How To Buy a Foreclosure

Foreclosures are everywhere. And real bargains can be found.But you better know what you?re doing. Understanding the bidding process is critical. Working with an experienced foreclosure agent is also critical. This is very different world than buying from a normal seller. 

           What?s the difference between a foreclosure and an REO? 

A foreclosure and an REO are the same thing. But REO (Real Estate Owned) 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 is 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 into foreclosure?. And the foreclosure process costs the lender money, in addition to the fact the home will be probably suffer some damage while it sits vacant between the time the owners leave and the bank secures the home. As a result, sometimes lenders will accept the offer, but 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  (the mortgage) 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, replace the bank as the homeowner?s lender and continue the foreclosure process. 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. As a result, the lender may offer them ?cash for keys?. That means they offer them a certain amount of money to move out before the redemption period is up so they can accelerate the process and get it on the market sooner.

If the homeowner decides to stay during the entire redemption period, and they wish to protect their credit from the damage of a foreclosure, they can redeem in one of two ways; either pay off the note and all extra fees. Or sell the home and pay off the note. This is known as 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 or removed in another way in order to close. Most often these will be some form of home equity loan or home equity line of credit. But there could be others. 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 an REO

 If the homeowner does not redeem through a pay-off to remain in the home or a sell 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. A common misconception is that banks sell their own foreclosures (REO?s). They used to. They don?t anymore. The bank will turn over the property to an Asset Liquidation Company to sell. Even government properties such as HUD and VA are sold by third party Asset Liquidation Companies.

Several things will happen now. The owners must leave, and the bank will assign the home to the Asset Liquidation Company (which is often out of state) to sell. In turn, that company will contract with a Property Management Company to change the locks and winterize it. The Property Management Company (which is also often out of state) will hire a local contractor to do the job. If the home was previously on the market, the Asset Liquidation Company will ask the current listing agent to pull the home off the market and give up the listing. Then they?ll give it to an REO agent they contract with in that region. While these REO agents are in the state, they?re often in other cities far away from the property.

 I Saw A Home With Knee High Weeds and Stickers on the Windows. I Want to Get Into It And Take A Look. I called the Number on the Sticker, but No One Will Help Me.  

Doesn?t The Bank Want To Sell This?

Between the time the redemption period runs out, the owners leave and the Asset Liquidation Company takes over, assigns an REO agent and a Property Management Company, the home will often sit vacant with the grass growing and utilities off for several months and as a result, could suffer damage, and many often do. These are the homes you see with the knee high weeds and stickers on the window. These properties are in that ? REO Netherworld? between the redemption period running out and finally getting back on the market as an REO.

If you are interested in such a property and you attempt to call the previous listing agent, (whose sign may still be there), or even the bank itself, they will tell you to go away until it?s re-listed. Gone are the days when you could buy such a home from the bank itself. REO?s are no longer sold by the banks. Most all banks and even government agencies turn over all their REO?s to third party Asset Liquidation Companies to sell. The time frame for the bank to assign it to the Asset Liquidation Company who will get the new REO agent to take over the listing and contract with a Property Management Company to go over to there to secure it and winterize it varies widely from a few days to a few months.

 As a result, the property is much more likely to be vacant and unsecured for a longer period and thus could suffer significant damage due to vandalism and the fact the utilities are off.  For example, 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. Vandals and thieves will often target copper pipes, electrical components, kitchen cabinets, light fixtures and anything else of value.

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. 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 supersede 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 usually done by the seller.  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 for you. If you?re paying cash it will be up to you to get the title search done. There are two title insurance policies issued for every residential real estate transaction. The buyer traditionally pays for the policy that covers the buyers lender for the amount of the mortgage. (If it?s a cash transaction that policy isn?t necessary). The seller traditionally pays for the owners policy which is given to the buyer when the deed is recorded. But this is not a traditional type of sale. The foreclosing party may require that you pay for both title policies. The bottom line?.do not close without a title search, clear title 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?

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 put warning language everywhere possible to cover themselves in case mold or other harmful toxins are found in the inspection. 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 for you, 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 be made within 30 days of close. Traditional mortgages will only be available for homes that are in fairly decent shape. If the home requires significant repairs, only a ?rehab? loan will work. Every lender has a different definition of ?significant repairs?. Suffice it to say, some sort of loan can be found for every foreclosure.

