Bargain-hunters beware!

With foreclosures up sharply in the Portland metro area and prices off 15 percent from the market highs of a few short years ago, bargain-hunters are out in full-force. A good number of these shoppers are first-time home buyers, anxious to take advantage of the market downturn. But buyers should tread carefully when it comes to “real estate owned” (REO) properties.

Often sounding like no-brainer deals with drastically reduced prices, REO’s entice new buyers and seasoned investors alike. But bidders beware!

Take the case of a recent client, an enthusiastic young man who managed to find a house he could afford, a too-good-to-be-true steal at $45K. By the time he got to me, he had paid $3000 by credit card to make a pre-auction bid on the home through a national real estate auction house. His accepted bid required a lump-sum payment of the $45K within 30 days or he would forfeit his earnest money. His plan: obtain FHA financing within the allotted time, in effect financing his purchase.

As I scrutinized the “Auction Sales Agreement” his realtor produced, these thoughts crossed my mind:

“Let me see… you bought a steal of a deal that’s going to auction, but there are NO SELLER’S DISCLOSURES provided and NO CLAUSE VOIDING THE CONTRACT IF YOUR FINANCING FAILS.

The sales price is $46,095. The appraised value is $50,000. Instant equity? Seems like a good thing so far.”

In a few days the appraisal arrived. That’s when I discovered that the property had been part of a bankrupted homeowner’s association that failed to maintain the community water and sewer systems. The systems had so deteriorated that the City of Portland was assessing each house for $19,000 for water and sewer connections.

Again, my thought process:

“Okay, so the $19,000–which is, after all, 38% of the value of this property–can be financed by the city. But when we add that to the FHA loan balance of $44,481 (96.5% of the sales price) and include the mortgage insurance of $400, it means that within 12 months you will owe $63,881 on a house worth $50,000.”

Unfortunately, as a pre-auction REO, the Auction Sales Agreement does not contain the buyer safeguards normally found in a real estate contract. My client did not have the benefits of backing out of the deal after viewing a seller’s disclosure, which would have red-flagged the pending water and sewer assessment. Nor did he have the customary 10 day inspection period, let alone the standard fail-safe clause guaranteeing the buyer’s earnest money be returned should he not qualify for a mortgage.

As I pondered the predicament that, after closing, my client would owe nearly 130% of the property’s current value, I thought, “Haven’t we done this before? Aren’t loans that exceed the property’s value what got us into trouble in the first place?   And, when is a ‘deal’ not a deal?”

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