What is REO?
REO is an acronym for Real Estate Owned. The term refers to foreclosed properties in a bank’s portfolio. Often the newly foreclosed real estate is auctioned off, and the bank that owns it will place a bid in the amount still owed against the property. When a third party fails to bid higher than the bank, the property reverts to bank ownership and is marked as real estate owned.
REO property is considered a liability, so lenders frequently offer the properties at deeply discounted prices. The bank may list real estate owned property on its website, or recommend them to customers who want to purchase a home. Financial institutions may also remove liens against the title to make properties more attractive to prospective buyers.
Who Buys REO Property?
REO foreclosures usually attract two types of buyers: homeowners and investors. Homeowners are interested in purchasing a property at a below-market place to live in. Investors plan to improve the property and sell it or rent it out.
REO homes are usually sold as-is, and buyers rarely get the opportunity to inspect the property before making an offer. Interested parties are wise to include an escape clause that allows them to back out if extensive repairs are needed. Once the initial offer is made, hire a home inspector with a reputation for being thorough and detailed. It is well worth a few hundred dollars to avoid thousands in essential renovations.
For buyers with good credit, many banks will loan the full purchase price of the REO foreclosure. This is especially true if the home is selling for under market value since the lower price means there is more equity. However, these homes have already been through foreclosure once. Financial institutions may be reluctant to issue loans for property that needs extensive repairs.
Investors with extensive equity in another property may be able to obtain a line of credit using the second property as collateral. Once repairs are made to the REO property, it may be possible to convert the line of credit to a mortgage. This approach isn’t without risk. Investors should weigh pros and cons carefully before committing to this course of action.
Another investment option is an interest-only loan. During a set initial period, no payments to the principal are required. Instead, the buyer is only responsible for the interest. Funds that would have been applied to the principal may instead be used to make improvements, and the buyer can begin making full payments once the property is leased.
While low payments and high flexibility are appealing in the beginning, investors should use caution. Careful planning and discipline are required to avoid a precarious financial situation when higher monthly payments come due.
HUD REO Guidelines
The US Department of Housing and Urban Development (HUD) offers some REO homes through the HUD Home Store. These one- to four-unit properties are acquired by HUD as the result of a defaulted FHA-insured mortgage.
The properties are initially available to only owner-occupant purchasers. Once the priority period has passed, investors may place offers on available properties as well.
Purchase and Financing Recommendations
Because each property is sold as is, HUD strongly recommends that interested parties invest in a home inspection before making a purchase. Once the sale is complete, the buyer is responsible for all necessary repairs. In some situations, severe omissions may provide the buyer with federal protections, but this is rare.
HUD does not provide direct financing, but some homeowners may qualify for one of two types of loans. An FHA 203 (k) Rehabilitation Loan consolidates paperwork and eliminates the need to establish a credit line for repairs before converting to a traditional mortgage. Instead, it offers a single fixed or variable rate mortgage that includes repairs. Standard FHA-insured loans may be available to buyers who meet income guidelines or other requirements.
Purchasing real estate owned property can be a good way to get a great deal on an investment or new home. However, buyers should perform due diligence and weigh all options before committing to a final sale.