FINANCING FORECLOSURES

Over the last decade mortgage options evolved, having dual effects: providing opportunities for more real estate buyers and an increased risk of mortgage defaults. In the immediate past, just about anyone seeking a mortgage could successfully find a program to accommodate a variety of situations and/or circumstances. From low FICO scores to no money down programs, the possibilities were endless. The subprime market was booming and the number of buyers increased exponentially. As the demand for properties escalated, so did prices/property values. According to the Case/Shiller Home Price Index, the property values (national average) rose from $109.638 in 1997 to $202.819 in 2006. Those figures represent an 85% continual increase compared to the highest increase of 16% during the 1987-1996 time period. However, issues began to rise when the interest rates increased on the adjustable rate mortgages (ARMs) that a large percentage of buyers obtained. These rate increases resulted in mortgage payments that were 25-100% higher that these buyers were accustomed to paying and/or could afford to pay. Most of them were depending on property values continuing to increase and interest rates to remain relatively low.   

Yet as a result, we are seeing what is being labeled the “mortgage meltdown”. Many people have lost their properties, many are currently in jeopardy of losing their properties and it is being projected that many more will lose their properties in the coming months. In addition, many of the lending institutions have gone under and those that are still operating have drastically altered their lending guidelines. The no money down, no income/asset verification programs are a thing of the past. The market has been saturated with a surplus of properties and the number of qualified buyers has decreased, leaving sellers to adjust prices – with a majority of properties being sold for pennies on the dollar. This is definitely not the best situation for the real estate market and economy overall, but it is music to both homeowners’ and investors’ ears.
 
So let’s begin with some general variables for dealing with foreclosed properties. There is a major variable, “bailouts”, that financial institutions consider a major negative. A bailout involves a transaction where the current property owner is behind on the mortgage payments and the foreclosure process has begun. In an attempt to savage the property, the owner finds a fictitious buyer to bail them out of their current situation by purchasing the property. Usually in a bailout situation, the property owner that was in foreclosure continues to reside in the property and make monthly payments to the buyer until they are able to repurchase the property. The buyer may negotiate an up-front fee and/or rental income that yield a monthly cash flow. Now I know you are thinking, how will the financial institutions know if it’s a bailout situation? Good question, the only way the financial institutions will know about a bailout situation is if there isn’t an “arm’s length” transaction. An arm’s length transaction is one where the seller and buyer are related or associated in some form or fashion. This is usually determined if the parties have the same last name or if a similar relationship can be proven. If not, and the new buyer qualifies for the loan program, the transaction is a go. Savvy investors have been very creative in these circumstances to lower risk, while creating a win-win situation for all parties. On the same hand, many homeowners have been victimized by unscrupulous investors and have had their properties/equity stolen from under them.
 
Additionally, another variable that lenders caution involves properties that are located in “declining markets”. Today declining markets exist in most communities, therefore lenders place a lot emphasis on evaluating the appraisal. According to Fannie Mae, each appraisal should be carefully reviewed to ensure the appraiser has appropriately analyzed property value trends and overall market condition to arrive at the value provided. More detailed requirements stress that the loan be processed in an Automated Underwriting System (AUS) that defines the risk in the area where the property is located and a suggested value. If there have been multiple foreclosures in a given area, the property will most likely have a declining value. If the value defined by the system is lower than the appraised value, the lender may require a third party Broker Price Opinion (BPO). The BPO report is usually done by a local realtor or specialist who has a vast knowledge of the area where the property is located. The financial institution will compare the findings from all three reports to comprise a value that will be used to determine the loan amount.
 
