"Foreclosure" is the legal process where a lender sells a property to satisfy a mortgage debt after the borrower defaults. The home is sold at a public auction at the end of the foreclosure process. Usually, the foreclosing lender is the only bidder at the sale and becomes the property's new owner.
REO properties (sometimes called "bank-owned homes") are properties the lender acquires through foreclosure. The lender then sells them, generally at a discount, because the lender is motivated to be rid of them.
But buying an REO property can be risky; they're usually sold as-is and might require extensive repairs.
The process of a property becoming REO begins when the borrower fails to make the mortgage loan payments. The lender may then foreclose. Depending on state law and the circumstances, a foreclosure is judicial or nonjudicial.
The property is sold at the end of the foreclosure process so that the lender can recoup the amount it loaned to the borrower. At the foreclosure sale, the lender makes a credit bid up to the total amount of the debt, plus foreclosure fees and costs. Any other parties must bid in cash or a cash equivalent, like a cashier's check.
In the majority of cases, the lender will be the highest—and only— bidder at the foreclosure sale.
If the lender is the winning bidder at the foreclosure sale, the property becomes "real estate owned" (REO).
Again, a real estate owned property is a bank-owned property that failed to sell to a member of the public at a foreclosure auction.
Usually, a property becomes REO through the foreclosure process. However, the term "REO" also applies to properties that a lender owns as the result of deeds in lieu of foreclosure.
Generally, by the time the property is REO, the servicer will already have a sense of the property's condition and occupancy. (The servicer orders periodic drive-by property inspections once the loan goes into default and throughout the foreclosure.)
Following the foreclosure, the loan servicer will secure the property and re-key the locks if the property is vacant. It will also make any needed emergency repairs.
But holding on to REO properties for an extended amount of time costs money: the lender must pay for upkeep, property taxes, HOA fees, etc. It's also financially risky to keep REO properties on your books because they're subject to vandalism and other forms of crime.
So, the lender will get an REO property ready for sale as quickly as possible and often list it for much less than the fair market value.
Sometimes, the servicer will hire an REO management company to facilitate the property's disposition following a foreclosure. These companies typically manage:
The servicer will evict the foreclosed homeowner if the dwelling is a single-family residence that the homeowner is still occupying. Before starting an eviction, the servicer or REO management company might offer a cash-for-keys deal to induce the foreclosed homeowner to vacate the home.
However, if the REO property is a multi-unit or investment property with tenants, the Protecting Tenants at Foreclosure Act (PTFA) applies. This federal law permits tenants to remain in the property through the end of their lease unless the purchaser from the foreclosure sale intends to occupy the property as a primary residence or the lease is terminable at will or month to month.
It also requires longer notice periods for tenants to vacate the property.
Also, some states have adopted additional notice requirements and more protections for tenants occupying foreclosed properties.
Once the property is vacant, the servicer or REO management company will develop a marketing strategy for selling the property. Usually, lenders prefer to sell a property in "as is" condition.
Suppose you make an offer to buy an REO property. In that case, it might need to be reviewed and approved by several individuals, like the asset manager and other management, before it's approved. Plus, you might get a counteroffer.
Once you and the lender settle on a price, the servicer, an asset manager, the agents involved, and/or the REO management company will oversee the closing, receipt of proceeds, and title transfer.
Buying an REO property allows you to acquire a home at a potentially low price. But some risks are also involved when purchasing an REO property.
Again, most lenders don't want to have a lot of REO properties on their books. So, they list and sell these properties at a steep discount, and buyers can often get a home for a very reasonable price.
Assuming that the homeowner wasn't underwater at the time of the foreclosure, an REO property is usually sold for less than its fair market value because the lender is mainly concerned with recovering the amount of money the borrower failed to repay.
Low prices mean you get more for your money. Because lenders don't offer mortgage loans that cover the full purchase price of a home (they require a down payment), the outstanding loan balance tends to be lower than the property's fair market value. So, the minimum amount a lender will accept for an REO property is typically less than the home's market value. This means you get more bang for your buck.
With generally lower prices, an REO property can also yield higher profits if you want to resell it after repairing, upgrading, or remodeling.
