According to the Mortgage Banker’s Association, one in every 200 homes winds up in foreclosure, with as many as 250,000 new homeowners entering foreclosure each quarter. Tough economic times typically see increases in the number of foreclosures on single family homes. Part of the increase is due how many homeowners already straddle the line between economic viability and financial ruin.
Numerous studies and surveys of average Americans bring to light some shocking statistics regarding the financial health of the average family. More than half live paycheck to paycheck, with almost as many having less than three month’s worth of bill money saved. In fact, almost half of all Americans have less than $5,000 in cash, retirement savings or other liquid assets. With so many struggling to stay afloat financially, it is understandable that a tough economy brings on more foreclosures.
Distressed Properties 101
Before jumping headlong into buying foreclosed real estate, buyers should understand some key terms. Reading real estate listings, watching commercials on television, or otherwise hearing about the benefits of buying foreclosed homes often leads buyers to get ahead of themselves. Without understanding the different types of distressed properties, buyers can easily pay far more for a property than they would otherwise.
The three most common terms used regarding distressed properties are short sale, foreclosure auction and Real Estate Owned (REO). Many new buyers mistakenly associate all three as meaning the same or similar things. In fact, each is very different and can have tremendous impact on the purchase price of a home.
A short sale is a home offered for sale by the owner, typically for less than what is owed. Acceptance of a bid depends on the bank agreeing to the sale, usually in an effort to save on the cost of foreclosure proceedings. A foreclosure auction is the first step banks take to recuperate the balance owed on a mortgaged property.
REOs are homes which have already reverted to the lender, typically after a failed foreclosure auction. While not always the case, an REO is typically cheaper than a short sale or foreclosure auction. Most often, the bank lists opening bids at a foreclosure auction based on the balance owed on the mortgage. If a home has little equity, that typically translates to a high initial bid at auction. Experienced realtors, investors and other bidders know that waiting until the house becomes an REO usually results in a lower price.
The Bidding Process
Making an offer, known as placing a bid, varies from lender to lender. State laws may also dictate how the bidding process works. Some sellers, such as HUD and Fannie Mae, limit who is allowed to bid and when. For example, Fannie Mae offers a First Look program, a period of time in which only those buyers who plan to live in the home are allowed to place bids.
While the bidding process might vary, it typically follows a similar pattern, depending on if the property is offered via a foreclosure auction or as an REO. Typically, foreclosure auctions are operated according to state law. A third party trustee is named and bids are made through the trustee. Depending on the state, each bidder may have to present either a cashier’s check for the full bid or a percentage of the total bid. In this case, the buyer typically sets the bid amount, although some auctions may list a minimum opening bid.
Most often, bids are submitted during an open period, where sealed bids are collected for a specific period of time and opened on a set date. The highest, most qualified bidder, if the bid amount meets the bank’s terms, wins. In some states, foreclosure auctions operate more like traditional auctions, with buyers increasing their bids in an attempt to become the highest bidder. If the home is not sold at the foreclosure auction, it becomes an REO. The lender then becomes the owner and decides how to accept bids or offers to purchase.
Buying an REO
Once a property becomes an REO, potential buyers must follow the lender’s guidelines for making an offer. Some sellers, such as Fannie Mae and HUD, only allow certified realtors to make offers on behalf of their clients. Other sellers leave it to the buyer to decide if they want a realtor or a real estate attorney involved. With REOs, the bank determines the selling price, usually based on market value. In some cases, the bank will set the price lower than market value, in an attempt to attract multiple buyers.
To prevent overpaying for a foreclosed home, buyers should understand the home’s appraised value before engaging in any bidding war. Likewise, if an appraisal is needed, buyers should understand the process can take months. Contacting the appropriate parties early is crucial to speeding up the process from offer to closing.
Tips for Finding and Buying
Buyers have numerous avenues for finding foreclosed properties available for purchase. Realtors and some real estate attorneys have access to listings, such as those listed in the HUD Home Store. Private buyers can contact individual lenders to inquire about available properties. Most lenders have entire departments devoted to handling foreclosure properties. This is typically the same department with whom buyers must consult about appraisals.
Before placing a bid or making an offer, buyers should keep the following points in mind:
- Set a reasonable bid limit
- Foreclosures are not always a bargain
- Homes are sold as-is, including damage, faulty systems, and other encumbrances
In many instances, buyers have the burden of educating themselves on buying foreclosed real estate. While some trustees and banks will offer details on their procedures, that is only part of the equation. To truly understand the process, buyers should observe an auction or employ the services of a realtor or real estate attorney.