Real Estate-Owned Homes for Sale: The Pros, Cons, and Steps to Buy One

Somewhere during the trials and tribulations of your home search, you might have heard real estate-owned homes for sale are deals worth pursuing. Perhaps you heard it from a friend who recently purchased their own home. Or, perhaps, you saw a catchy headline while perusing online listings. Either way, in a housing market that may at times look too daunting for buyers, you might believe it’s a shot worth taking.

The truth is: it depends. Real estate-owned homes for sale may be sold at a discount and can present an attractive path for some homebuyers. But they also may come with many potential challenges, including significant need for repairs, long closing timelines, and tricky financing. Unless you’re entirely prepared to deal with these types of homes, they may just produce more expenses and heartache than you’re willing to take on. That’s why it’s important to fully understand what real estate-owned homes for sale really are, what potential risks they hold, and how to do your due diligence to determine if you’re willing to take on the process.

We’ve talked with a veteran real estate agent who has flipped over 75 properties and worked extensively with bank-owned homes to bring you a comprehensive guide to these unique properties. So if you’re up for the challenge, you’ll be ready to compete with the best of them in finding a real estate-owned home that’s right for you.

What are real estate-owned homes?

Real estate-owned homes, also known as REOs or bank-owned homes, are properties that have gone through the stages of foreclosure, failed to sell at auction, and have been taken over by the mortgage lender, most commonly a bank. They arrive in the lender’s hands after the borrower defaults on the mortgage payments and, after the foreclosure proceedings, the bank takes ownership of the house. On some occasions, a property may become real estate-owned if a homeowner gives the lender the deed to their home in lieu of foreclosure.

You may also find REO properties owned by government-sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac. After all, both organizations are in the business of buying mortgage loans from banks and other non-bank lenders.

Interesting fact: The term “real estate-owned property” originally comes from a bank’s accounting terminology. Most banks have an “other real estate-owned” section on their balance sheet to list assets owned by the bank that are not part of their primary business. For example, a foreclosed property is now back in the bank’s hands and no longer produces any income for the bank. Eventually, the term was taken to label these bank-owned properties.

How do you find REOs?

According to Arizona real estate agent Kyle Keller, who has over 20 years of experience, real estate-owned properties are found everywhere, but you’re seeing less of them since the COVID-19 pandemic started. In June 2021, distressed sales, which includes REO sales, foreclosures, and short sales, represented just 1% of sales in the U.S, according to the Department of Housing and Urban Development. That’s because many states enacted foreclosure moratoriums that prevented lenders from evicting homeowners, especially those facing financial hardships, during the crisis. But Keller emphasizes they may become more common once those protections end throughout 2021.

However, for the real estate-owned homes that do come onto the market, there are several places buyers can look to find them. Let’s take a look.

• Real estate agents/ MLS database: Your best bet to finding real estate-owned homes for sale is through a licensed real estate agent, Keller says. Buyer agents have access to the MLS database, where agents can search for REO properties or other homes in foreclosure. Your agent will also walk you through the risks and challenges your specific REO home might hold.
• GSEs and government agencies: Fannie Mae has its HomePath program, Freddie Mac has its HomeSteps program, and HUD has HUD Homes.
• Bank websites: Many lenders have real estate-owned property listings available right on their websites. For example, Bank of America has a whole website dedicated to searching for REOs and foreclosed properties in certain states. This may be a good place to look if you’re just dipping your toes into REOs to see what’s out there.
• Specialty websites: Just like you can find websites focused on online home listings, you can find many websites focused on foreclosure and REO listings. Sites like Auction.com and RealtyTrac offer databases for real estate-owned homes for sale in your area.

Stages of foreclosure

As we mentioned, a real estate-owned property usually goes through several steps of foreclosure before it’s officially in the hands of the lender or bank. While the process may differ by state, there are certain general stages that are important to know when looking at REOs.

