When it comes to purchasing bank-owned foreclosure properties, many would-be buyers are discouraged by a few misnomers. For starters, buyers assume that if they find themselves in a competitive bid situation, their offer package which includes financing the purchase will always lose out to all-cash offers. While if all things are equal cash offers are more attractive, buyers who are financing their purchase have other ways they can make their offer more attractive. But before buyers with financing can play ball in the foreclosure game, they must understand the rules.
Loans for real estate come in all shapes and sizes, known as “programs”. Each program has its set of rules under which the financial institutions are willing to loan their money. For example, some loan programs require a certain down payment percentage, while other loans require that the home be located in an area that is classified as rural. Many buyers, without understanding what they are getting themselves into, try to go for homes where the nature of the sale itself fails to satisfy the terms of the loan program. These offers are discarded immediately, even if the amount offered is attractive to the agency in charge of listing the foreclosure property.
The aforementioned happens most frequently with regards to the home’s condition. This is actually an interesting issue, because buyers spend so much time making sure they qualify for financing that they forget to make sure that the home they want to buy will qualify as well. While some loan programs merely require that the home is in basic functional condition (no broken windows, no holes in roofs), other programs are much stricter. Financing through the Federal Housing Administration (FHA), for example, tends to error on the side of caution when approving a home. Issues such as defective paint, soiled or worn-out flooring, and minor pest, electrical or plumbing problems can sink a deal to be financed through the FHA. FHA buyers who make offers on foreclosure properties that aren’t up to snuff are doomed to fail from the start. Such considerations are particularly important when it comes to REO purchases, given that due to the foreclosure process, many REO properties are subject to varying forms of neglect before entering the market.
A good listing agent that represents bank-owned foreclosure properties has an understanding of the condition of their REO listings with regards to their “lendability”. In the world of real estate jargon, lendability is generally defined on a three-tiered basis. First, there are homes that qualify for all types of financing. Secondly, there are homes that qualify for conventional financing only, which is to say that they don’t meet the stricter FHA lendability guidelines. Lastly, we have the homes that are marketed as “cash-only” sales, which means their condition is so poor or there is a fundamental flaw in the home that will prevent it from qualifying for financing. Cash-only deals can be due to overall neglect, or something like a busted septic or failing retaining wall.
So for starters, buyers who are looking for finance their REO purchase need to investigate if the nature of their loan will jive with the nature of their target home. If not, then the type of target home or the loan program must be changed. This is different than with conventional sales, where sellers may be more willing to perform repairs in order to increase the likelihood of loan approval on the home during the negotiation phase. While possible in an REO sale, negotiations for repairs as part of an offer are not always entertained, with the banks preferring to sell their foreclosure properties “as is”.
The frustrations that come with the condition of many bank-owned foreclosure properties has given rise to a loan program that is gaining popularity. The FHA 203k rehab loan is a government-backed loan program where borrowers get a loan on a “fixer-upper” property based on the “as-repaired” value. So if a home is worth X amount of money in its present condition but would be worth Y if it was repaired, the banks lend Y amount of dollars (minus a small down payment) in conjunction with a binding contract to rehabilitate the property. This program not only allows buyers to get into fixer-upper homes with financing, but it gives buyers the freedom to repair and upgrade to their specifications. Clever buyers can use this program to enjoy some of the profit potential associated with the spread between actual repair costs and the market value associated with the repairs.
For those that see the increasing down payment requirements as a barrier to entry when it comes to their foreclosure purchase, the United Stated Department of Agriculture (USDA) has a loan program that is designed to promote rural population growth. The USDA loan offers 100% financing (no down payment requirement), granted that the subject property falls within the “rural property” guidelines. Qualification for the USDA loan program can be determined through an interactive map on the USDA website. The interesting thing about the USDA program, apart from being one of the last bastions of 100% financing is their determination of rural property. Rural property is not determined by proximity to metropolitan areas, but by population density from one immediate location to the next. Homes that are in relatively sparsely populated neighborhoods just outside of urban areas are often defined as “rural”. So when considering a home to buy, it may be worthwhile to check whether or not it is classified as rural, because the answer may prove to be pleasantly surprising.
When competing against all-cash offers, buyers looking to purchase bank-owned foreclosure properties can win, but they must be on top of their game in every way. First off, one advantage that borrower-buyers hold is that they may not be looking for as large of a discount as cash buyers. Cash buyers, given the strength of their position, often approach the negotiation table under the assumption that they are entitled to an additional discount. This leaves an opening for borrower-buyers to exploit, as long as they can present their financial position as strong as possible. In order to do that, they must have comprehensive pre-approval not just for themselves as borrowers, but with a loan program that will not raise any issues with the present condition of the subject property.
Buyers purchasing REO properties with financing can’t rely on their solely on their own efforts, they must have their entire house in order. Lenders, inspectors, and appraisers must be brought on board with the situation, and have everything they need handy to expedite the process. By pushing the generally accepted time frames for the purchase process with financing, sharp buyers can offer the fastest allowable close, which will help them compete with cash buyers who are subject to fewer time constraints. In the end the right home, the right loan, the right team and the right strategy, coupled with the requisite preparation can help ensure the best possible foreclosure purchase process. It may seem like a lot of work or a large investment of time, but it pales in comparison to the work and time that one must pledge in order to reconcile poor purchase decisions.