When a borrower stops paying, one of the principal resourses a lender has house extensions is to take over the property against which the loan was secured, and sell that asset to try to recover its money. Foreclosure can be a long process, but at the end of it, if no other way is found of settling that debt, the ownership of the property will fall to the bank. Banks are good at lending money but not at managing properties, so generally the banks don’t want to hold on to the properties and will usually try to sell them quickly. Traditionally the holding and selling of real estate this is handled by the “Real Estate Owned” department of the bank, thus today’s “REO” for short hand.
Buying directly from the bank has some advantages. The key advantage of course is that you may find a great deal on a house. Other benefits includes that you’re not dealing with distressed homeowners, constrained by existing mortgages, etc.
As the market for buying REOs heats up, all kinds of buyers are joining the fray, not only investors but also regular homeowners who intend to live in the property themselves. In some areas, banks are seeing multiple offers, and have to decide which offer to go with choose. One of the determining factors is the buyers ability to close the deal as promised. For this reason, banks are heavily biased toward accepting offers in which the buyer will be paying out of their own cash funds, rather than having to be approved for traditional bank financing, which could take a month for approval and for which the buyer may ultimately not be approved.
All of which leads me to my next advantage, which is that in this environment, anyone who can makes a cash offer will have a greater probability of getting their offer accepted. The disadvantage, of course, is that if you are not in a position to make a cash offer, its hard to be a player.
Another big disadvantage is that buying from a bank makes it more difficult to flip the property quickly. Banks do not allow you to purchase on an assignable contract, which is a standard technique for wholesalers. So, chances are you’ll end up closing on the property yourself. You could always find a buyer and sell it to them immediately; however, one big challenge is that FHA and possibly other lenders require a property to be owned for at least 90 days by the seller in order for them to make the loan. This is designed to discourage quick flips, and in fact its very effective, because it removes the possibility of financing (for a quick flip) for most of your lower-end buyers.
All this is not a problem if your intention is to hold the property and rent it out. However, if a long-term buy-and-hold is not in your plans, your remaining options if you purchase a bank-owned property is that you either have to hold it for a minimum of three months to be able to sell to an FHA borrower, find a borrower whose lender doesn’t include these guidelines, or find a cash buyer. One additional thing to note is that if your buyer is getting financed, the sales price has to meet appraisal; at the same, appraisals are coming in very conservative these days, so you have to be careful.
Another consequence of banks desiring to close quickly is that inspection periods can be quite short, so you have to be prepared to decide and act quickly.
Lastly, since the banks have simply taken over the property and are essentially absentee owners who have never lived there, the full raft of seller disclosures that is a standard part of the transaction in a normal person-to-person sale is simply not available.