Most everyone is aware of the recent downward turn in the Southern California real estate market. This trend has left the current real estate market with a large inventory of properties at reduced prices from just a few years ago. In addition to "traditional" listings, many of today's properties listed for sale include bank-owned (REO or Real Estate Owned), HUD (Department of Housing and Urban Developement) homes and pre-foreclosure or short sale properties.
As a home buyer, it's good to know the differences between the the different types of properties available for sale on the real estate market so you can make an informed decision as to which type of property is best suited for you.
STANDARD PROPERTIES
Standard properties are defined as properties sold by owners who have built up equity over their years of ownership. Some of the reasons these types of properties are listed for sale include relocation, changes in marital status, upsizing to a larger property, and downsizing to a smaller property.
DISTRESSED PROPERTIES
I think a better description for this would be Distressed Property Owners; afterall, it's not the property that's distressed, it's the property owner who is distressed. Bank owned properties - also called REO's (Real Estate Owned) - HUD homes and pre-foreclosure properties (also known as short sales) are commonly referred to as distressed properties.
To give you some background on why there has been such an influx of so many distressed properties in today's real estate market, you only have to look as far as the subprime loan industry meltdown.
Subprime lending (near-prime, non-prime, or second chance lending) is a financial term that was popularized by the media during the "credit crunch" of 2007. Subprime lending involves financial institutions lending in ways which do not meet "prime" standards to an extent which puts the loans into the riskiest category of consumer loans typically sold in the secondary market.
These standards refer to the size of the loan, "traditional" or "nontraditional" structure of the loan, borrower credit rating, ratio of borrower debt to income or assets, ratio of loan to value or collateral, documentation provided on those loans which do not meet Fannie Mae or Freddit Mac underwriting guidelines for prime mortgages (are "non-conforming"). Although there is no single, standard definition, subprime loans are usually classified as those where the borrower has a FICO score below 640. Subprime lending encompasses a variety of credit types, including mortgages, auto loans, and credit cards.
Subprime borrowers show data on their credit reports associated with higher default rates, including limited debt experience, excessive debt, a history of missed payments, failures to pay debts, and recorded bankruptcies and judgements.
People who were not otherwise able to afford to purchase a home, who did not have enough money for a down payment, who did not have the income to make a large monthly house payment, used "stated" - undocumented - income and/or had questionable credit were often offered "creative" financing terms from lenders eager to lend money.
The main vehicle used in this creative financing sub-prime ploy were adjustable-rate mortgages, also known as ARM's. Adjustable rate mortgages were often offered to home buyers who couldn't afford the payments of a fixed rate loan; home buyers who otherwise wouldn't be able to afford to purchase a home. Lenders typically set up borrowers with an ARM that had initial low “teaser” interest rates; when the ARM - ususally with a one, two or five year term - matures, the monthly payments skyrocket. Home owners found themselves facing increased mortgage payments that jump hundreds - and in some cases even thousands - of dollars a month.
As an example, let's say a homeowner takes out a $200,000 ARM. The initial a teaser rate is 4 percent, giving the homeowner an initial monthly payment of $954.83 in principal and interest. When the ARM matures, the interest rate jumps to 7 percent, say, in the second year of the mortgage, the monthly payments increase to $1,320.59 a month — a move that gives home owners what regulators call “payment shock.” Change that ARM figure from $200,000 to $300,000, $400,000 or more, and you can see how quickly payments can get unmanageable.
So why would you want to look into purchasing a distressed property? The number one reason is simple - these types of properties have the potential to offer you more value for your money.
BANK OWNED/REO PROPERTIES
Bank owned properties, sometimes called REO or “Real Estate Owned”, are properties that have gone through foreclosure and are now owned by the bank or mortgage company that was the lienholder on the orignial note or loan. The process for buying a bank owned property is not the same as buying a property at a foreclosure sale at the steps of the county courthouse.
When buying a property during a foreclosure sale, you must pay at least the loan balance plus any interest and other fees accumulated during the foreclosure process. You must also be prepared to pay with cash in hand. And on top of all that, you’ll receive the property 100% “as is”. That could include existing liens and even current occupants that need to be evicted. This is why many homes sold at foreclosure sales are purchased by the bank or lender that originally financed the home.
A REO, by contrast, is a much “cleaner” and attractive property. The REO property did not find a buyer during foreclosure auction. The bank bought it back and now owns it. The bank will see to the removal of tax liens, evict occupants if needed and generally prepare for the issuance of a title insurance policy to the buyer at closing. Do be aware that REO’s may be exempt from normal disclosure requirements. In California, for example, banks are exempt from giving a Transfer Disclosure Statement for REO properties. A TDS is a document that normally requires sellers to tell you about any defects they are aware of; in other words, just like the properties sold at the forecloser sale, the REO property is sold "as is".
