. This notice is recorded at the county clerk recorder’s office in the county where the property is located and is a document of public record. This means that anyone with an interest in the property may see it. The notice states when the lender is planning on foreclosing, ie. the date of the trustee’s sale and the outstanding amount the homeowner can pay to cure the default and stop the trustee’s sale.

More often than not, the default is not cured and the trustee auctions the property to anyone who will buy it. If there are no buyers at the trustee’s sale, the house becomes a foreclosed property and is referred to as an REO - real estate owned by the lender.

What you should know about an REO as a Homebuyer

Most lenders are not in the business of real estate; they are in the business of finance. And so, the house acquired by a bank through a foreclosure is usually put back on the open market. To come up for a sales price for the property, the bank hires a Realtor® and asks for a BPO - a Broker Price Opinion. The Realtor® appraises the property based on similar properties also known as “comps” and offers to list it. Since most foreclosures are fixers, they are usually placed on the market for a substantially discounted price.

As a home buyer of a bank owned home, your concerns are justified. An REO is usually a fixer. The most obvious reason for this being the family that was foreclosed upon was low on finances. If they didn’t have enough to make their mortgage payments, chances are there are quite a few things about the house that went unrepaired. This is also called deferred maintenance. Deferred maintenance can be a small problem, like a leaky faucet, or can hide bigger problems, like a leaky faucet that rotted the bathroom sub-floor.

You should also be aware that as a purchaser of an REO, you don’t receive full disclosure about the house. The bank is not required to provide you with a Transfer Disclosure Statement, partially because the lenders have never been in the home and are unaware of what exactly is wrong with it. 

Resolve your Concerns

So is purchasing a foreclosure the best bet? Sure, the price is deeply discounted, but does that make up for everything else? While that's a question only you can answer, the one thing I stress to take the pain out of any future problems: Always, always, always get a physical inspection!

Brokers recommend a variety of inspections, including pest, roof, septic system and a complete home inspection. Disregarding any of these inspections can be a big mistake on the part of a homebuyer. While most banks will not repair any items listed as potential or real problems during these inspections, you can get an idea of how much work is involved in making the home as habitable as you want it and decide if the asking price is worth the risk and work involved. The price you pay for the inspections is well worth its weight in gold.

You, The Homebuyer

With so many bargains out there in short sales, REOs and pre-foreclosures, if you are serious about buying a home at a deeply discounted price, chances are you will find what you are looking for. Do yourself a favor and get all the facts, look hard and long and don’t be scared to make an offer when you find the right one!

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