To avoid the angst, Ralph Spence III, 25, shopped for an REO foreclosure instead of a short sale in Las Vegas last summer. Spence thought that prices had fallen low enough to make buying worthwhile and set a limit of $200,000. His first bid lost out to an all-cash offer. He bid on a second home -- with five bedrooms and two and one-half baths -- after seeing photographs of the place. The lender repossessed it at auction for $155,000 and listed it for $180,000. The lender countered Spence's full-price offer with a request for his "highest and best" offer -- so Spence offered $196,000 with contingencies for a home inspection and financing. After the bank accepted his offer, Spence was relieved to discover that it looked as good in person as it did in the listing photos, and the inspection turned up only minor problems.
While Las Vegas has a plethora of REOs on the market, in other areas the pickings aren't as easy as you might think. In the third quarter of 2010 (the most recent data available), more than 2 million homes in the U.S. were somewhere in the foreclosure process, according to RealtyTrac, which tracks properties in foreclosure. The greatest numbers were concentrated in California, Nevada, Arizona and Florida. Of the total, lenders held 952,489 REOs, but RealtyTrac estimates that just 30% are listed for sale. Lenders will continue to dribble them onto the market to avoid creating a glut that depresses home prices even further.
Tips for buyers
The more unencumbered you are as an REO buyer, the more likely you'll succeed. Lower offers from cash buyers generally win out over higher offers from buyers who need a contingency for financing. Most institutional sellers won't accept a contingency for the sale of your home or other property.
It's also smart to hire a buyer's agent who has had recent experience with REOs, especially in your target neighborhoods. You want someone who knows what's selling there and what constitutes a really good deal. You can go to Realtor.com or similar sites to search for agents who specialize in buyer agency and in foreclosures or REOs. Or you can hire an exclusive buyer's agent.
Patience and keeping your cool are imperative, say agents, because you may have to put in many offers before you get a house. Exclusive buyer's agent Dawn Rae, in St. Petersburg, Fla., says real-estate agencies that specialize in bank-owned properties often have working relationships with groups of investors that will snap up properties before anyone else can.
Be prepared to accompany your offer with a minimum of $1,000 for an earnest money (escrow) deposit. If you need financing, you must include a prequalification letter from a recognized lender. If the seller receives multiple offers, "its procedure is discretionary," says Orlando broker Dorothy Buse, who lists REOs for institutional clients. You won't know how it picks one offer over another.
The seller will generally take at least five working days to accept or reject your offer. If the seller accepts, it will send a signed contract within about two weeks. If you can't meet the agreed-upon closing date, the seller may provide an extension -- or not. But if it does, it will typically impose a penalty of $50 to $100 for every day past the original date.
Although sellers hold the upper hand, you're not without influence:
Have the home inspected. REOs are sold "as is," and you've probably heard the horror stories about missing appliances and cabinetry, stripped wiring, and cement-filled toilets. Although agents say that banks now make more of an effort to make properties appealing, Minneapolis real-estate lawyer Steven Nash says that sometimes paint and carpet just cover up problems. The longer a home has been in foreclosure or vacant, the more likely it is to have issues. Nash suggests that you talk with the local police and fire departments as well as neighbors to learn whether the home has been damaged or vandalized.
The home inspector should look under, inside and behind everything possible, and use a moisture meter or infrared thermography to check for dampness. If you're thinking of renovating a home, you may also want to hire a structural engineer for a review. If the results of the inspections are unacceptable, you can bail out and get your earnest money back.
Get title insurance. One of the advertised benefits of buying an REO is that the seller assures you of clear title -- the seller has eliminated any claims against or defects in the title that could impede your ability to resell the property later or force you to defend yourself against those claims. But title searches aren't perfect, and recent foreclosure scandals have cast doubt on the validity of the title to some foreclosed properties (especially in states where foreclosure decisions are reviewed by a judge). Your best defense is an owners title insurance policy. With it, the title insurer will either "perfect the title" or pay any valid claims. Without one, you must bear your own legal costs to defend against a claim.
Ideally, you should obtain an enhanced owner's policy, which the American Land Title Association says covers a broader range of risks existing before and after the settlement date than a standard owner's policy does. Be sure to review the policy's Schedule B, which lists exceptions to coverage. Don't accept a policy that excludes challenges to your ownership deriving from the foreclosure process.
Get a lawyer. Hire your own real-estate lawyer to scrutinize the seller's contract as well as your title-insurance policy. Nash charges $200 to review closing documents and review or negotiate a title commitment.
Nash and real-estate agents recount instances in which a seller, having failed to do something specified in the purchase agreement, has come to the closing and said, "Take it or leave it." At that point, the buyer has little choice but to cave or walk away. Before closing, don't invest more money than you're willing to lose.
This article was reported by Pat Mertz Esswein for Kiplinger's Personal Finance magazine.
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Even those who don't like to shop are probably hitting the stores this month. Here's what to be on the lookout for and here's what to avoid.