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How to Buy a Foreclosed Home:

Danger, Danger…What to Look Out For When Buying a Foreclosed Home!

1.28.09

Nash & Lodge, PLLP

By: Stephen J. Nash

nash@nashandlodge.com

I. Before signing a Purchase Agreement

Prior to submitting an offer to buy a home, there are a few things a buyer can do to help reduce the buyer’s risks involved in purchasing a Bank (or lender) owned property.

A. View the Property

Are you able to view and walk through the home before making an offer? If not, having an inspection contingency in the purchase agreement becomes extremely vital since the risk in purchasing becomes higher.

B. Check for Issues with the City

You can check with the city to determine if there have been any citations or orders against the property.

1. The police often know about vandalism;

2. The fire department often knows if the pipes have burst in a home.

C. Check out the Neighborhood

Are there other foreclosed homes in the neighborhood? Have you talked to the neighbors about the premises? You can often learn a lot about the property by what is going on around the home and by what the neighbors have to say.

II. The Purchase Agreement

In Minnesota, most realtors use the standard MAR residential real estate purchase agreement, but when dealing with a lender owned property, the lender will often demand that you use their purchase agreement or that an addendum is attached that has control over your entire purchase agreement.

A. Not Your Standard Purchase Agreement

Do not assume that the lender’s purchase agreement or addendum is remotely similar to forms commonly used in Minnesota.

1. The terms are often confusing since the agreement was drafted in another State and uses terminology quite different than what is used in Minnesota or is just poorly written.

2. When a lender’s addendum is used confusion can arise when the terms of the addendum conflict with the terms of the purchase agreement in that it can be difficult to determine whether the addendum clause was meant to supplement the purchase agreement clause or to entirely replace it.

3. The purchase agreement or addendum required by the lender in almost all cases creates an “As-Is” purchase for both the condition of the property and the title to the property.

4. The purchase agreement or addendum required by the lender in almost all cases contains language that allows the lender to cancel the purchase agreement at any time without penalty.

5. The purchase agreement or addendum required by the lender in almost all cases contains language imposing daily monetary penalties on the buyer if the buyer does not close in a timely fashion.

B. As-Is Condition of Property/As-Is Condition of Title

These transactions are truly as-is deals. In most cases, the buyer has no recourse against the seller, even if title problems exist. Since the buyer has no recourse once he/she closes, the buyer must fully satisfy himself/herself prior to closing as to the condition of the property and title. This constitutes a much greater risk for the buyer than does a standard purchase.

C. Property Inspections

Since these are “as-is” transactions, the property inspections are essential. In addition, since the property went through a foreclosure it is highly probable that the home was not maintained or may have been abused.

1. Make sure you have ample time for an inspection and any required report.

2. Make sure the inspection is sufficient for the property. A visual inspection is not enough if the property potentially has severe issues.

3. Is there a possibility of mold or water damage or is the buyer willing to take the risk without having a more in depth inspection?

4. Will the inspector stand behind the inspection? Is there liability limited (often the inspectors’ damage is limited to the fee paid by the buyer)? Do they have insurance coverage?

D. Who is the Seller

This issue sounds simple but is not always simple in these types of transactions.

1. The real estate broker/agent merely represents the seller. The company that hires them may be some type of servicing company and is not the actual lender. Even the lender shown on title may be a company that is servicing the loan for the actual company or companies that own the loan.

E. Purchase Agreement Not Binding on the Seller

Does the Agreement require a committee or someone else to approve the purchase agreement before it can become valid?

1. Is there a time frame specified for this approval?

2. Is the buyer required to spend any money prior to receiving an approval?

3. Even after approval, can the seller cancel the purchase agreement without any reason?

F. Occupancy Clause

Does the seller warrant that the property is unoccupied or is the purchase agreement subject to the possibility that the property is occupied?

1. If the property turns out to be occupied, the buyer will need to bring an unlawful detainer action to evict the occupying party.

