Foreclosures, Short Sales, and REOs Oh My!
With so many Americans facing foreclosure today, it is important to know what the process is and all of the details relevant to the subject. This article is for the purpose of explaining, in detail, the foreclosure process and short sales and the process and procedures that must be followed for both subjects. We will address how sellers end up in foreclosure, ways to avoid foreclosure, alternatives to foreclosure and anything else that is pertinent to foreclosure. SHort sales in rela estate are an alternative for foreclosure and the positive side of short sales is the fact that many people, including astute investors, make a lot of money investing in homes about to go into foreclosure. Another subject in this article is REO investing as it is closely related to the other subjects and people should know about the money making opportunities that are available with REO homes.
What is the difference between Foreclosures, Short Sales, REOs
1 Foreclosures & Short Sales: When a homeowner fails to make the mortgage payments for 3 months, the lender will mail out a notice of default asking for payment by a certain date. If no payments are received by that date, the lender authorizes their attorney’s to start foreclosure proceedings. In the following months, the homeowner will be under much stress and strain, as the process can last as long as 12 months or more. The homeowners credit score is going to be affected negatively and it will remain on your credit report 7-10 years. You will not be able to purchase a home for at least 5 years or more. On top of that, the IRS considers a foreclosure as a home sale and the income is taxable.
Avoiding Foreclosure or Foreclosure Alternatives:
Each state has its own laws regarding the foreclosure process so some of the alternatives listed may not be appropriate for all cases. Some options are:
Repayment Plan: This usually involves establishing a schedule with your Lender to make a full regular monthly payment plus a little extra each month, to repay the delinquent amount over a specified period of time.
Special Forbearance Plan: This option may provide for a temporary reduction or suspension of payments, that will be increased at a later point to repay the delinquent amount over a specified period of time.
Mortgage Modification: This option may allow you to refinance the debt and / or extend the term of your existing mortgage loan.
HUD Partial Claim: If your loan is an FHA insured loan, your lender may be able to obtain a one time payment from the FHA-Insurance Fund to bring your mortgage loan current with payments.
Refinance: This option may allow you to use the equity that you have established in your home to pay the delinquent amount. Depending on the interest rate of your new loan, your monthly payments might be reduced. You can explore refinancing with your existing Lender as well as with any Lender of your choice.
Sell the house: If there is sufficient equity in the property, you may be able to receive more for your property than what is due on the mortgage loan.
Assumption: With this option, you would sign over the property to another person. That person would then take possession of your home, and take over making the payments.
Bankruptcy: Many people believe that by filing for Bankruptcy, it will allow the homeowner to keep a home, and will prevent it from going to foreclosure. Eventually the home will be taken by the lender and all bankruptcy will do is delay or put off the time until you loose your house. An attorney should be consulted before anyone considers any type of bankruptcy.
Pre-Foreclosure Sale: This option may allow you to sell your property for an amount less than what is necessary to pay off your mortgage loan.
Deed In Lieu Of Foreclosure: This option may allow you to voluntarily "give back" the property to your Lender without further damaging your credit.
Short Sale: A short sale is when the lender agrees to accept a mortgage payoff that doesn't cover the entire amount of the outstanding loan. This is a complicated process and can take up to 12 months or longer. The seller, or homeowner, must prove that they are having severe financial hardship, and then present to the lender a variety of documents and paperwork that goes on and on. The homeowner must list and sell the home. There is much stress involved as the homeowner is under the gun with time restraints dictated by the lender. Once you sell the property, you have to supply additional documentation. When the property is listed, your real estate agent prepares a comparative market analysis. You're going to need that and you will need to supply a copy to the lender, along with your hardship letter, and a variety of documents needed by the lender. The lender will need a copy of the purchase agreement, and a "net sheet" showing how much you will net (or lose) from the sale of the home. If there is PMI on the home loan, then the PMI insurance company also has to give their approval for any sale.
If the lender feels that the deal is good, and the lender accepts you hardship letter, most likely the sale will be approved. If the lender approves the sale, thus forgiving the debt, the IRS considers forgiveness of debt the same as taxable income and you will have to pay taxes on that income. The Short Sale Process is a long one and is complicated and there are certain procedures to be followed. The homeowner will have to hire a real estate agent, broker or Realtor to do much of the paperwork and leg work involved.
An Important Note to Buyers and Brokers Regarding Short Sales
A short sale is a situation where a property seller(homeowner) needs to sell fast and the sale proceeds are not sufficient to pay off the existing mortgage. It is an alternative to foreclosure. The term short sale or short pay refers to a process whereby the mortgage company must agree to a reduced payoff in order for the sale to take place. All sale costs must also be included and the seller receives nothing, except debt relief and not having a foreclosure on their credit record.