              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 most auctions, 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, you may 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 most auctions, 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 usually 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? What is A Buyers Agent?

How Do I Write The Offer? 

Your Buyers Agent will guide you through this process.  (To secure the services of a Buyers Agent see above). 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 Agent Purchase Agreement. However, in the case of auction properties, 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. Other auctions may allow you the option to make an offer yourself or use your Buyers Agent.

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 closing 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.  As I said before, this is not ?normal? seller.

After your offer is accepted, 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 KIND OF PRICE SHOULD I OFFER?

How Much Below List Will the Bank Go?

When it comes to making an offer on a foreclosure, understanding how the bank functions is critical. Lenders have had their little ?Come to Jesus? moment and are realistic about the market. As a result, they will list the home at much less than was owed on the mortgage. The first thing I check on a listing is what was owed on the note when it went back to the bank and compare it to the list price. Ideally, I like to see them take about a 50% hit.

After your Buyers Agent submits your offer, the Listing Agent does not present the offer to the seller like a normal Listing Agent would. In these transactions REO agents (that stands for Real Estate Owned, the term the banks use for properties that have gone completely back to the bank) are not functioning as a ?normal? type of agent would in the traditional sense. They are licensed Michigan Realtors or Brokers of course, but this is not a ?normal? transaction. In some cases they may be in another city or county far away from the listing itself and, especially if they have a team, they may never have seen the property themselves. They do not negotiate with you, your Buyers Agent or the bank. The offer comes into them from the Buyers Agent and they email or fax it to the seller, and that?s it. When the reply comes back, they fax or email it back to the Buyers Agent.

AREN?T WE DEALING DIRECTLY WITH THE BANK?

Banks don?t sell their own properties, not even HUD sells their own properties. In virtually all cases they farm them out to third party Asset Liquidation Companies to dispose of them and represent the bank in the sale. And that?s where the REO agent is sending your offer.

 These Asset Liquidation Companies are usually in another state, and the asset manager assigned to the property could very well be handling upwards of 50 properties from many different banks. Suffice it to say, he or she doesn?t want to do any more work than they have to. They do not chat on the phone with the REO agent or anyone else if they can possibly avoid it. It?s all by fax and email. Each bank has their own formula and criteria for the ?reserve price? they will take for the property. It?s the Asset Liquidation Managers job to follow the banks instructions for the timing of price reductions and what percentage of the list price they will accept. On average that can range anywhere from 85% to 99% of list, depending on the property, the bank, and how long it?s been on the market.

HOW DID THEY ARRIVE AT THE LIST PRICE? 

The list price of the property has been determined by as many as 3 BPO?s (Broker Price Opinion, that?s a realtor appraisal) and in adition to that, possibly one regular appraisal. The condition of the property will already have been taken into account when they prepare these opinions. So justifying a low ball offer by pointing out to the bank that there is water in the basement and the kitchen cabinets, carpet etc. need replacing, will not help you at all. They know that, and have already taken it into consideration when arriving at a list price. Everyhting the agent or appraiser could see when they evaluated the property is used to arrive at the list price. However, if a big issue the appraiser could not see, such as the condition of the septic or well, comes up in the inspection, you may revise your offer price to reflect that repair, or you can just cancel the deal and walk away. (Please See ?Buying A Foreclosure? for exceptions to that rule). Keep in mind, if you ask for concessions for repairs or revise your offer, the bank reserves the right to return your earnest money and cancel the deal, just like any other seller.

The Asset Liquidation Manager will usually take an average of those 3 price opinions to determine list price. They may also ask the Realtors and appraiser for what could be called a ?timeline price?. In other words; what will it take to sell it in 30 days? 60 days? 90 days? The 30 day price will be usually be what we refer to as the ?wholesale price? which is around 40%-50% below appraisal. Then the Asset Manager decides which price to list it at. If they really want to get rid of it fast they?ll go with the 30 day price. If they want to test the waters to see if they can get more they?ll start at the 90 day price. Every 30-60 days, if it doesn?t sell, they?ll reduce the price, just like a consignment shop. The percentage of the reductions can range from 3% to 10% depending on the bank, the Asset Manager, the property and the market.

