Everything you Need to Know to Buy a Property in Foreclosure
So, you've come to the conclusion that you can save thousands by buying a "foreclosure". Maybe you've even been down the short sale road and waited months for a property that never received short sale approval. Or worse yet, the deal was approved but meanwhile the prices dropped so much that that "steal" just wasn't a deal anymore. Or maybe you made an offer on a bank owned foreclosure (REO) and ran for the hills when you saw the bank "addendum" or were one of the few who braved the court house steps to try to buy an auction property.
It's important to understand the foreclosure process and the various stages at which you can buy and under what terms. Here's our guide on how to buy a property - condo, townhouse, or single family home in one of the three stages of the foreclosure process.
SHORT SALES
These transactions should more appropriately be called short pays rather than short sales. As far as time is concerned, they are anything but short. And, as one of our clients very accurately stated, there are "a lot of moving parts".
As you probably know, a short sale happens when the investor (the party that holds the note or notes secured by the property) agrees to a payoff amount for less than the seller (homeowner) owes. Here's an example. The homeowner purchased the property for $600,000 five years ago with no money down and an interest only loan. After making payments for all this time they still owe $600K but the home is only worth $480,000. Their agent lists the home for $450,000 in order to get offers and start the short sale process which in most instances (the exception being a "HAFA" short sale), the short sale process can not start until the seller receives an offer. Once an offer is received, the agent will prepare a short sale package for submission to the servicer (bank). The servicer may or more likely may not actually hold the note. So, initially the agent and seller are negotiating with a party that can only say no but can not approve the short sale. Once the servicer does grant approval, the short sale package is then submitted to the investor who may or may not approve the short sale terms and conditions.
A common misconception among buyers is that they are negotiating with the bank. While ultimately they may receive a counter from the bank months later, in the initial phase, they are negotiating solely with the homeowner-seller. Until title changes hands through either sale or foreclosure, the seller still controls the property. A frequent question we get is "why to sellers care what the sales price is - they don't get any money anyway?". While it is certainly true that the seller isn't walking away with any proceeds (unless they are receiving money to relocate from the HAFA program), the seller still wants to submit the strongest offer possible so that the bank and investor accept it.
Other than the price, many short sales fall apart because the seller just doesn't qualify or doesn't supply the required documents to receive short sale approval. The seller has to actually have a hardship such as a death in the family, divorce, job loss, medical problems, etc AND not have the assets (hidden or otherwise) to make up the deficiency between the sale price and the amount owed. In other words, you can't sell your home short and be sitting on a ton of money in 401Ks, mutual funds, or your checking account. If you need to do a short sale, work with an agent who has experiencing representing short sellers and find out if that agent uses a negotiator or how they handle the file.
If you are a buyer, ask your agent how many loans are outstanding on the property and if a NOD has been filed, try to get a feel for or an exact number of the "payoff" or default judgment. That would be the loans, plus delinquencies plus property taxes owed and if it is a condo or townhouse, the delinquent HOA dues as well. Your agent should also be able to look at other comps in the area and give you an idea of what the property will sell for. If there is a huge discrepancy between the listed price, comps, and amounts owed, you know that one will never get approved.
While there are more short sales being approved today than when the housing crisis started, this is till a long and stressful process for all involved. Our advice to buyers considering buying a short sale listing is that if this is really the home you want and you are willing to wait for 3-6 months, go for it. Otherwise, move on.
AUCTIONS
As part of the foreclosure process, the holder of the note (the "investor") will authorize a trustee sale which is held on the courthouse steps. These auctions are different than the auctions you see advertised on TV. The TV auctions are held by companies in the business of acquiring pools of properties from the banks and investors specifically for resale. The auction we are referring to as part of the foreclosure process is a different beast entirely.
The auction on the courthouse steps is an all cash transaction with (usually) no inspection, no title insurance, and typically subject to various liens. If that is not enough, the buyer may well have to evict the former owner or current tenants. To further complicate matters the tenants may or may not have a bona fide lease and/or may be protected by other local ordinances.
When we refer to "all cash" that doesn't literally mean US dollars but means certified funds. Typically, you will find bidders with bank checks in various denominations that add up to the purchase price.
Here's something else you need to know: auction doesn't equal bargain. Here's why.
The opening bid is often the default judgment obtained against by senior note holder and that may or may not be a good price. Quite often, considering the risks and hassles associated with buying at auction, the auction property is far from a good deal. Very far.
Let's look at an example. The foreclosed homeowner bought a property for $600,000 at the height of the market with no money down and a negative amortization loan (neg am - also called option arm). There was a first and second mortgage, the first is for $480,000 (80% of $600,000).
At the time of auction, the homeowner was a year behind in the payments. That, plus the negative amortization has resulted in a default judgment of $535,000. As home values in the area have gone down 25% making the property only worth about $450,000 the opening bid of $535K is actually higher than fair market value (FMV). What may happen is that the investor instructs the trustee to "underbid" meaning to offer for less than what is owed just to get rid of the property. But, that is rare.
So, finding a great deal at auction is not that easy and you may still have the other problems (eviction, title insurance, property defects) we mentioned. Our advice: there may be deals on the courthouse steps but this is not the optimal way to acquire your primary residence. Definitely not a transaction for the feint of heart. Sorry.
REOs
You may have heard the term REO which refers to "Real Estate Owned" by the bank. More commonly referred to as a foreclosure or bank owned property. This is really what you are looking for. Here's why.
By the time the bank has listed the REO with a Real Estate Broker, in most cases the occupant (former owner or tenant) has been evicted, the title issues and liens have been addressed and will be cleared before close of escrow, and the asset manager - the person at the bank or management company - can make a decision and respond to your offer in a reasonable time frame (unlike a short sale). Also, unlike an auction you have the ability to view and inspect the property beforehand.
