How To Buy A Foreclosure
What’s the difference between a foreclosure and an REO?
A foreclosure and a REO are the same thing. But REO designates the end of the foreclosure process.
The beginning of the process is Pre-Foreclosure.
This is when the owners are still current on their payments, but are headed for trouble. During this time they will often list the home and try to sell it before they get behind. However, most homeowners in this position are facing another challenge, they’re “upside down” on their loan. Meaning that they owe more than the home than it’s worth. In such cases, when an offer comes in, the agent will have to negotiate a “short sale” with their lender. That means convince the lender to take less than is owed on the note. The argument put forth to the lender at this stage is; “Take a short sale now…or a bigger short sale later, because if you don’t take this offer, this is going to foreclosure”. Sometimes lenders will accept the offer, and sometimes they won’t. They’re all different. If they don’t, and the owners fall behind in their payments 30-90 days later (depending on the lender), it goes to the next stage.
This is the Sheriffs Sale
The owners are notified that the home will be sold at Sheriff’s Sale on a certain date at the county courthouse. Anyone can bid on a home at a Sheriff’s Sale. The term “Sheriff’s Sale” is really a misnomer. Technically the home itself is not being sold, only the note on the home. What’s happening here is this; the bank is saying “Will somebody please buy this mortgage from us and take our place as the lender?…We want out”. However, since most homeowners owe more than the home is worth, it’s unlikely anyone will be kind enough to pay off the bank to take the note off their hands and replace the bank as the homeowner’s lender. So, the bank buys it back from itself (sounds confusing I know…basically another department at the bank pays off the note and takes over as the “new” lender). Now the foreclosure moves into the next stage.
This is the Redemption Period
Michigan gives a homeowner the right to redeem their property from the bank during this time. The time frame to redeem will be 6 months if the home is on 3 acres or less. It will be one year if it’s on more than 3 acres. They may remain in the home during this time and will probably not be making payments. The homeowner can redeem in one of two ways; either pay off the note and all extra fees and remain in the home. Or sell the home and pay off the note. Once again, if the home is sold during this time it will probably be a “short sale”. If you buy a foreclosure at this stage keep in mind there may be other liens on the property that will have to be paid off in order to close. The title search will reveal all liens on the property. You must have clear title or you do not close. If it doesn’t sell, or the homeowner does not redeem, it goes to the next stage.
Now it’s a REO
If the homeowner does not redeem through a pay-off to remain in the home or a sells it to a new owner, and the redemption period runs out, the bank gets the property back completely. Banks refer to these properties as REO’s which stands for Real Estate Owned. Not a positive thing for a bank to have. Two things will happen now; The owners must leave, and the current listing agent will surrender the home to a new real estate agent designated by the bank as their REO agent. Between the time the owners leave and the new REO agent takes over, the home will sit vacant with the utilities off, and as a result, could suffer damage, and many often do. The time frame for the lender to get the new REO agent to take over the listing and get the property management company over to the home to secure it and winterize it varies widely from a few days to a few months. If the mortgage was insured against default by a third party such as FHA, VA etc. the process takes longer, because they will pay off the lender in full and take over the home, and that process takes time. As a result, the home is much more likely to be vacant for a longer period and thus could suffer damage, because the utilities are off. As a result, if it has a sump pump, it will fail to go on and the basement will flood, or the pipes will freeze due to the fact the furnace cannot operate. These are the two most common causes of mold in foreclosures.
What about liens on the property? Am I buying those too?
If you buy the home during the redemption period, all liens will still be on the property so a title search is critical before you close. Do not close without clear title. If you’re taking out a loan to buy the property, your lender will require clear title and title insurance to close and will order those. If you’re paying cash it will be up to you to get the title search done. The buyer traditionally pays for the policy that covers the lender for the amount of the mortgage. The seller traditionally pays for the owners policy. But this is not a traditional type of sale. The foreclosing party may require that you pay for both title policies. If you buy it after it has become a REO, all other liens and claims are automatically gone, all except IRS liens that is…they supercede everything (of course). If there are any past due property taxes and other assessments, they must be paid in full and brought up to date in order to close. This is often done by the bank or government agency that has the REO. The bottom line….do not close without a title search and title insurance even if you have to pay for it all yourself.
The listing says the property is being sold “as is”, it also says “mold may be present.” Does that mean I’m stuck with buying a home that’s a train wreck?
All foreclosures and some privately owned homes will be listed “as is”. In the case of a privately owned home, it simply means the seller is not willing, or is not in a financial position, to make any repairs you may request. However, they may give you concessions (money back) at close or reduce the price of the home to compensate you for the repairs.
