Understanding the Foreclosure Process and REO Transactions.
It is an unfortunate commentary, but when economic activity declines and housing activity decreases more real property enters the foreclosure process. High interest rates and creative financing arrangements also are contributing factors. If you are prospective Buyer and you run a cross a REO Property for sale, the information below will help you understand the unique characteristics of these transactions and prepare you for an escrow process which may be different from what you have experienced in the past. Please remember, this information is provided for general informational purposes only, is subject to change without notice and should not be relied upon.
First a little Background on REOs and Foreclosures.
When a borrower defaults on his loan, the bank can take back the property which is the collateral or security for its loan. Most lenders do not want to own these properties, because the maintenance and management expenses add to their costs and decrease profitability. This climate creates a favorable environment for both investors and residential home buyers who are searching for a good deal.
What Is Foreclosure?
A foreclosure occurs when a mortgage lender takes possession of a property from a borrower who fails to keep up with their loan payments. Virtually all mortgage loan contracts legally entitle the lender to seize the property if the borrower defaults, so the lender can recover as much of the unpaid loan amount as possible. However, the Lender will need to follow one of three types of foreclosures based on the state the property is located.
What are the Three Types of Foreclosure?
Judicial Foreclosure: Under a judicial foreclosure proceeding, the lender files suit with the court to initiate foreclosure—typically after the borrower misses their third consecutive mortgage payment (also known as going 90 days past due on their loan). The borrower receives a letter indicating foreclosure will commence if they don't bring the loan current within 30 days. (The time limit may be longer in some jurisdictions.) If payment is not made in time, the property is sold at an auction conducted by a court or sheriff's office. All states allow this type of foreclosure, and some mandate it.
Power of Sale (Nonjudicial) Foreclosure: Is also known as statutory foreclosure, this procedure is authorized in states where the mortgage contract can include a power of sale clause. This contract language allows a lender to conduct an auction to sell a foreclosed property without involvement from the judicial system, as long as they issue required notifications to the borrower and observe a mandatory waiting period that varies in length by state and locality. Power of sale foreclosures often take less time than judicial proceedings, but in some states the borrower can seek judicial review of the process by filing a suit of their own with the appropriate court.
The 29 states that allow power of sale foreclosures are Alabama, Alaska, Arizona, Arkansas, California, Colorado, Georgia, Hawaii, Idaho, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, North Carolina, Oregon, Rhode Island, South Dakota, Tennessee, Texas, Utah, Washington, West Virginia, and Wyoming. They are also allowed in Washington, D.C.
Strict Foreclosure: Only two states, Connecticut, and Vermont, allow for a special type of judicial foreclosure known as a strict foreclosure. Under this proceeding, the lender files suit against the borrower who is in default. If the borrower does not pay the mortgage within a time limit specified by the court, title to the property transfers to the lender directly, without requiring a sale. Strict foreclosures generally occur when the amount of outstanding debt exceeds the value of the property.
What Is a REO?
REO means “Real Estate Owner” and is an expression used in the real estate industry to describe property which is owned by a bank because it has foreclosed on one of its loans.
Properties are Sold in “As Is” Condition
As a Buyer, remember that REO properties are sold in their present “as is” condition. The Seller has never lived in the property and will not make representations about its condition or provide warranties against defects. As the Buyer, you are responsible for making your own determination as to the condition of the property, its suitability for use, and for repairs or refurbishing that may be needed.
About Your Purchase Contract and New Financing
The REO Seller is not likely to accept changes to the purchase contract once the original deal has been struck. Your transaction will move more smoothly if you don’t attempt to change your original agreement. Even minor alternations can create a problem for the Seller. If you are obtaining new financing to purchase your property, your lender should be aware that you are purchasing REO property, especially if the property is in a distressed condition. Conform that your lender is willing to participate in an escrow with a REO Seller and understands that flexibility with the Seller’s timetable may be required.
The Escrow Process
It is important to recognize that the Seller is a corporate lending institution, dealing with a huge volume of properties. To quicken the process of liquidation its properties, the Seller employs a large staff of professionals whose sole job is to manage the sales of the bank’s properties according to the policies and procedures which it has established.
As a result, the typical timetables of a standard escrow will not apply in an REO environment. For example, after a Buyer’s offer is accept, the first contact with the escrow officer may not occur for three weeks or more while the Seller completes its internal procedures. Though you can’t control the Seller’s actions, you will want to be sure to fulfill your own commitments under the contract in a timely way by working with your escrow officer and your agent throughout the escrow process.
What to Expect at Closing?
Your escrow officer will give the Seller a 72-hour pre-closing notice. This is a standard requirement for REO sellers. During this time, the Seller will sign final escrow documents and approve the settlement statement. Occasionally, this step will take a day or two longer than expected. It is not helpful to the process to try to rush this time period before closing. The Seller will follow its established guidelines, even if it means delaying the escrow closing date.
The Importance of Communication and Flexibility
Consider the possibility of a closing delay if you are making moving plans. Understand that the Seller will set the pace of the transaction, and this is especially true in the last days prior to closing. Maintain good communication with your real estate agent. An experienced REO escrow office is an excellent resource for information and understands the best ways to move your escrow to a timely, trouble-free close.
