For most people, buying a home is the largest purchase of their lifetime. Given the high costs of homeownership, it's natural to look for opportunities to save money. Thankfully, several nontraditional listing options are available to help home buyers purchase a home for less.
Real estate-owned (REO) properties are one money-saving option you might consider in your home buying search. An REO property is a lender-owned property that fails to sell at a foreclosure auction and is now available for sale directly from the lender. Let's take a closer look at how REO properties work, their advantages and disadvantages and how to purchase them.
What Is an REO Property?
REO properties are properties a lender, bank or mortgage investor owns that don't sell at a foreclosure sale. Often referred to as "bank-owned properties," these homes typically gain REO status through the following process:
- Homeowner defaults on the mortgage. Pre-foreclosure may begin after the original homeowner falls behind on the mortgage and is unable to work out a repayment arrangement with the mortgage lender to stay in the home.
- The mortgage lender begins the foreclosure process. Once the property enters foreclosure, the house goes up for auction on a specific date. If the property remains unsold after a foreclosure auction, the lender or mortgage investor begins managing the home, and it becomes REO inventory.
There are other ways a home becomes an REO property, such as when the owner and lender agree on a deed in lieu of foreclosure. For example, if a homeowner passes away, their heirs could choose to give the home to the lender rather than pay the mortgage or sell the property themselves.
Once the lender begins managing the property, they'll take steps to get the property ready for sale. This could involve removing occupants, resolving home liens and determining an appropriate listing price.
Of course, managing a property comes with costs like property taxes, maintenance, repairs and homeowners association (HOA) fees. That's why mortgage lenders are motivated to sell REO properties quickly, often for less than fair market value.
Pros and Cons of REO Properties
REO properties present an opportunity to save money on a new home purchase but they also have downsides. Consider the following benefits and drawbacks to help determine if purchasing an REO property is in your best interest.
Pros of REO Properties
- Lower purchase price: Keeping REO inventory on their books is expensive for lenders, so they're incentivized to price an REO property below market value for a faster sale.
- Potentially faster purchase process: When buying an REO property, you're not negotiating with a homeowner. This could expedite the negotiation period since the bank doesn't have the same personal attachment to the property as a homeowner. Similarly, a homeowner may require a longer escrow period, while mortgage lenders are motivated to sell the property quickly.
- Clean title with no outstanding liens: Generally, mortgage lenders remove title liens and bring property taxes current before listing for sale—but not always. It's a good idea to run a title search and ask your lender about any liens or taxes owed.
- Potentially higher investor returns: Real estate investors may parlay the lower sales price into a higher profit margin by repairing and renovating the home before resale.
Cons of REO Properties
- House sold as is: Purchasing a home "as is'' means you accept that you're getting the property in its current condition, including any issues found in the home. The mortgage lender doesn't have to provide a seller's disclosure. While your state still mandates specific disclosures, you might not be alerted to other issues.
- May need repairs: Repairs are more common with REO properties in part because homeowners facing foreclosure may not have the funds to pay for them. As with the traditional homebuying process, it's wise to get an independent home inspection so you'll know what repairs need to be made. You can also factor repair costs into the price negotiations with the lender.
- Could be occupied: If an REO is a single-unit primary residence, the mortgage lender will typically make sure the home is vacant. However, federal and local laws may apply if a home is a rental property with tenants. The Protecting Tenants at Foreclosure Act requires you to give tenants a 90-day notice to vacate. Some states may allow for more than 90 days, and you may need to honor the existing lease terms. Consult a real estate attorney to better understand the tenant laws in your area.
How to Buy REO Properties
Buying an REO property is a lot like purchasing any other home but with a few key differences. Here's a breakdown of the REO homebuying process:
- Get preapproved for a home loan. Before house hunting, get preapproved so you know how much you qualify for. Additionally, a preappoval shows the selling bank you're a serious buyer who is qualified to buy the property.
- Work with a real estate agent. Having a real estate agent with REO experience on your side can help you structure the most appealing offer and negotiate with a mortgage lender or investor.
- Find REO properties for sale. Your agent can help you locate REOs available for sale. You can also find many listings on online platforms like Zillow and Realtor.com, or you can check listings from the Department of Housing and Urban Development (HUD) and other federal agencies. Some banks list their REO properties on their websites.
- Make an offer. Work with your agent to craft a competitive offer and submit it to the mortgage lender. In many cases, you can submit your offer on the same platform where you found the listing. For example, you can find REO property listings and submit offers on Fannie Mae-owned homes through its HomePath platform.
- Get a home inspection and title search. Before purchasing a real estate-owned property, you'll need to make sure you understand what repairs and home improvements need to be made. It's also imperative to ensure there aren't liens against the property that could hinder the sale. You might consider getting title insurance in case someone later claims to own the property.
Improving Your Credit May Save Money on Your Home Loan
Whether you're buying a real estate-owned property or another home through the traditional homebuying process, maintaining strong credit could help your approval odds. Also, borrowers with higher credit scores tend to receive more favorable mortgage loan terms than those with lower scores.
Before applying for a home loan, check your credit report and score for free with Experian to see where your credit stands. Then, make improvements if necessary to strengthen your credit. Additionally, monitoring your credit during the escrow period could alert you to any changes to your credit report that could derail the mortgage closing process.