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REO Foreclosure: Understanding Real Estate Owned Foreclosure

REO, or real estate owned, properties can be a great investment. The value of REO foreclosures makes these properties attractive opportunities. However, there are some risks you should know about before purchasing an REO property.

Don’t let the risks of bank-owned properties dissuade you from considering the REO process. The word foreclosure can intimidate potential buyers, but it doesn’t need to. REO properties just require a different negotiation process, and if you take the time to learn about these properties, you’ll find yourself a great deal.

What Is Real Estate Owned (REO)?

Real estate owned (REO) refers to property that is owned by a bank or a lender, like Fannie Mae and Freddie Mac. The property has also not been sold at a foreclosure auction. The bank or lender becomes the foreclosure owner if the property does not sell for enough money to cover the remaining balance of the loan.

When a Foreclosure Property Becomes an REO

For a foreclosure property to become an REO, one of three things must happen.

  • A borrower misses payments and defaults on the mortgage.
  • Pre-foreclosure short sales or public auctions take place.
  • A foreclosure becomes property of a bank or a lender.

Sometimes, banks will sell REO properties. Check out your bank's website and look for their portfolio of REO properties to see the extent of their experience. Additionally, clients who are in the market for a home and are working with a bank can seek out information from the bank's loan department regarding that specific bank's REO inventory.

REO Specialists

If a bank or a lender has an extensive or complicated REO portfolio, they will likely have an REO specialist. A bank's REO specialist manages the REO properties by fulfilling the following needs:

  • Finding deeds
  • Marketing
  • Managing reports
  • Reviewing offers
  • Securing the properties

An REO specialist will keep the properties in great condition and ready to sell. The bank benefits from having a supply of properties to match with customers after they’ve secured a loan.

Where to Find REO Properties

To find an REO property, check with your bank's REO specialist. Their main job is to make the property accessible and well known to homebuyers like you. As a result, the REO specialist will negotiate with local real estate agents and have the bank's REO inventory listed in multiple listing services (MLS).

Being in the MLS makes it easy for real estate websites to find and list REO properties, especially for the following sites:

  • Local real estate agents
  • Zillow
  • Realtor.com
  • Trulia

Real estate agents work with REO specialists to sell the property. The agents work on moving the properties, and they also receive a commission for selling REO properties on behalf of banks or lenders.

REO vs. Foreclosure: Which Is Better?

There are pros and cons of buying both REO properties and foreclosed properties. But in general, REO properties are the safer investment. Let’s take a closer look at the benefits and drawbacks of each!

PROS

REO 

FORECLOSURE

  1. Cost
  2. No tax or title liens
  3. Good ROI
  1. Cost
  2. Quick transactions
  3. Less competition 

 

Pros of an REO Property

Cost

REO properties cost less because banks don't want to maintain ownership over dead assets. When an REO property becomes part of the bank's portfolio, the bank becomes a motivated seller. As a homebuyer, you will benefit from the bank's eagerness to get rid of the asset.

Out of convenience, banks will sell REO properties for a major discount. You may find properties that are selling for far below market value. Consequently, intelligent homebuyers, or investors, who are limited by capital can get a great deal on discounted REO properties.

No Tax or Title Liens

One of the challenges of investing in real estate is the question of ownership. From time to time, questions about the legal owner of a property can plague the entire buying process. Unpaid taxes and title liens could prevent you from legally owning the property.

REO properties do not come with tax or title liens. As soon as property becomes real estate owned, the bank will cover any and all liens against the real estate. In most cases, the bank will pay the property’s outstanding taxes. The bank that seizes the property will answer the question of ownership, and from there, the bank will work on selling the property.

Good ROI

Investors benefit greatly from investing in REO properties. For example, an investor can buy the property and convert it into a rental property. The new rental will generate rents and cash flow for the investor. When it comes time to divest ownership, your property will have appreciated, meaning you can sell it for a generous lump sum.

In the event that you are a house flipper, REO properties are a great opportunity for you to make quick money. The cost of buying, remodeling, and relisting the home for sale means you can purchase the property for a cheap price and sell it later on for market price.

Pros of a Foreclosed Property

Cost

Foreclosed properties sell below market value.

Quick Transactions

Instead of spending weeks or months on end negotiating with the property owner, the process is much faster with foreclosed properties. You can make an offer and close on a foreclosed property very quickly.

Less Competition

The cash-only aspect of foreclosed properties can be a barrier for some buyers. Auctions require cash bids, and this restriction lowers the pool of potential buyers, making competition a lot lower.

CONS

REO 

FORECLOSURE

  1. Competition 
  2. Associated risks
  1. Cash required
  2. Associated risks

 

Cons of an REO Property

Competition

REO properties sound like a good deal, which are attractive to a lot of people! Many investors and other homebuyers understand that REO properties are good investment opportunities because they are a solid way to make money from real estate.