In the case of foreclosures “as is” means they will not make any repairs, because repairs hold up closing, and once they accept an offer, they want to close as soon as possible to get it off the books. However, they too may give you concessions at close or reduce the price of the home to compensate for major repairs. If you are coming into the transaction with FHA backed financing, FHA will require certain repairs must be made before close. Some foreclosures will comply and some will not. As a result, not all foreclosures are acceptable for traditional FHA financing. There is however, a special FHA rehab loan that will allow certain repairs to made within 30 days of close. Most foreclosures, especially government properties, will always have a mold warning in every listing and/or addendum, This does not necessarily mean mold is present. (Your inspection will reveal that). But they must put warning language everywhere possible to cover themselves in case mold or other harmful toxins are found in the inspection.
Can I have an inspection before I buy the property? And who pays?
Absolutely! Never buy anything without an inspection! All offers, whether it’s for a privately owned home or a foreclosure should be contingent upon acceptable inspection. (However, in the case of VA foreclosures or Uninsurable HUD homes, the right to cancel due to unacceptable inspection is not allowed.) The process works like this: You make an offer on a home with a Purchase Agreement executed by your Buyers Agent. (See below). The offer contains a clause which states that you have a certain number of days to have the property inspected after the offer is accepted. If the inspection is unacceptable, you have two choices; first, revise your offer to the lender (or homeowner) to deduct for the repairs that must be made. In the case of the homeowner, you may request that they make the repairs for you. The lender or homeowner then has the right to accept your new offer, counter it, or return your earnest money deposit and call off the deal. Your other option is to simply call off the deal yourself and get your earnest money back. (Remember…you do not have this right with VA foreclosures or Uninsurable HUD homes, or if the lenders addendums specifically forbid it). Who pays? You do. Most home inspectors charge by the square foot. A good ballpark figure is around $300. But it varies by region. This covers the structure itself, plumbing, heating, electrical and appliances. However, septic, well, radon, pest, and mold tests will be extra. A mold test will be required if mold is found during the course of the inspection. This is done to determine what type of mold is present. Occasionally an air quality test may be required and sometimes certain areas of the country require tests for issues that are indigenous only to that region.
How Do I Make An Offer?
First secure the services of a Buyers Agent. This is an agent who must, by law, represent your best interests only, not the best interests of the seller. The Listing Agent is not a Buyers Agent. The Listing Agent is the Sellers agent and must, by law, represent only the best interests of the seller, not you. To secure the services of a Buyers Agent you must sign a Buyers Agency Agreement designating a specific agent to represent you. You do not pay this agent, they are paid from part of the commission charged to the seller. If you do not secure a Buyers Agent thru a Buyers Agency Agreement, that agent must also, by law, represent only the best interest of the seller, even though they are not the actual Listing Agent. So get a Buyers Agency Agreement, it costs you nothing and it protects you as the buyer and the consumer.
How Do I Write The Offer?
Your Buyers Agent will guide you through this process. You must attach a pre-approval letter and a copy of your Earnest Money Deposit (EMD) to your offer (see below). In most cases, your offer will be written on your Buyers Agents Purchase Agreement. However, in the case of HUD and VA, only their Purchase Agreement can be used. HUD homes require an online or phone bid thru an authorized HUD agent prior to writing the Purchase Agreement. Some lenders or government agencies will hold onto your offer for 48-72 hours waiting for others to come in. Some, like FannieMae or FreddieMac will send you a “Multiple Offer” bid form if other offers come in before they make a decision, regardless of when yours was received. Some will counter, others, like HUD will simply accept or reject. Some will ask for your “highest best and final” offer right from the start. You will most likely receive a verbal acceptance a few days to a week or more before they will actually return a signed Purchase Agreement to you. If a better offer comes in after they have given you a verbal acceptance, but before they actually sign your Purchase Agreement, they could take it instead of yours and your deal is off. So keep in mind, although you may have a verbal acceptance, you don’t have a deal until they’ve returned your signed Purchase Agreement. And even then, you may still not have a deal until you sign their addendums and return them. The irony of this is that sometimes they will start the clock ticking (for you) with regard to close and inspection deadlines from their verbal acceptance, not their signed acceptance. It doesn’t have to make sense. Wait till you see their addendums! There will usually be a strict time line that the lender or government agency requires for you to get signed docs back to them. They however, can take their time (and often do) and there’s nothing you can do about it. After your offer is accepted, and they have signed and returned your Purchase Agreement, they will forward their addendums for your signature. Now the real fun begins! If any language in these addendums contradicts language in your Purchase Agreement (and there will be), the addendums will prevail. These addendums are non-negotiable and cannot be altered in any way. And every one is different depending on which lender or government agency they come from. One thing they will all have in common…pages and pages of tiny type and complex language. Rarely do they make much sense. They will have one set of rules for you, and another very different set of rules for themselves. Example; most lenders or government agencies charge a $50-$100 penalty to the buyers for every day they miss their close date. But the lender can miss the close date for any reason and the buyers do not have the right to charge them anything. It’s at this point, as a buyer, you have to decide….how bad do I want this house?
What is Earnest Money Deposit Anyway?