Most buyers assume that any REO property must be a bargain and purchasing one is an opportunity for easy money. This simply isn’t true. You have to be very careful about buying a REO if your intent is to make money off of it. While it’s true that the banks are typically anxious to sell REO's quickly, they are also strongly motivated to get as much as they can for it. When considering the value of a REO, you need to look closely at comparable sales in the neighborhood and be sure to take into account the time and cost of any repairs or remodeling needed to prepare the house for resale. The bargains with money-making potential exist, and many people do very well buying foreclosures. But there are also some REO’s that are not good buys and not likely to turn a profit. This is where you have to do your homework to make sure the property you are interested in fits your needs. This is where your Realtor can be of great value to you.
FORECLOSED PROPERTIES
When a property owner is no longer able to make their mortgage payments and defaults on the loan, the property goes through a process know as foreclosure. Foreclosure is the process of the lien holder (the bank, lender, etc.) initiating it's legal right to take back the property when the property owner defaults on the loan.
When this occurs, the lender initiates the sale of the property by auction through a third party; called a trustee. The trustee is required to advertise a notice of default of the property in the newspaper for four continous weeks; take a look in the classified section of your local newspaper and you'll see a list of foreclosed properties for your area. The owner of the property has until five days before the scheduled date of the auction to pay all monies owed; if the owner of the property can't come up the money within the alloted time period, the trustee conducts an auction for the property on the steps off a courthouse located in the county where the property is located.
As previously stated, when buying a property during a foreclosure sale, you must pay at least the loan balance plus any interest and other fees accumulated during the foreclosure process. You must also be prepared to pay with cash in hand. And on top of all that, you’ll receive the property 100% “as is”. That could include existing liens and even current occupants that need to be evicted. Foreclosure auctions are particularly attractive to all-cash buyers and investors who are familiar with the process and are looking to get the most value for their investment dollar.
HUD HOMES
A HUD home is a property that was financed with an Federal Housing Authority (FHA)-insured mortgage where the owner has defaulted on the loan. Two FHA divisions you are probably familiar with are Fannie Mae and Freddie Mac. The lender forecloses on the home, FHA pays the lender what is owed and the lender transfers ownership of the home to FHA/HUD. In turn, HUD then sells it at market value. As with REO's and foreclosed propeties, HUD homes are sold "as-is"; however, there are a couple of notable differences in the purchasing process when compared to purchasing a foreclosed property.
First, a HUD home can be purchased with cash or you can obtain financing; one benefit that's not available when purchasing a property at a foreclosure auction. Secondly, rather than holding a live auction, the purchasing process is conducting by submitting a bid to the agency holding the property. You could be the only one bidding on a particular property, or there could be numerous bids placed; you just never know. When I purchased my home (a HUD home) back in 1997, I was the only one who submitted a bid on it.
Most HUD Homes are initially offered on a priority basis to owner-occupant purchasers (people who are buying the home as their primary residence). Following the priority period, unsold properties are then made available to all buyers, including investors.
SHORT SALE or PREFORECLOSURE PROPERTY
Pre-Foreclosure property is a property being sold by owners who are heading towards having their property foreclosed. Owners realize they can no longer afford the monthly payment and they try to sell the property before they default on the loan and the lender initiates the foreclosure process on the property. The term "short sale" means that the amount the owner has listed the property short - for less than the amount owed on the loan. Listing prices for short sale properties are the reflection of the current market value of comparable properties in the properties in the immediate area.
As an example, let's say someone purchased a home a few years ago for $480,000 in the middle of the hot real estate market. The home was purchased with an ARM; the ARM matures after two years and their payment jumps $1,000 a month. In the meantime, the real estate market cools down, driving down prices of homes in the area. The owner is no longer able to make the new house payment and decides to put the home up for sale.
After contacting his Realtor to perform a Competitive Market Analysis (CMA) on the home, the owner is told that based on comparable sales, his property is now valued at $399,000. The owner is now upside down, owing more on the home than it's worth, and has to sell it at the lower value of $399,000.
The short sale process is similar to the "normal" purchase of a property, only all offers are submitted directly to the lender. Just as any other property owner, the lender has the authority to approve, deny or counter offers that have been submitted.
Buying a pre-foreclosure/short sale property is best suited to those who don't have to move right away, as the process of purchasing this type of property tends to take significantly longer than purchasing traditional and REO property listings.
