Thursday, March 13, 2008

Foreclosure Risks: Read Those Bank Addenda!

I get a lot of questions on foreclosures. How could I not? Some neighborhoods are flooded with them (though some are not...see the graph in my post on Beyond Auctions.) Buyers want to know if they’re a good deal, what the risks are, and how they can get in on one.

I’ve decided to write a series of posts on the risks specific to buying foreclosures—trust me that there are too many risks to put into one post! Some risks can be mitigated, some can be eliminated, but most remain; that’s part of the trade off you make in deciding to buy a foreclosed property.

First, a quick overview on the process. (For a review of how a home moves from short sale to auction to REO, read the post “I want to buy a foreclosure.”) Once a home is foreclosed upon, also known as Real Estate Owned or bank-owned, it is usually listed in the MLS with a listing agent, similar to any other home for sale. It will usually be noted right in the comments that this is a “bank owned property” or “special addenda required.” What is this special addenda?

When you decide to make an offer on a foreclosure, you put together the offer using the standard regional forms, just like any other resale (though not the same as new construction—for those you use the builder’s contract.) You include any contingencies or other negotiables you want—home inspection, seller subsidies, etc. Then you send it off to the listing agent, who sends it to the bank. The bank’s representative may respond right away, they may throw it into a pile to see what else comes in, or they may not do anything. (So controlling the timing becomes a big risk of a foreclosure, but I digress.) Let’s say they get back to you and let’s assume they even agree to all of your terms. They’ll return it all with a copy of their own Bank Addendum. An addendum is simply the legal term for a condition that amends the main contract. Even “regular” resales have a half dozen addenda-- for home inspections, appraisals, and to meet jurisdictional requirements. Bank Addenda are written by the bank’s lawyers to protect themselves during foreclosure transactions. Any guesses on which side they favor?

Every bank’s addendum is different, and it’s critical that you read and understand every clause prior to signing it. Because it’s an addendum, which amends the main contract, it doesn’t really matter what you think you negotiated—anything in the addenda trumps the main contract. Think you negotiated an inspection but the addendum says no? Or what if the addendum says you can inspect but not void? The addendum wins the day. A lot of good that inspection does you if the home inspector says the place needs to be demolished by you aren't allowed to walk away.

Unless you sign the addendum, there’s no deal, so you can still get out if you don’t like what you read. Occasionally, on some clauses, you may be able to negotiate certain clauses, but that increases the likelihood of slowing down the process—after all, some guy in a cube in Idaho (no offense, readers in Idaho) has to get that change sent to the bank’s lawyers to review, and I guarantee that those lawyers have their hands full with all their other foreclosures right now. If you decide to live with the clauses, then once you sign the addendum, the contract proceeds as is more typical.

There are many examples of egregious clauses, but here are a few of my favorites:

- The bank may not own the property and may not be able to go to settlement. You may be required to go to settlement even if the bank cannot deliver the deed at that time.

- The bank may guarantee only insurable title, not marketable title (more on that in another post)

- The bank may give themselves the right to change their mind and walk away at any time up to settlement for no penalty

- There may be easements or restrictions on the property that aren’t recorded; if you find one, the addenda may prevent you from backing out of the contract as a result

There are many more, as these addendum often run about ten pages. Because they are written to apply nationwide, there are occasionally even clauses that are illegal in Virginia!

So read those addenda carefully, and caveat emptor on this foreclosure pitfall. It’s a doozie.

I’ll continue the series with future posts on these other critical risks:

- Lack of control over turnaround and the dependent risks it creates for buyers (and not just your move date)

- Inspections, repairs, and warranties

- Financing complications (Don’t rely on using an FHA loan!)

- Title and deed issues

- Condo/HOA docs

Have another risk you want addressed? Add it in the comments and I’ll write about it.

Are you thinking about buying a foreclosure and want to know the risks you’ll face? Contact me to discuss the risks and some mitigation strategies.

Read the second post in the series, about the challenges in controlling the timing of a foreclosure transaction, here.


Anonymous said...

Good post. You're right about those addenda. They can end up being quite a bit longer than the sales contract itself, and are all written to protect the bank from future liability. They should always be read by the potential investor, too, since there will be a lot of outrageous clauses.

Unknown said...