HOW LOW WILL THEY GO? 

When making an offer timing also plays into it. If it just listed, they'll stick very close to full price. If it?s getting close to a price reduction, they?ll take less. If they just did a price reduction, they?ll stick pretty close to it. When it gets to be around the 20th of the month they?ll accept a lower offer if you can close by the 30^th. If it?s close to the end of a quarter they?re more apt to take a lower price. But by lower price I don?t mean 50% less. They will stick pretty close to the 85% - 99% average. The strength of the buyer also plays into it. A cash offer will trump the same offer by another bidder that requires financing. That?s because they know the cash offer is more solid than financing and can close faster. FHA financing will usually trump USDA financing on offers that are the same because USDA occasionally runs out of funding and has to wait for congress to appropriate more, thus holding up closing. An offer with 20% down will trump an offer with little or no money down because they consider that buyer that is less likely to lose their financing when it goes to underwriting. If there are multiple offers on a property, (which has been happening a lot lately), you?ll probably have to go over the list price to get it and you still may not be the winning bid.

 Lately I?ve noticed a trend in pricing strategy on some properties. Occasionally, after a property has been on the market a while, say 90 days or more, the asset manager will slash the price way below market. This results in buyers who looked at it previously taking notice and coming back with multiple offers which causes a bidding war, which drives the price right back up to where it was when it was previously listed.

Understanding the pricing strategy of the various sellers is critical to insure you don?t waste your time putting in offers that will never be accepted. Retaining the services of a qualified Buyers Agent who understands this procedure is critical to your success.

                                                What is EMD 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. Your 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! Just another reason to be represented by a Buyers Agent. This is not a transaction you want to go into without representation.

                              What Else Do I Need To Make An Offer?

                                                       Financing Options Available

 Most conventional financing and FHA can be used to buy foreclosures. ?No money down? loans from private lenders are gone now due to the meltdown in the mortgage industry. However they?re still available through the USDA Rural development Program (see below). 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, inspectors and the buyer 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. 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. One of my favorites is the following loan program.

The USDA Rural Development Loan

The answer to this one:

 ?OK?I put in an offer on a foreclosure for $115,000. The inspection revealed $15,000 worth of work will be needed to get the home in good condition. As a result, I revised my offer to the bank to $100,000 and they accepted it.

Now where do I get the $15,000 I need to rehab the property?

I have no money for a down payment or closing costs either. Help!?

 This government loan program is a ?guaranteed loan? program like FHA, but it?s better. It will provide you with an additional amount for rehab costs folded into the mortgage to buy the home. Like FHA, the loan is obtained from a commercial lender, not the USDA directly, 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. (Note: Recently they have adjusted their criteria with regard to allowable repairs, certain major repairs no longer qualify, so check with your lender first.)

 The home is appraised in its 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 up to 6% 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 $15,000 in repairs. You also need $5,000 for closing costs for a total loan amount of $120,000. The home appraises at $120,000 in it?s rehabbed condition. Therefore USDA will give you a loan for $120,000.

The terms are a 30 year fixed rate at current market interest, depending on your credit score. 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. In this area, all of Livingston County qualifies, and certain parts of Washtenaw, Oakland, Ingham and Genesee as well. Check out the USDA maps on their website to see if your area qualifies.

Don't Qualify for USDA Rural Development Loan?

There are Others That Work

 If you don't qualify for the USDA loan because your income is above the threshold, the home requires major repairs such as new well or septic, or it's not in a location that USDA considers "rural", there's other rehab loans that also work very well. FHA 203K is a rehab loan that will work for homes in need of major repairs.There is no limit on income and no limit on the amount of money they will fold into the mortgage for rehab purposes up tp the value of the home in its rehabbed condition. And no location requirements either. It works like this; the home is appraised in it's rehabbed condition. FHA will fold in the amount you need to rehab it and buy it in one mortgage. Example; a home appraises for $200,000 in rehabbed condition and it needs $35,000 in repairs. You can buy it in it's present condition for $100,000. FHA will loan you $100,000 to buy it and up to $35,000 to rehab it for a total of $135,000. You can fold in up to 6% of the purchase price to cover your closing costs as well. FHA requires 3.5% down.