Buying a house in foreclosure or short sale can be challenging, but precautions, patience and smart choices can lead to significant advantages.
Buyers who are considering purchasing a foreclosed home or short sale property may get excited at the prospect of scoring a sale at below market value. But the opportunity doesn’t come without risks.
In the wake of the bust of the 2002 – 2007 real estate bubble, home prices started to decline. Owners with little equity soon found themselves owing more on their home loans than their houses were worth. This is known as being “underwater” on the loan, and it often leads to a foreclosure or short sale.
If a homeowner just can’t afford the house, he may decide to relinquish ownership and give the house to the bank that holds the mortgage. This is called a Deed in Lieu of Foreclosure. Or, the foreclosure decision might be made for the homeowner when the bank initiates foreclosure proceedings.
Foreclosure is a lengthy and complex process. The lender must prove that it has accurate, complete paperwork supporting its right to claim the title. Homeowners often try to win loan modifications or other types of help to salvage the situation and stay in their homes. Related financial and legal problems, such as bankruptcy, multiply the complications – and the number of lawyers involved.
Houses in foreclosure look like bargains: typically they sell for 35% less than what they would have fetched if they were not in foreclosure. But financially distressed owners often let their properties fall into disrepair. Foreclosures can come with many hidden problems, from leaky basements to bills from homeowners’ associations to quarreling lenders. It takes a long time to sort out who is owed what, how they will be paid, and when the title will finally be cleared.
• You might want to order up a title search when you make your first offer so you don’t get surprised at the point of closing.
• The title search might uncover nasty surprises, such as unpaid taxes.
• Disputed title and loan paperwork might sink the deal.
• You might have to pay a real estate lawyer to review documents several times.
• Closing fees may be high due to the complicated paperwork.
• The closing will probably be difficult to schedule, with multiple delays.
When a lender agrees to take less than the mortgage owed, that transaction is known as a short sale. For example, a homeowner might have bought the house for $200,000, putting down 5% and carrying a mortgage of $190,000. If the market value of the house declines to $175,000, that homeowner has lost her down payment. On top of that, her $190,000 mortgage is now $15,000 more than the house is worth. She is underwater on the mortgage.
If the homeowner were to sell, she would have to bring $15,000 to the closing to make up the difference to the lender. But what if the lender is willing to share the losses with her? The homeowner might be able to persuade the lender to accept $175,000 at closing. She loses her $10,000 down payment and the lender writes off $15,000 of the loan. Doing so clears the title and makes the house available for a clean sale. That’s a short sale.
Short sales are easy to understand on paper but hard to accomplish in real life. It’s hard to get the ok from the lender to take a loss on the mortgage. The paperwork can drag on for months. Other liens – such as unpaid bills from contractors who helped get the house ready to sell — often pop up, further entangling the process.
• The process will be slow and unsteady, with many frustrating delays.
• As a buyer, conduct a title search to verify all liens and mortgages against the property to avoid unnecessary risks or surprises like unpaid taxes.
• It may be hard to find a real estate agent adept at navigating the process.
• You may have to pay a real estate lawyer to review documents several times.
Both scenarios present an opportunity to obtain a property below the potential market value. Foreclosures can be as much as 10-20 below their potential value. However, they also tend to have the potential for more inspection issues than your average home because of extended vacancy, deferred maintenance associated with the foreclosure process.
Short sales are also often priced slightly below what the market may suggest (5-15%). This is intended and sometimes necessary to entice and keep a potential buyer who will be willing to wait through the short sale process (typically four to six months or more). Once you come to an agreement on price and terms, the seller then begins the negotiation process with the lender. This can be challenging as there is always the potential the sellers’ bank can counter on price, decline the seller request, or require terms and stipulations that the seller must agree to in order for the lien to be released.
Title is your ownership right to a property. When you close on a property, that ownership right is granted to you physically in the form of a deed. It’s like a receipt. It’s proof that the property is yours. In order to be able to sell or finance the property, you must have a clear title to it. That means you must be able to deliver title (ownership) of the property to a buyer or pledge it as collateral to a lender, free of any liens and encumbrances.
The priority of a lien is established by when it was imposed. For example, if you apply for a refinance mortgage in 2018, but a lien was placed on your property in 2015, that lien will have priority over the mortgage in the event of a foreclosure action. Mortgage lenders require that you are able to deliver clear title to the property as collateral for the new loan. That means all prior liens will need to be satisfied before you can close on the new mortgage.
When you buy a house with a loan, the lender has the right to claim the house if you stop paying. Most homeowners continue paying back their loans even if the value of the house has eroded. But some decide that they will not continue paying for a house that is worth less than they owe on it. Other complications could arise if someone must move for job, family or other reasons. No matter why the house is being sold, its title problems must be cleaned up so they are not inherited by the buyer.
In many cases, the history on a title that has changed hands through foreclosure or short sale can be messy. Under normal circumstances, the homeowner pays off the mortgage and the lender releases the title (the legalities of this vary by state). That might happen when the homeowner sells the house and repays the mortgage with the proceeds of the sale. Or, it could happen if the homeowner stays in the house for the duration of the mortgage and eventually makes that final mortgage payment.
But if the homeowner has taken out other loans collateralized by the house, such as a second mortgage, a home equity line of credit, or construction loans for remodeling, the lenders behind those loans also have claims on the house.
All of these claims against the house “cloud the title.” If you don’t repay these loans, the lenders will put a lien on the house. Only when the creditors are satisfied is the title cleared.
If you’re planning on buying a foreclosure or short sale, you should be aware of title issues that could remain unresolved and how you can safeguard against them. Just because the lender owns the property doesn’t mean their staff will have tidy records and be responsive when a sale is in process.
A title search researches the property’s history to see if there are any complications in its ownership. If the search comes up clean, the company performing the search writes a title insurance policy promising to cover the expenses of correcting any title problems discovered after the sale.
Without a title search, you may not become aware of any liens or encumbrances until after you’ve bought the house. Once it’s in your name, you become liable for any debts attached to the property. The title search protects you by uncovering such issues before you buy the house, and the policy protects your investment against any claims resulting from an issue that was missed in the search.
You can find foreclosure properties listed on a number of sites, including ForSaleByOwner.com, bank websites, Fannie Mae and Freddie Mac. Another option is to pay for a foreclosure-listing service. Although there’s a fee, this is a good way to get a comprehensive national listing.
You can also visit the local county recorder’s office and investigate pre-foreclosure notices or Notices of Default. These are the first legal steps that lenders will take before filing for foreclosure.
These notices show the property owner, contact information and the lender, along with other characteristics of the home. At this stage, the lender may be open to a short sale request – but the owner must make the request, not you.
One of the most convenient ways to find short sales as potential investments is to check the listings on Auction.com. Here, the initial work has been done for you. The lender has already accepted a short sale request — all that’s needed is a buyer. Property details and photos are available for buyers to review before choosing to place a bid.
The process of closing on a foreclosure or short sale can be slow and unsteady, with many frustrating delays. But with a bit of legwork and patience, and your due diligence with your title company, you may secure yourself substantial savings on your new home.
Be prepared and be flexible, because disputed title and loan paperwork could sink the deal. Your title search might uncover some nasty surprises, but it’s better to discover those issues before you’ve purchased the property. Let your title company deal with it so you don’t inherit those liens and encumbrances.
To learn more about what title insurance is and why it’s important, watch “What Is Title Insurance,” a cool video designed to make understanding title insurance easy.
