Homebuyers can find themselves a discount by buying a foreclosure. This process typically entails looking for a home that's been foreclosed on by the bank because the owner had financial difficulty.
There are several ways to locate these properties, and several things you'll want to know about finding the right agent to help you. First, we'll share how homes end up in foreclosure.
- Foreclosures and REO properties are homes that banks have taken back from borrowers who could no longer pay their mortgages.
- Banks are often eager to move these properties, so they can represent a chance for a good deal when you are buying a home.
- There are several ways to find foreclosures or REO properties, but the best option usually is to work with a buyer's agent.
- Look into all of the costs involved before you sign a contract, as these can surprise you on REO properties.
What Are Foreclosures and REO Properties?
Banks own real estate because they have acquired the properties through foreclosure. A foreclosure occurs when a homeowner is unable or refuses to pay their mortgage payments. When that happens, the lender that backed the mortgage repossesses the home, since the property is collateral for the loan.
Once repossessed, the lender—typically a bank—will auction off the property in hopes of recouping the losses it incurred when the homeowner missed payments. If the home fails to sell in the auction, it goes on the bank's books and is referred to as a "real estate owned" (REO) property. A home may fail to sell because no one showed up to bid the minimum amount of the existing mortgage or because the bank started the minimum bid so high that no one would touch it.
Why Buy Bank-Owned Homes?
If a bank is looking to recoup its losses on the foreclosed properties, why would there be good deals? There are two reasons why an REO home can be profitable for you:
First, if two loans were secured to the property (which is common these days), the second lender sometimes does not foreclose. If the second lender does not make up the back payments to the first lender and commences its foreclosure proceedings, the second lender gets wiped out in the foreclosure.
Second, the bank often does not want to sit on its inventory.
Since it did not receive its minimum bid from an investor or homebuyer during the foreclosure sale at the courthouse, there's a decent chance that the bank might price that REO home for a significant discount to get rid of it.
How to Find Foreclosures and REOs
To find foreclosures and REOs, you can take on the task and find them on your own. Alternatively, you can hire a buyer's agent.
Locate REO Listing Agents on Your Own
There are many places available online to find foreclosures. One of the best is on a multiple listings service (MLS), which helps connect buyers, sellers, and brokers. Search the MLS for "REOs" to find agents in your area who specialize in REOs. Once you identify some high-potential listings, it's time to start reaching out.
There are several things you'll want to know about REO listing agents:
- Focused activity: Most REO listing agents list only REOs, not other types of property.
- Dual agency: REO listing agents make money by either selling a lot of REOs or operating as dual agents. Under dual agency, the REO listing agent will earn both the listing commission and the buyer's agent's commission.
- Commission: To attract buyer's agents, many banks offer a larger commission percentage to the buyer's agent while discounting the listing agent's commission.
- Representation: REO listing agents generally represent sellers, not buyers.
- Relationship: REO listing agents are typically top-producing agents because of the volume of business they conduct. They typically do not spend a lot of time working with buyers and will probably not engage in much hand-holding.
- Communication: Some REO listing agents are so busy that they hire assistants to field calls. Many do not give out their phone numbers, which can make communication difficult.
A Better Option: Hire a Buyer’s Agent To Represent You
Unless you have direct experience negotiating with banks, you may receive better representation by hiring your own buyer's agent. Before selecting an agent, choose several and interview them to find a good fit.
Here are a few things you'll want to know about buyer's agents:
- Fiduciary duty: A buyer's agent has a fiduciary responsibility to protect your interests.
- Representation: A buyer's agent does not represent the seller, even when the seller is paying their commission.
- Costs to you: The seller generally pays the buyer's agent. It usually does not cost you to hire a buyer's agent.
- Broker agreement: The buyer's agents may ask you to sign a buyer's broker agreement, which will specify the agent's duties and designate who pays the commission.
- Agent experience: Consider working with a buyer's agent who has experience working with REOs.
Negotiating Tips for Buying a Bank-Owned Home
Once you've located some listings of interest and found yourself a buyer's agent, you're ready to move to the next step: contacting the bank.
If the home listing is relatively new to the market, it is possible the bank will not deviate much from its asking price. You will have greater negotiating power if you make offers on homes that have been on the market for more than 30 days.
If you are aiming for a certain price that would make the REO a great deal, don't be afraid to ask for it. You have substantial leverage. On top of the property being foreclosed on, it failed to sell at the auction. The representative or agent you are dealing with is there to get the sale done.
During this process, you should expect the following:
- An as-is purchase: You will likely be asked to buy the home "as is," and it may or may not be in good shape. Make your offer subject to a home inspection.
- A waiting game: You could find yourself waiting a while when dealing with the bank. After prequalifying for a loan, you might be kept waiting for 10 days for the bank to respond to your offer. If the bank won't budge, and you receive an offer rejection, wait another 30 days and then resubmit your original offer.
Unexpected Costs of Buying a Bank-Owned Home
Beware that you may run into unexpected fees during the transaction.
Take note that the bank may also run the transaction differently from how you would experience in a non-foreclosure home purchase.
Banks negotiate bulk-rate discounts with title and escrow companies. If you elect to use the bank's title and escrow company, check the fees that those companies will charge you. Generally, fees not paid by the bank but paid by the buyer will be higher. That's because title and escrow often make up for those discounts by charging buyers more.
Expect the bank to draw up a purchase contract or addendum to your standard purchase contract. Read it thoroughly, and ask a real estate lawyer for advice if you do not understand it. You can bet that the bank's lawyer drew up that contract, and it's not likely in your favor.
Finally, some banks will not sign a counteroffer until all terms are mutually agreed upon verbally between the parties.
Frequently Asked Questions (FAQs)
What's the difference between a HUD foreclosure and an REO foreclosure?
A HUD foreclosure is essentially the same as any other REO foreclosure, but the mortgage that covered the home was backed by the government. That changes the foreclosure process a bit, although the essential functions of the process are the same. When a foreclosed home was bought with a government-backed loan, the REO foreclosure is listed on the HUD Home Store.
How do I know what to pay for an REO foreclosure?
As with any home, you can offer to pay whatever you think is fair for an REO foreclosure, but there may be another buyer who is willing to pay more. That's why it can help to work with a good buyer's agent. If an agent thinks a property is within a price range you're comfortable with, then they can help you place a competitive bid.