Saturday, March 15, 2008

Foreclosure Risks: Unpredictable Transaction Timing--Don't Pack Those Boxes Yet!

I’m often asked about the risks involved with buying a foreclosure. This is the second post in a series of as-yet-undetermined size. (Have a question on the risks? Contact me.) The first post on REO Bank Addendums covered the all encompassing risk—the risk that the bank can basically do whatever they want, including walking away at any time with no penalty, if you’re not very careful with what you sign. That addendum always includes one or more clauses protecting the bank if they are unable to meet certain deadlines—like actually proving they are the owner (oh, do I have to OWN the property before I sell it?) before settlement. These broad clauses lead to our second major category of risk: controlling the timing of the transaction.

In a typical transaction, you make an offer, the seller takes a day or so to review it and either a) accept, b) counter, or c) reject. If you’re concerned that a seller might be “sitting on the offer” to wait for a better one, or even “shopping it around” by calling all the agents who have previously visited the property to see if they can scrounge up a competing offer, then you might consider including an expiration or exploding clause. These clauses state that the offer will expire by x time and date if not responded to in writing. It’s a great way to protect a buyer and maximize your chances of a quick turnaround.

However, with a bank owned property, the bank takes as long as they darn well please. Might be a day, might be a month, might be several months. They don’t really care about your expiration clause. Well, maybe not that they don’t care, it’s just that they’re a big corporate entity, and your offer is likely to be sitting in a pile of paperwork that needs to get done asap, but the individual sitting in a cube somewhere really doesn’t have the right incentives to make sure he gets to your offer today, or tomorrow, or the next day.

In the meantime, you’d be wise to keep looking at properties to see if there’s anything better that catches your eye. As a buyer you have the right to withdraw your offer anytime before the bank gets back to you. In reality, the bank’s response will NEVER be an “accept.” Rather, it will ALWAYS include that pesky Bank Addendum that you will have to read (please, I beg of you, read) and sign before your contract becomes official.

Once you’re ratified, is it time to give notice on your lease and call the movers? Hardly. Remember one of the common clauses is for the bank to give themselves the right to back out at any time. I’m not saying the bank does this out of malice…there are a million reasons (deed issues or delays are common) the bank might be very willing, but simply unable, to proceed to settlement. (You’d be out the cost of your appraisals, inspections, moving deposits, etc in this case.) As an aside, you can be sure that one of the clauses in that Addendum imposes a hefty daily financial penalty on the buyers if they aren’t ready for settlement on time, so apparently what’s good for the goose is NOT good for the gander.

Other than not being sure when to start packing, this open-ended timing creates issues with financing. Most loans are locked for just 30 days, and after that you need to pay a fee to maintain the lock. If you pay the fee, you may be out that money and never close. If you don’t pay it, and rates change, you may be in an even worse situation—in fact you may not even qualify for the loan anymore if rates change too much! Make sure you fight hard for a financing contingency that will protect you in the even that settlement gets delayed. (Side note—often banks will offer to give you financing in the event of problems…but they never specify the terms!)

So when can you start making plans? Not until the deed has been recorded, which is typically the day after settlement. Yes, you read that right. Don’t make any plans to move until a day AFTER SETTLEMENT OCCURS.

If your lease is up soon without the option to go month-to-month, make sure you have a back up plan for where to stay in the event of unforeseen delays. The timing risk can be partially mitigated by 1) continuing your search knowing you have the option to walk away and 2) keeping a financing contingency. But chances are strong that you’d incur extra expenses, along with sleepless nights, along the way.

Thinking of buying a foreclosure? Contact me to discuss the other risks and how you might be able to mitigate some of them. Remember, it's not a bargain if you're taking on too much risk for not enough reward.

Read the next post in the series on Foreclosure Risks: Property Condition & Inspections

Read more on the differences between short sales, foreclosures, and REO properties.

Read the first post in the series--risks related to Bank Addenda--here.

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