• Short sale: This isn’t necessarily a stage of foreclosure but an option to avoid foreclosure. A short sale is when a lender agrees to a sale of a property for less than the outstanding mortgage balance. The homeowner doesn’t have to be in default for a short sale, but they will usually have to prove financial hardship.
• Pre-foreclosure: When a homeowner fails to make their mortgage payment for a certain amount of time (usually three consecutive months), the lender will issue a notice of default. This is the beginning step for all foreclosure proceedings. Typically, a lender will give 90 days (again, it depends on state laws) for the borrower to get back on track with payments before proceeding.
• Sheriff’s sale or trustee sale: If the borrower doesn’t resolve the foreclosure within the 90-day grace period, they are given a notice that the house will be sold. The house will then go to auction, which is typically either called a “Sheriff’s sale” or “trustee sale,” depending on your state and the foreclosure proceedings. The bank will often have a minimum opening price that is not necessarily based on market value, but what it is trying to recoup from the mortgage loan it initially provided.
• Bank-owned properties: If the home doesn’t sell at auction, the property goes into the hands of the lender. Most banks have or contract REO specialists that will handle the house from here. They will ensure it gets back on the market, review offers, make sure the property is in good standing, and complete the transaction from the bank’s end. It’s not uncommon for homes to make it to this stage. In May 2021, lenders repossessed over 1,300 homes in the U.S., making them REO properties.
• Government-owned properties: While a government-backed mortgage, such as an FHA loan or USDA loan, may provide some protection or support during foreclosure, a borrower that defaults on payments still may face the possibility of losing their home. If foreclosure does occur, the government repossesses the house and sells it via government-registered brokers.

Are real estate-owned homes cheaper?

The biggest reason a buyer might seek out real estate-owned homes for sale is that they’re looking to score a good deal. But are they actually cheaper? The short answer is: usually, but it depends.

Keller, our Arizona real estate agent, says some REOs can be bought at a discount, at least compared to homes in the same area. After all, banks generally don’t want to have properties on their books that aren’t bringing in any money. So if a home doesn’t sell at auction, a bank may likely want to get rid of it, even if that means it’s at a lower price. In fact, REO properties sold at a 36% discount compared to the average home price in the U.S. during the third quarter of 2020.

At the same time, the deal might not always be as sweet as it looks on paper. Like any business, banks are looking to make money — or at least recoup their losses from the defaulted mortgage previously on the home. So, depending on the circumstances, they will still try to get a fair price for the home, meaning some REOs don’t come at the deep discount you might expect.

Risks of buying an REO property

Even if you can get a real estate-owned home at a good deal, there’s usually a trade-off. Let’s take a look at the challenges you might face.

They’re usually sold “as-is”

Most lenders sell their REOs “as-is,” meaning in the exact condition you find them. Unlike a typical seller who might be willing to negotiate on potential repairs or at least offer a credit, the bank will usually leave all of those potential issues in your hands.

They may be distressed

Keller warns that many REOs may be in rough condition, especially if they’ve sat vacant for a while. In most cases, you can still ask for a home inspection, but you’re most likely not going to receive a seller’s disclosure, Keller says. So it will be harder to learn the property’s history than it may be with a typical transaction.

Plus, if a home has been vacant, it might have been subjected to squatters and vandalism. Keller says he’s seen many real estate-owned homes for sale where the air conditioner units have been taken, as well as copper pipes and wiring stolen. That will only add to the cost of repairing the home.

“Once you figure out how much money it’s gonna take to get the home in good condition, you could actually end up spending more money buying an REO home than buying a regular home that’s already in good condition,” Keller says.

It may be a lengthy process

The average closing time on a home in the U.S. takes anywhere from 30 to 60 days. But when you buy an REO home, you’re not dealing with the average seller. You’re working with an organization that has rules, a hierarchy, and approval processes. That means the transaction and closing may be held up with delays — ranging from a few weeks to more than a month — and the potential for inconsistent communication, especially if the bank that owns the home isn’t local.

Financing may be tricky

Many banks and lenders will approve a loan for an REO home. However, financing may be tough to receive depending on the condition of the home, Keller says. That’s because many banks and government-backed loan programs have minimum standards a home needs to meet for mortgage approval.

Due to that, Keller says cash buyers might be better suited for an REO property, especially those who have the resources to make extensive repairs. That’s why investors tend to look at REOs. They may have the cash, time, and resources needed to pursue these types of homes that many traditional buyers don’t have.