As such, real estate investors and homebuyers should expect to go against several other offers and competitors. It’s best to work with an experienced REO real estate agent to create an offer that stands out from the competition.

Associated Risks

Banks sell REO properties as is, meaning the property is a risk because the bank will not pay for any repairs. The repair risk does not affect investors who plan to flip the REO property, but an investor seeking to turn the REO property into a rental might need to pay for substantial repairs before moving in tenants.

Property investors or homebuyers can have REO properties inspected before signing any contracts. If the home does not meet an investor’s requirements, then the investor can walk away from the deal. But paying for repairs is not as bad as it seems because those costs should be viewed as investments into a property that will eventually appreciate.

Cons of a Foreclosed Property

Cash-Only Sales

Auctions accept cash-only offers.

Associated Risks

Home inspections are not allowed. The bank won’t offer any property history or assessment of conditions either. As the owner, you’ll be responsible for researching the title and paying back any existing taxes or liens.

Things To Consider When Buying An REO Home

Banks dislike having REO properties in their inventory and cash is a much better payment option in their eyes. The bank's enthusiasm to unload the property results in REO listings that are at or below market value. The attractive price will attract more buyers, too.

Consider Hiring a Buyer’s Agent

Inexperienced buyers may find it stressful and time-consuming to purchase an REO property. As such, it might be worthwhile to hire a buyer's agent who can negotiate with the bank on your behalf.

Remember these tips when searching for a buyer’s agent:

  • Buyer’s agents have a fiduciary duty to you so they must act in a way that benefits you.
  • The seller pays the buyer’s agent, so you won’t have to incur that cost.
  • Ensure that your agent has experience dealing with REO properties.

Get an Appraisal and an Inspection

An appraisal is an objective, independent assessment of the property's worth. When buying a home, a review is critical because banks will refuse to lend money if the appraisal value is less than the selling price.

REO properties are sold as is, meaning that you’ll oversee and pay for repairs. Unlike foreclosures, REO properties allow for a home inspection. An inspection is a vital step in the REO process.

A professional inspector will locate any issues and provide a general idea of how much you will need to spend on repairs. An inspection can reveal a lot of information, like whether or not the anticipated maintenance or repairs are out of your budget.

Do a Title Search

When buying an REO property, you will probably obtain a quitclaim deed instead of a warranty deed. A quitclaim deed does not guarantee that a title is free from liens. Fortunately, liens are public records, meaning you can discover them on your own accord.

That's why it’s important to conduct a title search when buying an REO property. The title search will scan the property's public records and let you know who the legal owner is. The title search will also reveal any claims or liens on the property.

You should conduct a title search because you’ll be able to locate any unpaid debts that will come with the property. These debts may include unpaid taxes, HOA fees, or outstanding home improvement bills. If you overlook the importance of a title search and purchase the property without checking for existing debt, you’ll inherit the debt along with the property.

Decide Whether to Buy an Owner’s Title Policy

If your title search overlooked outstanding liens or unpaid taxes, it might be prudent to get an owner's title policy, which is also known as title insurance. The policy will protect you from ownership problems that happened before you bought the property or were unknown when you purchased the property. Consult with your buyer's agent to see if an owner's title policy is best for you.

Make A Strong Offer

You've found the right real estate. Now, you need to make a solid offer to the lender. Your agent will advise you on an offer that is competitive and likely to get accepted. From there, your agent will submit the offer on your behalf.

It’s important that you don’t lowball the bank. There will likely be several buyers, so the bank will reject your offer and move on to the next buyer. If your offer is successful, the bank will sign a contract, issue a quitclaim deed, and transfer ownership of the property to you.

The bank may require earnest money, which is usually anywhere from 1% to 2% of the purchase price. The funds will be held in escrow until the sale is finalized.

In Conclusion

REO properties can be a valuable option for real estate investors and homebuyers, especially those who are willing to invest in repairs. It's critical for interested buyers to research the property and discuss it with experts before agreeing to deals or making any purchases.

Are you looking to buy an REO property? Get pre-approval for a loan through your bank to make the process easier!

 

Ready to Buy an REO Foreclosed Home?

All material is presented for informational and educational purposes only and should not be construed as individual financial, investment, or legal advice or instruction. ZeroMortgage does not guarantee the quality, accuracy, completeness or timelines of the information in this publication. While efforts are made to verify the information provided, the information should not be assumed to be error free. Some information in the publication may have been provided by third parties and has not necessarily been verified by ZeroMortgage. ZeroMortgage, its affiliates, and subsidiaries do not assume any liability for the information contained herein, be it direct, indirect, consequential, special, or exemplary, or other damages whatsoever and howsoever caused, arising out of or in connection with the use of this publication or in reliance on the information, including any personal or pecuniary loss, whether the action is in contract, tort (including negligence) or other tortious action. ZeroMortgage does not provide tax advice. Please contact your tax adviser for any tax related questions.

This page last updated: April 26, 2022