Find out more about buying bank owned foreclosures and short sales
Many people ask us about buying bank owned foreclosure properties, as they have heard of people getting great deals, below market value. In fact, since about 2008, our market here in the Orlando area has been flooded with foreclosures and although in 2014 things have calmed down somewhat, foreclosures are still something we cannot avoid. We thought we'd share some of our thoughts on the subject.
Why does a property go into foreclosure?
Well, most simply put, the homeowner has not kept up with the mortgage payments and the bank has to exercise their rights as a lienholder and take the house as payment of the debt. There are several reasons why homeowners were unable to pay their mortgage, such as the downturn in the economy, loss of jobs, having bought with very little down payment and a high mortgage, leaving little to no equity in the home and a greater willingness to walk away from the debt. Also, for those people who bought during 2004-2007 before the financial crash brought house prices tumbling down to half price, many people were left with much higher loans than the property is currently worth. Very lax lending policies during these times enabled people to get into mortgages that they couldn't really afford, which helped to create a flood of foreclosures.
So what about things like prices and the condition of foreclosure properties?
In the majority of cases, the loans on such properties will often equal very close to the market value of the house, or in many cases after 2007, the loans are much greater! In addition, the lender has to take over payments of property taxes, insurance and homeowner associations during the time when the borrower has stopped paying, then they have to pay for attorney fees and extra closing costs, so they are extremely unlikely to sell a property under market value. Banks are not usually willing to simply offload the property cheaply, below market value, just to get their money back!
As regards the condition of foreclosure properties, in our experience, when a property owner is evicted from their home for non-payment, they often get angry and frustrated. We have seen time after time that many foreclosure properties have damage such as holes punched in the walls, wires ripped out, excretia and such on the carpets, all done by such a frustrated owner. If you do see a foreclosure for sale at less than market value, it is usually because the lender has allowed for the fact that several thousand dollars in repairs will have to be made, to make the house habitable. In addition, in many cases, this type of house is not usually in the best part of town.
So is it worth considering a foreclosure?
Absolutely, especially since we still see properties for sale much lower than they sold for in the boom times and many of them are foreclosures. There are always "gems" out there to be found, but just like all gems, you have to search for them and do your homework. Be aware though, that there are investors out there who do nothing BUT buy foreclosures and if there are any great deals out there, be sure they will be the first in line!
Anyway, having said all that, if you are an investor determined to hang in until you find that good deal, or a keen handyman who is not scared of a "fixer-upper", either for an investment or to live in, then by all means, this might be for you. We wouldn't recommend this though for the majority of our buyers, who all live thousands of miles away from the properties they buy for investment or second homes. The work needed to bring fixer-uppers back to a decent state is usually way too much to handle unless you are on site and in control the entire time.
You will also need to know that there are very strict procedures to follow when purchasing such properties, with lots more paperwork involved and a lot of patience needed. Banks will also always need to see proof of funds before accepting an offer and it is difficult to get financing for such properties. In addition, in many cases, banks will not pay certain closing costs that are traditionally paid by the seller, such as owner's title insurance (which on a $200,000 property, for example, costs around $1,100) and documentary stamps on the deed ($1,400 on the example $200,000 property). That's $2,500 more than you would pay on a non-foreclosure purchase. It also usually takes time for a bank to accept an offer, so if you are in a hurry to know whether you have the property or not, this would be a problem. Banks also insist on using their own contracts instead of the standard contracts that are normally used every day for regular sales and these contracts are always biased in favor of the bank, but if a buyer wants to buy that property, that's the way it is.
Another thing to consider is that it is very common for a bank owned property to sell for more than the price you see listed. Foreclosures often end up in multiple offer situations, where bidders can get into a buying frenzy and the result is almost always a higher sales price. Some listing agents have also been known to list a property at a price lower than the bank would ever accept, hoping to create interest in a property from multiple buyers, which again almost always ends up in a sale price much higher than the unreasonably low asking price.
The bottom line is when putting in an offer on a bank owned property, you will always need to submit your highest and best offer and not expect the banks to respond to unreasonably low offers. You also need to have lots of patience and expect more frustration and surprises than with a regular purchase. It is not uncommon to end up losing out to someone else and for your Realtor to have to submit several offers on different properties (not at the same time though), before you finally end up with a property.
We started hearing about short sales around 2007, but like many things, the words "short sale" are often overused, used improperly and not understood correctly by many who believe they know. The results of lack of understanding can be at best an inconvenience and at worst a nightmare! Let's first define what a short sale is....
A short sale occurs when a lender agrees to allow a seller to sell a property for less than the mortgage that they owe on that property. Since 2007 when property prices started to fall, many property owners (especially those who bought during the boom times of 2004- 2007) found themselves in a situation where the value of their property actually fell well below what they paid for and owed on the property.
Many people, including some real estate agents, use the term "short sale" loosely when referring to all circumstances where the owner has to offload the property for some financial distress reason or another. This is far from the truth and not all properties are actually short sales, nor would they even qualify as a short sale.