REO properties usually don't have outstanding liens or unpaid taxes. Also, a foreclosure eliminates any junior liens from the property. So, REO properties are generally lien-free. Lenders usually also pay any outstanding property taxes before the foreclosure or prior to listing an REO property for sale to ensure a fast and smooth transfer of ownership.
Still, it's always a good idea to do a title search to verify that an REO property has clear title and that property taxes are current. (A "title search" is a search of public records to ensure that all liens associated with a property have been paid.)
Unlike buying a home at a foreclosure auction, paying for a title search as part of an REO purchase is typical to ensure all outstanding liens are paid off. You should also buy an owner's title policy, which protects you if title issues arise later.
A detached negotiation process. Another benefit to buying an REO property is that because no homeowners are involved, the negotiations don't involve emotions or sentimentality. You can expect a relatively easy negotiation process because you won't deal with homeowners who have a personal attachment to the property.
REO properties are usually sold as-is, and they often need some repairs.
Why REO properties need repairs more so than other homes. People who don't have money to make mortgage payments also typically can't afford the basic upkeep of their homes. A financially-distressed homeowner might have put off doing repairs or routine maintenance—perhaps for years.
Also, when homeowners know foreclosure is inevitable, they often lose the motivation to keep the home in good repair. In addition, homeowners sometimes intentionally damage the property before losing it to a foreclosure sale. You could end up with a house that needs a lot of fixing or extensive restorations.
So, the cost of making repairs could cancel the savings you get on the purchase price. Even in a regular real estate sale, experts say you should generally expect to shell out between one and three percent of the purchase price to pay for yearly wear and tear. And a home that's gone through a foreclosure could require quite a bit more.
Pay for a home inspection to avoid unexpected surprises. To get an idea of what to expect, be sure to get a home inspection. However, while you can get an inspection before buying an REO property (different from getting one at a foreclosure auction), you'll probably have to agree to accept the property in its current condition—no matter what the inspection report says.
The lender normally won't make any major repairs or even minor modifications. So, you should be ready to make some upgrades or renovations. Though, you can use the information from the inspection as part of your negotiations.
Competition for REO properties is sometimes steep. Another downside to purchasing an REO property is that you might face some fierce competition if the price for an REO property is really good. Many people, including investors, landlords, and prospective home buyers, know the various advantages of REOs over regular sales.
So, different potential buyers might be eyeing the exact property you're considering.
If you want to buy an REO property, you'll want to work with an experienced real estate agent who can submit your offer to the REO agent or asset manager. You must have a mortgage approval before making the offer. (The lender will want to be sure you can afford the amount you're offering.)
The REO management company might hire a local real estate agent to list REO properties in the multiple listing service (MLS). The MLS is a network of databases that real estate professionals use to list homes that are on the market. Because you need a real estate license to access the MLS, this is one reason to work with an experienced real estate agent.
You can also look at websites like Zillow and Realtor.com. While these websites aren't MLS databases, they generally get data from various MLS databases and aggregate it. Then, they make the information publicly available.
But sometimes lenders sell the REO properties they hold in their portfolios without help from real estate agents. Lenders often list their REO properties on their websites when this is the case.
Mortgage investors, like Fannie Mae and Freddie Mac, and guarantors, like the Federal Housing Administration (FHA) and U.S. Department of Veterans Affairs (VA), acquire REO properties through the foreclosure or deed in lieu process. You can look for REO properties that these entities hold through their websites:
Websites such as auction.com and foreclosure.com also list REO properties.
Your agent will probably submit your offer through the lender or investor's REO website. In most cases, the websites your agent will use to submit your offer are the same ones where the investor listed the home, like HomePath or HomeSteps.
The process for buying a home this way, for example, through HomePath or HomeSteps, and submitting an offer is similar to buying any home listed on the market.
If you have questions about buying an REO property or need help with the process, consider working with an experienced real estate agent or talking to a qualified real estate attorney.
Contact a local foreclosure lawyer if you're a homeowner facing a foreclosure and have further questions about the process.
To learn about different alternatives to a foreclosure, like a modification or short sale, talk to a HUD-approved housing counselor who can help you at no cost.