Wednesday, March 19, 2008

Foreclosure Risks: Property Condition & Inspections

One of the most common scenarios in a bank owned (or REO) sale is that the property is “as is.” But most people don’t understand exactly what this means, or how to protect themselves from buying a home that may need tens of thousands in repairs.

Let’s back up a moment, and put “as is” in the context of a “regular” (i.e., non-REO) sale. “As Is” is a commonly misused term. We first must understand the home inspection process and one particular paragraph in the regional sales contract – the Property Condition paragraph, also known as paragraph 7 (because it’s literally paragraph #7 in the contract…sometimes we agents aren’t all that creative.) Paragraph 7 indicates that the systems of the house, including plumbing, electrical, and appliances, must be in “normal working order.” Unless the parties agree to strike through this paragraph, that means the seller must ensure all of those systems work at the time of settlement.

Beyond that, buyers may wish to also get a home inspection (highly recommended). If the home inspector notes items related to plumbing, electrical, or appliances that are not in “normal working order” then the homeowner must fix these—they’ve already agreed to based on paragraph 7. Any OTHER items the home inspector may find—e.g., foundation problems, roof problems, window/door problems, etc.—are negotiable.

Sometimes a listing will be marked “as is” but technically, unless they’ve crossed through paragraph 7, or unless an addendum supersedes paragraph 7 (see Bank Addenda post here.), then the seller is still obligated to fix those systems of the house indicated in that paragraph. They’re simply telegraphing to potential buyers that they will not repair or provide a credit for any additional items.

In a foreclosure, banks always say “as is”, and most Bank Addenda trump any inspections that you may think you’ve negotiated. The last thing a bank needs is the back and forth negotiating to give a buyer a small credit for some electrical problem—they’re way too busy and have tons more foreclosures to get off their books. Most banks though, do not have a problem with you having a home inspection; they just want a “go or no go” decision immediately following. You either take it as it is with the inspection findings, or void the contract. Tip: Even when a bank allows you to do an inspection, make SURE it includes a “right to void” based on the results!

You should always try to get an inspection so you know what you’re getting into with an REO property. It’s a sad fact that many frustrated borrowers take out that frustration on the property on their way out the door. (Read a WSJ posting discussing that approximately half of all bank-owned properties have "substantial" damage inflicted by angry homeowners prior to vacating. ) Often the repairs are simply cosmetic—a good scrubbing, some patched drywall, missing cabinets or appliances, or a fresh coat of paint—and those are good opportunities for a quick bargain. But structural and mechanical issues can easily run into the tens of thousands of dollars. And once settlement occurs, you have no claim against the seller, even if there was a problem that wasn’t disclosed to you (unlike other transactions). So remember that taking on that additional risk requires an additional reward, in the form of a very discounted price; otherwise that bank owned property isn’t such a good deal after all.

Read about some other risks of foreclosures here:
Foreclosure Risks: Title Defects
Foreclosure Risks: Bank Addenda
Foreclosure Risks: Unpredictable Transaction Timing
Foreclosure Risks: Financing Complications