This is right on the money. I made an offer a few days ago for a foreclosed property and received a 12 page addendum from the bank containing a combination of redundant, outrageous, and even contradictory statements (e.g. page 1 and page 3 state different lengths of time for a home inspection). An attorney helped me sort out what needed to be changed and I made edits to make the contract consistent and submitted the modified addendum to the bank yesterday. I don't know yet if they will accept my modifications or even respond any time soon, but it was better to risk losing the sale than buying something the bank doesn't even own or singing a contract that almost guarantees that I will be in default and have to forfeit my deposit!

Katie Wethman said...

Noah and foreclosure fish - thanks for sharing your experiences! Curious to hear your thoughts on my other related posts on financing risks and condition risks as well if you get a chance. Thanks again!

Anonymous said...

I was glad to see your post, although I am looking for a house in California, rather than DC.

I was shocked when our Buyer's Agent presented us with the bank's addendum which carefully detailed how we were welcome to inspect but couldn't cancel regardless of what we found and couldn't get out of the contract even if the bank couldn't present us with a clear title.

Worse, our real estate agent was angry with us for not wanting to sign and really put the pressure on. She told us that the addendum was just a formality for the bank to cover its butt, and that we would still have some legal rights.

We didn't (and won't) sign without serious modifications to the addendum. We like the house but not that much.

One more thing in the contract. If it goes beyond the closing date without closing, we owe the bank 1/10 of 1 percent of the cost of the property per day, until the actual close. This amounts to more than $400 per day.

Katie Wethman said...

Thanks for your post Jasmine. Those types of clauses are very common. That's too bad about how your agent handled it though. With some creative thinking and the right attorneys involved it's entirely possible to mitigate your risks *almost* completely, even without changing the addendum, since changing the boilerplate language in those is frequently a non-starter for banks.

Unknown said...

I thought it might be helpful to provide an update on my earlier post: After a few days I ended up getting the bank to agree to all of my changes, and I was no longer signing a contract that would be impossible to avoid defaulting on. To conclude the story, however, about a week before my closing, I decided that A) in the month since my offer, I felt less confident in the price as other properties in the area were still showing declines and B) I realized I hadn't thought enough about the inconvenience of the move (I live across the street from work, and this would have turned into a 20-30 minute commute depending on traffic, and I was planning on having 2-3 tenants which would have caused all kinds of other issues and responsibilities). What started out as a moderately good investment turned into a questionable one (even at 36% below the previous sale price 2 years earlier) with a lot of hassle, and I cancelled the contract (I was able to do this because the bank had neglected to provide me with the HOA documents, which meant I could cancel with no penalty). In the end I only lost my mortgage application fee and inspection costs, which amounted to substantially less than the cost of a real estate course that would have taught me much less (and 2 months later the property finally sold for 7% less than my offer). I'm still watching the market and looking mostly for an investment property to rent out, but I learned to trust my instincts and never to sign something that I am not comfortable with, because if it really is unreasonable, it should be possible to convince the other party that it needs to be changed.

Anonymous said...

Does any Maryland real estate agent know what forms go with a foreclosure condo contract. I have been given noting by the listing agent, just told to send the contract only as the bank was going to send their own version back. What about inspection my client wants and right to see HOA docs ahead of time. HOA docs can always get you out or the inspection? Help!

Katie Wethman said...

Anonymous, you've stumbled onto some of the very common, and very frustrating, parts of writing on a foreclosure. The process works a little differently with a foreclosure. You should check with your broker for more information. If you want to email me directly I will share my experiences working on foreclosures with you (I'm licensed in DC, MD, and VA).

Unknown said...

Hi there! thanks for the post! I have a similar case that the bank sent a 10 page addendum! One of them being that the bank can walk out anytime from the agreement, wnd we can't. And also the loan money should arrive one day before closing, instead of on the day of closing (wonder why?). WHich attorney should I pick to read this addendum? Is there a special one? and if I don't contact an attorney, what should I do to change the addendum? should I just tell my realtor to change it?
my realtor is not really experienced with this foreclosure, but act like she does :(

Katie Wethman said...


Sorry that it seems you are in a tough spot with your agent. The clauses you describe are very common, in fact. My advice to you would be to go to your agent's supervising broker and ask for assistance from him/her and/or ask them to assign another agent in the office with more experience with foreclosures. Your agreement is technically with the broker, not any individual agent, so the broker should be able to accommodate you.