There are several variables involved in the loan application process. The emphasis here is on conventional/FHA financing, since non-conventional programs are rapidly dwindling. Let’s look at the requirements for properties that are in move in condition and/or may need minor repairs. If the property is owner occupied (property the buyer will live in), the lender will require a minimum of 3-5% down. Generally, we are looking for a 620+ credit score, a documented/verifiable income source with a total monthly obligation expenses to income ratio at or below 36%. Debt to income ratios can be higher if approved by an AUS factoring in other variables. The seller can contribute up to 3% toward closing costs and 2-6 months PITI (principal, interest, taxes & insurance) payment reserves or funds left over after closing.
 
As far as government financing, FHA is KING for the purchase and refinance of owner occupied 1-4 unit properties. It is the best program available today. FHA requires a 3% down payment (the funds can be a gift from family members or a down payment assistance program). FHA is not credit score driven, however there are very few lenders that will approve applications with credit scores below 580. All court ordered judgments must be paid off, but collections accounts do not. If the buyer has collections or judgments, a letter of explanation (LOX) must be included in the file. The buyer must have a documented/verifiable income source with a general total monthly obligation expenses to income ratio at or below 33%. As with the conventional financing, the ratio can be higher if approved by an AUS factoring in other variables. The seller can contribute up to 6% toward closing costs and cash reserves may vary depending on the overall loan package.
 
Conventional financing options for investors require a minimum down payment of 10% for 1-2 unit properties and 25% down for 3-4 units. Generally minimum credit score requirements can be as low as 620 and as high as 700, depending of the logistics of the deal. The borrower must have financial reserves equal to at least 6 months PITI mortgage payments. When multiple mortgages are made to the same borrower, there is a ten mortgage limit and the borrower’s total liquid assets must be sufficient to satisfy the reserve requirement for ALL of the mortgages. (We will discuss FHA financing for investors shortly and YES investors can utilize FHA financing!)
 
Now as you are probably aware, sometimes foreclosed properties have been trashed by previous owners or experienced major deterioration due to neglect. In these instances, the properties don’t meet the financial institution’s program requirements and in some cases larger down payments are required. However there are financial institutions that offer programs that advance funds to cover the purchase and renovation of the properties. These are called renovation loans and they can be used for owner occupied and investment properties. HUD offers the FHA 203(k) renovation program that can be used for owner occupied 1-4 units.  In addition, there are conventional renovation programs resemble the FHA 203k program. We will discuss renovation programs in detail next month.
 
REO Properties
During your quest to secure foreclosed properties, another option may be to look into Real Estate Owned (REO) properties. REOs are foreclosed properties that were not sold before or at the foreclosure auction and are still owned by the financial institutions that held the previous mortgages. Because financial institutions are in the money business and not the buying and selling of real estate business; in the instance they acquire real estate, the ultimate goal is to get rid of the property and recoup their financial losses on the defaulted mortgage. They normally hire a real estate broker to assist with the sale of the REO properties. Some financial institutions even post their REO properties on their websites.  Buyers interested in purchasing these properties should first attempt to obtain financing from the financial institution that holds the property. This information can be obtained from the listing agent or public records. If the buyer qualifies, a considerable amount of money on closing cost can be saved and/or financing at a slightly lower interest rate may be obtainable.
 
Foreclosed properties that are held by the Department of Housing and Urban Development (HUD) and have mortgages that were insured by the Federal Housing Administration (FHA) is another option. As with REO properties, substantial savings on closing costs are available if the buyer qualifies for an FHA loan. This is a viable option for both owner occupied buyers and investors. The requirements are the same as discussed earlier for owner occupied buyers. However for investors, the requirements are slightly different. HUD requires investors to bring a 25% down payment for single family units and a 15% down payment for 2-4 units. Please note, this only applicable to investors that purchase HUD owned properties.
 
If you are looking to finance foreclosed properties, contact a qualified banker or loan officer. The requirements and criteria will vary depending on the financial institution and the program.

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Anita Clinton is an Illinois licensed loan originator.  Visit her website at www.OwnSomethingToday.com or call her 888-842-9732.  This article and other practical and useful information for real estate investors can be found at www.InvestWithPassion.com. 


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