Think twice before buying REO, short sale

Buyers want bargains. Some even limit their search to REOs and short-sale listings.

REO, or real estate-owned, refers to a property that a mortgage lender acquired through a foreclosure. It's owned by the bank. A short sale refers to a situation where the sellers still own the property but they can't sell for enough to pay off the mortgage(s) and costs of sale.

There are pros and cons to buying distressed sale properties. They often sell below market price. However with REOs, there is usually very little information about the property and no seller disclosures.

Banks that hold REO properties usually have an infrastructure in place to deal with these transactions. Lenders are motivated to get REOs off their books so they can put the money to better use.

But, there's no emotion involved. What's important to the lender is the bottom line. So be prepared to negotiate. Save a concession or two to add to your offer, like a higher price or a quicker close.

Unless the listing agent convinces the bank to do fix-up before selling, the property could need work. If so, it won't appeal to as many buyers and could be a good opportunity for buyers with vision.

Short-sale properties also tend to have a lot of deferred maintenance. If the sellers are having trouble making the mortgage payment, there may be no funds for fix-up.

A big frustration for buyers and agents working short-sale transactions is that many lenders don't have systems in place to deal with them. This situation is improving as more short sales move through the pipeline.

Some lenders are easier to deal with than others. Lenders who hold mortgages in their own portfolio are usually quicker to make a decision. Lenders who sold their loans may need investor approval before accepting an offer.

HOUSE HUNTING TIP: Buying a listing that's subject to lender approval requires patience on the part of the buyers, sellers and their agents. It can take three to four months to get an answer. There's no guarantee that a short-sale offer will be approved, and it's not uncommon for lenders to reject a purchase offer without giving a reason why.

Most lenders won't even consider taking less than they're owed until there is a signed purchase agreement and the buyer's deposit has been placed in an escrow or trust account. The lender needs a settlement sheet prepared by the closing agent before they'll consider the package. Bank approval usually depends on the net price, the buyers' ability to pay under the terms of the contract and a bank ordered appraisal of the property.

Short-sale properties that have more than one loan secured against them can be problematic. They require approval from more than one lender. In some cases, the market value is so low that the sale won't generate enough money to pay off the first loan and nothing at all to pay to the second mortgage holder.

Sometimes lenders will grant conditional approval. For example, approval might be conditioned on the seller converting an amount owed to the lender(s) to an unsecured loan that would be paid off over time. If the seller won't agree, the transaction fails.

An offer to buy a short-sale property should include a provision that allows the buyers to withdraw from the contract without penalty if the seller is unable to verify lender approval by a certain date. Be aware that until a deal is approved, the lender will review other offers that might be made.

THE CLOSING: One benefit of a short sale over an REO listing is that the buyers may be able to obtain more information about the property, particularly if the sellers are still living there.

Dian Hymer is a nationally syndicated real estate columnist and author of "House Hunting, The Take-Along Workbook for Home Buyers" and "Starting Out, The Complete Home Buyer's Guide," Chronicle Books.

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