If you're a prospective buyer on such a property, beware! The seller may accept your offer; you may invest $1000 in an appraisal and a property inspection, but you may not get the property because the mortgage company may not agree to reduce their payoff. The mortgage company is a third entity that is not a party to your contract, yet their decision will affect the outcome of the transaction. The mortgage company will review the short sale proposal and closing the sale will depend on their response. Many short sales fail because the mortgage company representative is unfamiliar with the local real estate market and responds with an unrealistic proposal.
When buying a short sale property, don't expect a quick answer and don't expect the mortgage company to respond logically. They will seek any additional assets the homeowner may have and they will demand that the real estate agents or brokers reduce their commissions. They may demand the seller to sign a personal note to pay back the shortfall. Remember, the mortgage company wants to recover as much of the loan as possible.
Additionally, many loans have PMI (Private Mortgage Insurance) that will cover a portion of their loss so the mortgager's motivation to reach an agreement may be less because they're covered regardless. You may have to start negotiating with the PMI company, adding additional time to the sale process. Unless you have considerable experience with short sales, foreclosures and working with lenders' loss mitigation departments, be very cautious in submitting an offer on a property in a short sale situation.
Buyers, ensure that you have an escape provision if the process takes longer than you want or if a more suitable property becomes available.
Sellers, be realistic. Consult with your accountant and your attorney on the tax and legal ramifications of a short sale. You may have to be willing to undergo an asset evaluation and even be willing to walk away and let the lender have the property.
Brokers, you will have to work two to three times as hard and may never help your client achieve their goals and/or receive appropriate compensation.
REOs: REOs are bank owned properties that did not sell when the foreclosure auction took place, usually due to no bids or too low bids. These properties can be purchased directly from the banks for investment purposes.
REOs vs. Foreclosures
An REO (Real Estate Owned) is a property that goes back to the mortgage company after an unsuccessful foreclosure auction. Most foreclosure auctions do not result in bids. Usually if there was enough equity in the property to satisfy the loan, the homeowner would have tried to sell the property and pay off the bank.
That is why the property ends up at a foreclosure or trustee sale.
Foreclosure sales begin with a minimum bid that includes the loan balance, any accrued interest, plus attorney's fees and any costs association with the foreclosure process. In order to bid at a foreclosure auction, you must have a cashier's check in your hand for the full amount of your bid. If you are the successful bidder, you receive the property in "as is" condition, which may include someone still living in the property. There may also be other liens against the property. Since what is owed to the bank is almost always more than what the property is worth, very few foreclosure auctions result in a successful sale. Then the property "reverts" to the bank. It becomes an REO, or "real estate owned" property.
REO Properties For Sale: The bank now owns the property and the mortgage loan no longer exists. The bank will handle the eviction, if necessary, and may do some repairs. They will negotiate with the IRS for removal of tax liens and pay off any homeowner’s association dues. As a purchaser of an REO property, the buyer will receive a title insurance policy and the opportunity to investigate the property. A bank owned property might not be a great bargain. Do your homework before making an offer. Make sure that the price you pay is comparable to other homes in the neighborhood. Consider the costs of needed repairs and renovation, including time to complete them. Don’t get caught up in a ‘bidding war’ and pay over market value. It’s an old myth that “foreclosures” are a bargain.
How Banks Sell REO's: Each bank/lender works a little differently, but they all have similar goals. They want to get the best price possible and have no interest in "dumping" real estate cheaply. Generally, banks have an entire department set up to manage their REO inventory. Once you make an offer to purchase, banks generally present a "counter-offer." It may be at a higher price than you expect, but they have to demonstrate to investors, shareholders and auditors that they attempted to get the highest price possible. You should plan to counter the counter-offer.
Property Condition: Banks always want to sell a property in "as is" condition. Most will provide a Section 1 pest certification, but not unless you include it in your offer and negotiate the point. They will allow you to get all the inspections you want (at your expense), but they may not agree to do any repairs. Your offer should include an inspection contingency period that allows you to terminate the sale if the inspections reveal unanticipated damages that the bank will not correct. Even though you agreed to “as is," always give the bank another opportunity to make repairs or give you a credit after you’ve completed your inspections. Sometimes they’ll re-negotiate to save the transaction instead of putting the property back on the market, but don’t take it for granted. Most banks will not provide financing on their REOs but it doesn’t hurt to ask. Especially if the property has extensive damage and you are purchasing it "as is."
Making an Offer: Before making an offer, have your agent contact the the listing agent and ask the following:
- Are there any inspection reports?
- What work has the bank agreed to?
- Is there a special "as is" form?
- How long does it take the bank to accept an offer?
- How does your agent deliver the offer?
Note: Offers are usually FAXED to the bank. The listing agent needs your originals. There is no formal presentation. Keep in mind: nothing happens evenings and weekends (banks are closed)
Since there is no face-to-face presentation to the bank, provide the listing agent with a pre-qualification or better yet, a pre-approval letter and buyer biography. Make your offer easy to accept. Remember that REO's sell at pretty close to full market value and are not the good deals presented on late night television.