Why would a lender accept less than what is owed?
Lenders are in the business of lending money, not holding or even selling real estate. The last thing lenders want is to have to go through the trouble of foreclosing on a property. Not only is the procedure time consuming and cumbersome, but the process can be very costly to the lender. In addition to the legal fees and other costs related to foreclosing, once a lender acquires the property, they have to pay the costs of maintaining that property until sold. Upon sale, there are more closing costs and commissions. The longer this whole process takes, the higher the lender's carrying costs are, while not receiving any payments from the person who borrowed the money in the first place. It is often better for the lender to accept less than what is owed and move on.
What qualifies as a short sale?
Not all lenders agree to do a short sale, especially when it makes more sense to them financially to just take the property back and resell it on the open market at a better price. In addition, not all sellers qualify anyway. There are many hoops that a seller needs to jump through in order to qualify for a short sale. Here are just some of the general criteria needed (although individual banks also have their own criteria, which could change without notice):
1) The mortgage must be in default. If the borrower has been keeping up to date with payments, the lender will not agree to accept less than the balance owed.
2) The seller must be able to prove hardship to the lender. Several things do not qualify as a hardship, even though people think they might. Certain things that would qualify are divorce, death, sudden illness, loss of employment and of course, these need to be proved to the lender.
3) The seller must have no other assets which could be used to pay off the difference. The lender will get proof of this.
4) The property value must have dropped to less than what is owed.
5) Although each case is different and there are exceptions, lenders generally will not approve a short sale unless the property was a primary residence, not an investment property or vacation home.
There is always substantial documentation that needs to be submitted, before a lender will consider a short sale.
Some other issues to consider One of the things that sellers need to know in advance of even starting this process is that if they were not totally honest during the original loan application (which is more common when people put down larger deposits and got a "stated income" loan, where less documentation was required), then the short sale application process is the time when things will come to light and could even put the borrower at risk for mortgage fraud.
Also, the lender has the right to issue a 1099 to the borrower for the amount of the debt that was forgiven. The IRS will consider this income as being taxable to the borrower, although since an act was passed in late 2007, there may be some instances of exemption from that, but these are mainly for principal residences.
A person's credit rating can also still be negatively affected by a short sale.
So how does this affect someone looking to buy a short sale?
Even if a property and its seller has been "qualified" or "approved" for a short sale, the bank may take several weeks and even months to actually approve a buyer's offer. In 2010 legislation was passed to try and cut down on this time substantially, but years later, expected timelines are still much longer than with normal sales. During the waiting time and depending on how a contract is written, the property could very well still be on the market for sale and other bidders could come along and complicate things, since the bank could take time to consider those offers also! This can be extremely frustrating for most potential buyers, who tend to want to know where they stand, especially after a few weeks have passed and still nothing!
Not only that, but there are unfortunately many people out there, including some agents, who advertise the property as a short sale, without really knowing that the situation will not actually qualify as such. An unsuspecting buyer can go through the whole offer and even contract process and then after several weeks, discover that the seller doesn't even qualify, which can causes more delays and even sometimes a withdrawal of the property from the market.
Unlike a bank owned foreclosure, a short sale is still a contract between buyer and seller (in this case the seller being the homeowner, not the bank). The proper procedure, once the seller (homeowner) has accepted the buyer's offer, is for the contract to become a fully binding contract just like any other normal purchase, with the listing being noted as pending in MLS. The contract would then be submitted, along with all the other paperwork, to the seller's bank for approval. The contract should be fully binding between the buyer and seller from that day, subject to the seller's lender approving the short sale (which is in reality a financing contingency on the seller's side). This is no different from a normal contract where the buyer is seeking financing and the seller take the property off the market for several weeks, awaiting bank approval on the buyer's side. During this time (whatever is stated in the contract, but usually several weeks), neither party can walk away from the sale, even though they are still unsure as to whether or not this sale will go through. This is a very frustrating part for the buyer and so buyers need to be fully aware of the potential wait and the potential for disappointment.
At the end of the day, a buyer has to be prepared to wait it out and go the distance, often with hiccups and headaches along the way, perhaps for nothing at the end. If a buyer is going this alone without a Realtor (which is definitely not advisable, especially if the buyer is international or out of State), then this can be even more of a headache. The problem is though that the sales commission paid by lenders to agents on short sales can most often be so very little (and is often even up in the air until long down the road), that some agents are unhappy about working with them. After all, who wants to spend the amount of time working hard with a buyer, only to find that the commission earned is little to nothing at the end? The way to solve this is to work with a Realtor under a Buyer Representation Agreement, which is how we work with our short sale buyers at Dolby Properties.
Even though we encourage most of our buyers to stay away from distressed properties whenever possible, we do have agents on our team who are very experienced with this type of property, so we are still happy to help you with your next purchase. E-mail us to get started, at firstname.lastname@example.org