One of my biggest hurdles is getting new investors to understand the difference between a foreclosure that is going to auction and a REO (Real Estate Owned). First, let’s start with simple definitions.
Foreclosure: A legal action that ends all ownership rights in a home when the homebuyer fails to make the mortgage payment or is otherwise in default under the terms of the mortgage. Federal Trade Commission
REO (Real Estate Owned): This is a term used in the United States to describe a class of property owned by a lender – typically a bank, government agency, or government loan insurer. Wikipedia
Now that we understand the terms, let’s talk about the procedure that happens for a property to become a REO property.
Typically, there is a notice filed that explains the owner is behind on their mortgage payments. If the owner doesn’t bring the payments up to date, the lender (now the foreclosing beneficiary) will set the opening bid amount that will be asked for at the auction. If there is a successful bidder, the property will be transferred to the new owner and the outstanding loan amount (plus fees) will be paid to the bank. If there is not a successful bidder, the lender (beneficiary) will repossess the property. Once the property has been deeded over to the lender it, becomes a REO.
So what are the advantages and disadvantages to buying a REO?
- Unlike buying at the foreclosure sale the purchase doesn’t have to be all cash. Conventional financing can be used (if the property qualifies).
- The bank has incentive to sell the property rather than keep it on its books
- You will get clear title
- Property may be purchased at a discount
- Property may have extensive issues such as; burst pipes, insect infestations, stripped electrical, all fixtures removed, structural as well as things that need to be updated
- Property sold “as is” – no guarantees
- Lender may consider the discount enough and not offer deferred maintenance.
So why would someone consider buying a property that might need extensive remodeling and repairs? Opportunity. As an investor it is your job to find a property that is under value and to also add value.
Here are a few suggestions of things you can do to prepare for taking on a REO:
- Go through the property before signing the contact with a fine tooth comb so you have an accurate feel for the needed repairs
- Make sure you give yourself ample time to have an inspection done. Most of the time they will allow 10 days. Try to get the inspection scheduled as soon as you have the contract accepted.
- Have your request for repair done quickly so you can go back to the negotiations table with the lender selling the property.
- If you are purchasing the property as a personal residence, you might want to look into a FHA 203K home repair loan. This is a conforming loan that allows you money to make repairs and cosmetic changes.
Diana D. Hill