All offers on foreclosures (and privately owned homes) require an Earnest Money Deposit (EMD). This shows the owner you are a serious buyer. The amount varies, but most lenders will accept around $1,000.00 as an Earnest Money Deposit on a foreclosure. HUD has a sliding scale, based on the price of the home, beginning at $1,000. The check is not deposited until the offer is accepted. Some, like HUD, will require certified funds as EMD on foreclosures. It must go into an escrow account within a specific time frame from accepted offer (depending on your state laws) and is credited back to you at close. If both parties agree in writing to cancel the transaction, the money will be returned to you providing you have met the qualifications for return of the deposit that the foreclosing party has set forth in their addendums or their Purchase Agreement. So be sure to read those carefully before you sign them!
What Else Do I Need To Make An Offer?
You must obtain a “Pre-Approval Letter” from your lender showing the purchase amount and/or mortgage amount they have approved for you. This is the first step, because it tells you what your home buying budget will be. You are not required to take out your loan from the lender that gave you your pre-approval letter. They are simply saying that you have met their lending criteria and should you decide to take out your mortgage with them they’d be happy to welcome you as a customer. So be sure to shop around for the best rates. This letter must be attached to all offers along with a copy of your EMD.
Financing Options Available to Buy Foreclosures
Most conventional financing and FHA can be used to buy foreclosures. You can still buy homes with “no money down” loans as well, though due to the recent meltdown in the mortgage industry, they are much harder to find these days. In the case of homes that do not qualify for conventional mortgages because they require major repairs, there is special financing available. These are commonly referred to as “Rehab” Loans. Even homes that require only minor repairs can qualify for these loans as well. FHA, USDA and private lenders offer them. There are a variety of options with these loans, but most commonly they work like this; The home is appraised for what it would be worth in it’s rehabbed condition. Then the lender works with contractors and inspectors to determine what will be required to rehab the home. The bank loans you the money to buy the home and the money to rehab it folded into one mortgage. Some will also fold in closing costs as well so it’s a “no money down” transaction. Every lender has different criteria for these loans. Some require that the home appraises for at least 10% more in it’s rehabbed condition than the amount of the loan. Some only require that the appraisal in the rehabbed condition equal the total amount of your loan. Some require a down payment. Some are no money down. My personal favorite is the following loan program.
The USDA Rural Development Rehab Loan
The answer to this one:
OK…I put in an offer on a foreclosure for $150,000. The inspection revealed $35,000 worth of work will be needed to get the home in good condition. As a result, I revised my offer to the bank to $115,000 and they accepted it. Now where do I get the $35,000 I need to rehab the property? I have no money for a down payment or closing costs either. Help!
This loan program is a “guaranteed loan” program like FHA, but it’s better. It will provide you with an additional amount up to $35,000 for rehab folded into the mortgage to buy the home. Like FHA, the loan is obtained from a commercial lender, but it’s guaranteed by the USDA against default, so you get good interest rate, just like FHA. But unlike FHA there is no down payment required. The rehab money may be used for anything you need to remodel the home, from major repairs to appliances or even carpet and painting. The home is appraised in it’s rehabbed condition. The amount of your loan to buy the home and fold in rehab costs only needs to at least equal the appraisal in it’s rehabbed condition. You may also fold in closing costs and seller concessions, if there are any. So it’s truly a “no money down” loan, and there’s no PMI (Private Mortgage Insurance). Example: you buy a foreclosure for $100,000 and determine it will need $25,000 in repairs. You also need $5,000 for closing costs for a total loan amount of $130,000. The home appraises at $140,000 in it’s rehabbed condition. Therefore USDA will give you a loan for at least $130,000 and you may even increase your rehab money from $25,000 to $35,000 if you choose, for a total loan amount of $140,000 and still be within the guidelines. The terms are 30 year fixed rate at current market interest. The qualifications are; an income that does not exceed $89,900 (for a family of four) and a credit score of at least 640. These loans are available only in certain areas of the country that are considered “rural” by the USDA. But since the USDA maps have not changed in many years, areas that were rural 30 or 40 years ago and are now suburbia will often qualify. Check out the USDA maps on their website to see if your area qualifies.
Don't Qualify for USDA Rehab Loan? There's Others That Work
If you don't qualify for the USDA loan because your income is above the threshold, the home requires more than $35,000 in work, or it's not in a location that USDA considers "rural", there's another rehab loan that also works very well. This one is also 100% financing, but unlike USDA, you will be required to pay PMI. There is no limit on income and no limit on the amount of money they will fold into the mortgage for rehab purposes. And no location requirements either. It works like this; the home is appraised in it's rehabbed condition. The lender will fold in the amount you need to rehab it and buy it in one mortgage up to 90% of the appraised value. Example; a home appraises for $200,000 in rehabbed condition. You can buy it in it's present condition for $100,000. The bank will loan you $100,000 to buy it and up to $80,000 to rehab it for a total of $180,000 or 90% of the rehabbed appraisal. It's a 30 year fixed loan at current market rates depending on your credit score.