How to buy an REO

Buying a real estate-owned home isn’t that much different than buying your average property, but there are some unique aspects. Let’s take a look at what those are and what steps you should take to protect yourself.

Get mortgage pre-approval

Getting pre-approved for a mortgage is beneficial in any home search. However, when buying an REO home, it can help speed up the process and potentially make you a more attractive buyer to the bank. This can be especially true if you get preapproved through the same bank that’s selling the home as this might streamline communications a bit as you work your way  through the transaction process.

Find a real estate agent

Again, a real estate agent is extremely valuable no matter the home you’re buying. But a knowledgeable buyer agent can help you find the right REO home, walk you through the challenges, and help you protect yourself throughout the process. An REO transaction can become all too confusing, but a trusted agent will tell you what’s worth pursuing and what’s too good to be true.

Research comparable homes

Before you make an offer, take a look at similar homes in the area and pay attention to what price they sold, Keller says. This will give you a good idea of what the REO may be worth and if the listing price is reasonable. It will also give you a better idea of what your offer should be. Keller also says to keep in mind any potential repairs you’ll have to do and the associated costs. It’s essential to look at the entire amount you’ll invest in the property, not just what the purchase price will be.

“Make sure that homes in that neighborhood in good condition aren’t selling for [less than your investment],” Keller says.

“At that point, you might as well just buy a traditional home in good condition.”

Make an offer

With help from your agent, your research should have given you an initial offer amount that makes it a good deal for you and fair for the bank. Now it’s time to go for it.

Include a cover letter that states why you’re interested in the home and why you’re the best choice for the bank. Keeping the amount as close to the listing price and with as few contingencies as possible may help you close the deal as well. And, if you’re willing, it may be helpful to state in your letter you’re willing to take the property “as-is.” The bank will most likely be looking for a clean offer that makes the transaction a little easier.

However, that doesn’t mean you should just give up any negotiating power you have. Keller says, like a traditional transaction, it’s still ok to ask for a home inspection. That way, you can include an inspection contingency and potentially back out of the deal if you find too many issues.

Protect yourself

Just like any average home purchase, there are ways to protect yourself in the process. Keller recommends getting a home appraisal and completing the home inspection, even if you’re buying the property in cash (if you’re financing, the lender will require an appraisal). Even if they don’t allow you to back out of the sale, they will at least provide you more information on what you’re getting into.

A title search to check for liens or judgments is helpful during this step, but not always necessary, Keller says. He says a bank-owned property will most likely have a clean title and no lien issues because the bank usually straightens that out during the foreclosure process, but you should always check to confirm.

Secure your financing

As we mentioned before, financing can be challenging with real estate-owned homes for sale, but it’s not impossible. If a conventional loan doesn’t work out, take a look at a few special programs that may help with bank-owned properties.

• FHA 203(k) loan: A 203(k) loan, sometimes known as a rehab loan or a construction loan, is a government-insured loan that provides financing for the purchase of a house and the cost to repair it. HUD’s FHA program sets certain requirements that need to be met. There may also be higher interest rates and mortgage insurance premiums you need to keep an eye on. However, since many lenders won’t approve financing if your home is in bad shape, this can be a good option for REOs that are fixer-uppers.
• Fannie Mae’s HomePath ReadyBuyer program: This first-time homebuyer program gives buyers up to 3% in closing cost assistance toward an REO home from Fannie Mae. You need to complete a homeownership education course before you can qualify, however.
• Fannie Mae’s HomeStyle loan: Like an FHA 203(k) loan, this type of renovation loan will cover the purchase price and repair costs. It will allow you to finance your purchase and at least a portion of your renovations all in a single mortgage. However, depending on your loan-to-value (LTV) ratio, you may have to complete a homeowner education course before getting approval.

After you have your financing approval, you should be all set to sail through your closing. Pretty soon, you will have your (previously) real estate-owned home in your own hands. And you’ll have all the information to know you made a sound, secure investment every step of the way.

Header Image Source: (Maximillian Conacher / Unsplash)