Real Estate Owned (REO)

Real estate owned, usually shortened to REO, is real property that a mortgage lender or a mortgage insurer or guarantor owns because it took the property back from a borrower who defaulted. The label comes from bank accounting: a national bank's regulator defines the category it calls other real estate owned as real estate "acquired by a national bank or Federal savings association through any means in full or partial satisfaction of a debt previously contracted," plus former bank premises (12 CFR 34.81). For a home buyer, an REO property is simply a home whose seller is the institution that held the mortgage, or the agency that insured it.

REO is the last stage of a defaulted mortgage, and it is easy to confuse with the stages before it. In a short sale the homeowner still owns the house and sells it with the lender's agreement to accept less than the balance. At a foreclosure auction the property is sold to the highest bidder before the lender ever owns it. A property becomes REO only when neither of those produces a buyer, or when the borrower gives the lender a deed in lieu of foreclosure, and the lender or insurer ends up holding title.

Who sells REO. A bank may hold REO on its own books and list it with a real estate agent. Fannie Mae and Freddie Mac, which own or guarantee mortgages, also end up holding and selling REO. And HUD sells homes that lenders convey to it, to be paid under the FHA insurance, after foreclosing on FHA-insured mortgages; these are the "HUD homes" listed on HUD's Home Store site, where buyers must bid through a HUD-registered selling broker.

HUD's bidding periods. HUD reserves an exclusive period during which owner-occupants (individuals who have not bought a HUD home as an owner-occupant within the past two years), government entities and approved nonprofits may bid and investors may not: 15 days for homes that can be financed with FHA insurance, 5 days for those that cannot. Investors can bid only in the extended period that follows. HUD's Good Neighbor Next Door program, formerly Teacher/Officer/ Firefighter Next Door, goes further for eligible buyers on single-unit homes in designated revitalization areas: HUD's own example is a home listed at $100,000 that a qualifying buyer can purchase for $50,000 by living in it as a personal residence for 36 months.

Title and liens. How the institution acquired the property matters to what comes with it. A completed foreclosure sale generally extinguishes liens junior to the mortgage being foreclosed, which is why a lender that buys at its own sale generally ends up with title free of second mortgages and any home equity line of credit. A deed in lieu involves no sale, so the lender takes the property subject to every other recorded claim against it. Whether every lien has been cleared is what the buyer's title search and title insurance confirm, and they matter more on a property whose history includes a default.

What is different about the purchase. The seller never lived in the home, so it may be unable to answer questions an owner-occupant could, and it may decline to make repairs, sell the property in its current condition and use its own addendum that overrides parts of the standard contract. A home inspection is the buyer's main protection. Financing works as it does for any purchase, and some government-related sellers are exempt from paperwork other sellers must sign: HUD's handbook lists HUD real-estate-owned sales, sales by Fannie Mae, Freddie Mac, VA or another government agency, and sales by a mortgagee disposing of real-estate-owned assets among the sales that do not need FHA's amendatory clause.

A defaulted loan ends in a foreclosure sale or a deed in lieu. If the lender or insurer ends up with title, it secures the property, decides whether to repair it, sets a list price and sells it through an agent or, for HUD homes, through bidding on HUD Home Store. The buyer makes an offer, often on the seller's own forms, obtains financing, and closes with the institution as seller.

Consider an example of why the route to REO matters. A borrower owed $260,000 on a first mortgage and $40,000 on a home equity line of credit. If the first lender forecloses and takes the house at its own sale, the $40,000 line is generally extinguished by the sale, and the bank lists a home with clean title at, say, $245,000. If the borrower had instead given the first lender a deed in lieu, the lender would own a house still subject to the $40,000 line, and it would have to pay off or settle that lien before it could sell with clean title, which is why a second lien can lead a lender to refuse a deed in lieu in the first place. A buyer looking at either listing relies on the title search to show which of those happened.

Pros

• An institutional seller wants the property off its books and may price it to sell.
• A home acquired through a completed foreclosure sale generally comes free of junior liens.
• HUD homes give owner-occupants an exclusive bidding window before investors.
• Buying from an institution avoids negotiating with a homeowner in financial distress, as a short sale requires.

Cons

• A property may be sold in its current condition, with no repairs and limited disclosures from a seller that never lived there.
• Vacancy can mean deferred maintenance, winterization damage or missing fixtures, which an inspection may not fully reveal.
• An institutional seller may use its own contract addendum, which can shorten deadlines or limit remedies.
• Bidding rules on HUD homes require a HUD-registered broker and can take longer than an ordinary offer.