How do Short Sales, Foreclosures and REO's Work

Question

Need an explanation on how Short Sales, Foreclosures and REO's are used by banks. What is the best way to buy properties in these situations?

John Hyatt · Answer

Hi Kathie,

Short Sale – when the borrower owes more than the house is worth and must get the lender and/or the investor to agree to sell for less than is owed. Every lender/investor is different, I have processed over 300 short sales with over 30 different lenders and they each have their own way of doing things (One negotiator at Bank of America told me they worked with over 1,400 investors), but usually they all request the same documents (bank statements, pay stubs, hardship letter, 4506-T, etc). If you owe $110,000 and the property is worth $100,000 the bank must agree to the $10,000 they will be losing (plus commissions and closing costs which makes it more than $10k). Why would a bank do this? So they don’t have to go through the foreclosure process, list a property and wait for buyer, hire an attorney, liability, can go after seller later in some cases, and so on. Note: someone doesn’t have to be late on payments to do a short sale, they can be current (again, every lender/state/investor are different). I would recommend finding an agent who has does short sales and knows the process otherwise it can take a long time. Timeline depends on so many factors (buyer, seller, agents, lender, investor, situation, etc). On average though a short sale should take 90 – 120 days. If you want to buy a short sale just ask a realtor to send you short sale listings or network with people/investors who have short sales listed.

Foreclosure – When someone is late on payments and the bank takes legal action to get them out of the property so they can sell it. Typically when someone says they bought a foreclosed property they really mean they bought an REO property from the bank (even though HUD houses are foreclosed on, only difference is they were FHA loans). Foreclosure is the process, not the type of listing. That’s why there is Pre-foreclosure deals. You can look for Pre-foreclosures (properties that are past due, but can’t be foreclosed on yet because of state laws, etc). If someone is 60 days past due and the bank will foreclose in 90 days you can buy the property or do a subject to and bring the loan current, depends on the situation (make sure you know what you are doing – seek counsel if not).

REO – Many people define REO as Real Estate Owned by the bank. This is when the bank forecloses on a property and it doesn’t sell at auction or they buy it back at auction and list it as for sale. Technically though REO can be anyone who owns the real estate (no mortgage). If you buy a property for $100k cash and you own it free and clear with no mortgage you can list it as an REO property (marketing tip). In this situation though again it depends on the bank or lender selling on the process. My current house that I own was purchased through an REO and it was quite a bit more paperwork than a traditional sale, but nothing too crazy. Again, if you want to buy an REO ask a realtor to send you REO listings.

Let me know if this is what you were looking for…or if you have any other questions/concerns.

-John

Timothy Murphy III · Answer

@Christopher Winkler

This sounds right to me. A foreclosing lender typically bids the minimum at foreclosure auction, and their bid amount is just used to offset the deficiency on the note. The banks do this because, as happened in your case, if no bids are placed then the owner still retains title. As such, banks always send a representative to bid the minimum, if not more, to ensure they actually recover the property after litigating the foreclosure. Of course, things happen and every once in awhile the bank's representative does not show up. Sounds like that's what happened in the past here prior to your purchase of the note.

And yes, most people use the term "REO" to mean property held by a bank after taking it back via foreclosure auction. It doesn't typically apply to private individuals or companies that have taken back a distressed property. Of course, that's really just semantics. You are in the same position with the same kind of asset as a bank that took back a property at foreclosure and is now listing an REO.

Ron S. · Answer

@ Kathy - Nice job! Generally,  a pretty good write up. I'd offer clarification on a couple of things though. MANY lenders do NOT take "legal" action to foreclose. In trustee states (States that do not require a lawsuit to foreclose) the trustee for the lender exercises the "Power of sale" clause in the contract and do not use the courts. It's not a requirement to foreclose judicially in most of the western states.

Also, no, you can't put a loan in foreclosure for nonpayment in 60 days and go to sale at day 90 any longer (Thank the CFPB for that). Now, you must wait to file the "first legal" (Usually the NOD) after the 120th day of delinquency and ONLY if the borrower isn't working with the lender on any alternative to foreclosure (Again, thank the CFPB for eliminating "dual tracking" on a national level). And taking a property "Subject to" can trigger the due on sale clause that exist in 99.99999% of contracts out there. It's not Illegal, but it’s a violation of almost every contract where real estate is involved.

Account Closed · Answer

Thank you @John Hyatt. Good explanation and good tips.

John Hyatt · Answer

Hi Chris, good point I should have clarified that is how it usually goes down, but not always. I also am not that familiar with other states (I know AZ and a little bit about California). Technically, REO is any real estate that is owned. So although they don't sell it as an REO doesn't mean it's not classified as REO. For example if you own your house outright, you could list it as an REO...(real estate owned). Typically people who own their house cash don't advertise it as an REO (prolly cause they think it's only banks that can). I didn't want to get to technical, so I just provided the basic term for REO as most people know it.

Christopher Winkler · Answer

Hi John, not sure this is correct, though want to clarify your comments. We bought a note in Ohio that the bank did take to foreclosure and it did not sell. They did not bid the minimum, so it sat in limbo for a couple years, and to top it off, the owner is deceased. So while the bank did own the note & mortgage, they did not have the deed and they could not sell it as an REO.

We bought the note/mortgage, substituted council, scheduled another foreclosure sale, and bid the minimum to get title. Now we own it and are looking to sell it. Now its an REO as we have title, and if they don't bid at auction, they don't have title. Anyone, please correct me if I am wrong...

How do Short Sales, Foreclosures and REO's Work

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