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If you’re in the market for a new home, you may have come across a few real-estate owned (REO) property listings. These types of properties can be a steal, often selling for below market value. However, there are some risks involved that you should know before considering an REO property.
What Are REO Properties?
Real estate-owned property—also called bank-owned property—is when a lender or government entity, such as Fannie Mae or Freddie Mac, owns the property rather than an individual or business. There are a handful of situations where this can happen.
Often, a bank or other institution becomes the owner of property when the original mortgage holder severely defaults on their loan. If this occurs, the homeowner may have the option to go through a short sale in order to unload the property and pay off their remaining loan.
If the borrower is unable to sell the home and/or pay back the mortgage, the lender will foreclose on the property and attempt to sell it at auction. However, it’s common for foreclosed properties to go unsold. At this point, the lender becomes the owner of the property, and so it will sit on the bank’s books until they’re able to sell it other ways.
A mortgage holder in default may also opt for a deed in lieu of foreclosure, which means they transfer interest (ownership) of the property directly to the lender in order to avoid foreclosure proceedings.
If a homeowner passes away, or they have a reverse mortgage that comes to an end, the property may be returned to the bank if the heirs can’t or don’t want to provide the money to keep it.
How to Buy an REO Property
Banks don’t want REO properties sitting on their books—they’d rather have the cash. That’s good news for you since REO listings are often priced at or below market value to entice buyers.
Here are some steps you should take if you’re considering an REO property.
1. Get Pre-approved for Financing
Lenders want REO properties off their books ASAP, so you don’t want the mortgage process to slow everything down. You may want to get preapproved for a home loan before you start house-hunting so you know your exact budget and can come to the table prepared, with financing already secured.
If you plan to pay in cash, you will need to secure a Proof of Funds letter from the institution that’s holding your money. This lets the selling bank know that you are financially qualified to purchase the property.
2. Find REO Properties
Once you know the price range you’re working with, it’s time to browse REO listings. Here are a few ways to find them:
- Search the Multiple Listing Service (MLS). This national database connects real estate buyers, sellers and brokers. You can search the MLS specifically for REOs.
- Check lender-specific listings. You can also go directly to a lender’s online listings to see what REO properties it currently holds.
- Ask a real estate agent. A real estate agent should be able to point you toward REO listings in your neighborhood. Some real estate agents specialize in REO properties, which can help you find exactly what you’re looking for. It’s important to keep in mind that some agents do not prefer doing business with REO properties so ask the agent upfront about their experience in this area.
- Review national real estate websites. Free websites such as Zillow and Trulia allow you to search for REO properties in any city.
3. Consider Hiring a Buyer’s Agent
You don’t need your own agent to buy REO property, but it might save you some time and stress to have someone negotiating with banks on your behalf. A buyer’s agent will do just that. Plus, they have a fiduciary responsibility to advocate for your best interests. Even better, the seller typically pays the buyer’s agent, so there’s no additional cost for you to hire one. Ideally, you should work with an agent who has experience dealing with REO properties.
4. Make an Offer
Once you’ve found the right property, it’s time to make an offer to the lender. If you’re working with an agent, they can help you determine what offer is likely to get accepted and submit the offer on your behalf. It’s important to get this right—if you attempt to lowball the bank, they will likely reject your offer and move onto the next prospective buyer.
If your offer is accepted, you will sign a contract with the bank and transfer ownership. You might also be required to pay an earnest money deposit upfront, which is typically 1% to 2% of the purchase price and held in an escrow account until the sale goes through.
Also, keep in mind that with REO properties, the seller will likely charge a penalty for every day closing is delayed past the deadline. Having inspections scheduled ASAP and securing your financing ahead of time can help avoid any delays.
5. Get a Home Inspection
A home inspection is a crucial step when buying an REO property. These homes are sold as-is, meaning you are responsible for any repairs needed.
The property you’re eyeing may be in pretty good shape. On the other hand, it’s common for foreclosed properties to be neglected or damaged by the former owners. A professional inspection will uncover any hidden issues and give you a sense of how much you’re likely to spend to make the home more livable after it’s purchased. It may turn out that an REO property is out of your budget once maintenance and repairs are factored in.
Also, the lender might have performed an inspection when the property became bank-owned. If so, you can review the report and decide if it’s comprehensive enough. However, if the property has been sitting vacant for a long time, you may want to have another inspection done. This typically costs between $300 and $500.
6. Perform a Title Search
In addition to a home inspection, it’s important to perform a title search on the property you’re considering. There could be a lien against the home, which is another nasty surprise you want to avoid.
For example, the previous owner may have owed property taxes. When you buy an REO property, you will likely receive a quitclaim deed rather than a warranty deed. This means the lender is simply transferring interest of the property and can’t guarantee there aren’t any lingering judgements against it. Several types of liens survive the foreclosure process, which means you would become responsible for them once you buy the property.
Fortunately, liens are public records, so you can search a property’s title for any issues. You can also hire a title search company to do this for you. The cost varies by state but averages about $150.
Pros & Cons of REO Properties
Buying REO property might seem like a cheaper and faster way to buy a house, which it can be. However, these properties come with some risks, too. Consider these pros and cons before deciding whether an REO property is for you.
Pros of REO Properties
- Lenders are motivated to sell: Banks don’t want a bunch of properties sitting on their books. That means holders of REO properties are eager to sell and will work to offload a property quickly. That can mean a leg up on negotiations and potentially better terms for you.
- The price will likely be competitive: Because lenders are so motivated to sell, properties are usually priced lower than other homes on the market. That doesn’t necessarily mean you’ll get an REO property for cheap. Lenders still need to recoup their losses, after all. But it does mean that you probably don’t have to worry about inflated prices in a hot housing market.
Cons of REO Properties
- REO properties are sold as-is: Lenders with REO properties are attempting to minimize their losses. That means they won’t invest anything in fixing up a property before selling it. You have to agree to buy the property as-is, meaning there could be expensive repairs or hidden damage that you’ll need to pay. That’s why getting an inspection is so important. You don’t want to discover water damage or a termite infestation after the sale goes through.
- There could be other hidden costs: Aside from general repairs and upgrades that may be needed, there could be other costly issues. For instance, it could turn out that there is a lien against the property. You can buy title insurance to avoid this issue, but that’s one more expense that can eat into your budget.