2. The occupying person may be the prior owner, a renter or simply a “squatter” but in each case an unlawful detainer action is necessary if they refuse to vacate.

G. One-Sided Default Clauses

Look closely at the default clauses since they always tend to be one-sided in favor of the seller.

1. Is there an attorney fee clause that only works in favor of the seller?

2. Does the agreement allow the seller to cancel the transaction for any reason?

3. Does the purchase agreement contain a penalty for a delay in closing? Does this penalty clause apply only to the buyer?

4. If the seller says the buyer is in default, does the agreement provide for who gets the earnest money?

H. Title Issues – Buyers Needs Protection

If the seller is not going to warrant good title by selling the property as-is it is imperative that the buyer obtain an owner’s policy of title insurance that fully covers the buyer’s interests in the property. Just purchasing a policy of title insurance for the lender does not protect the buyer. All owners’ policies are not the same and unfortunately many lenders require a buyer to close the transaction at the lender’s title company who is more interested in protecting the lender’s interests, than they are in protecting the buyer’s interests.

1. Minnesota law states that a buyer has the right to select their own title company. Does the purchase agreement require the buyer to use the seller’s title company? Even if the purchase agreement does not require the buyer to use the seller’s title company is the seller or someone on the seller’s behalf attempting to force the buyer to use the seller’s title company?

2. Most buyers assume that the foreclosure was done properly. What if it wasn’t? Mistakes do happen. Taking someone’s property by force, which is what happens in a foreclosure, must be done correctly or the courts will likely void it.

3. If the property is Registered (Torrens) property, who will be completing and paying for the Proceedings Subsequent court action to validate the foreclosure?

a. This can take up to 3 months to complete and, if not approved, the foreclosure may have be re-done.

III. Prior to Closing – Everything Must Be Checked Out Before the Buyer Closes

After signing the purchase agreement, a buyer must be pro-active in making sure that the appropriate inspection(s) are done within the time frames given in the agreement, and that all title issues are taken care of prior to closing.

A. Inspections: More Than a Standard Inspection is Advisable

It is extremely crucial that buyers obtain a through property inspection and that all inspections are performed within the amount of time allowed under the purchase agreement.

1. If there are issues, they must be discovered and responded to in writing pursuant to the terms of the purchase agreement. If not done within a timely manner you may be waiving your right to cancel the purchase agreement.

a. The buyer must make sure that there is more than enough time to complete whatever inspections are necessary.

b. The buyer has to assume the worse about the property since the seller will not give any warranties and the property most likely has not been maintained or has been sitting vacant.

c. Foreclosed homes are prone to vandalism by former owners and strangers to the property.

2. Assume the seller will not make any repairs. If they do agree to do repairs, put that agreement in writing as a new addendum to the purchase agreement.

B. Title Commitment: Buyers Need a Marked Title Commitment That Protects the Buyer

A title commitment is the title insurance company’s promise to provide certain title coverage. This is highly important since the seller will not warrant good title to the property.

1. Make sure you review the title commitment prior to closing. If you do not understand it, seek the advice of an experienced real estate attorney.

2. Contact the closing company to make sure that you will be getting a “marked up” commitment at closing. Be sure that “gap coverage” will be provided, that you will be listed as the fee owner of the property and that all liens and encumbrances currently appearing on the commitment will be deleted on the owner’s policy. It can be difficult to determine what needs to be deleted from the commitment unless you have training and experience with title law.

IV. Expectations of Buyers: Can the Buyer Live With the Risks Inherent in Buying a Foreclosure?

A. Because of the inherent risks involved in purchasing a foreclosed property, the buyer must have reasonable expectations. Make sure that you are aware of the risks and develop a plan to take the risks. Ask yourself the following questions:

1. Why do I want to buy a lender owned property?

2. Am I prepared to wait for the lender if the transaction does not close within the time specified in the purchase agreement?

3. What will I do if the property is in worse shape than I expected?

4. What will I do if the property has title problems?

5. Do I have an accountant, an experienced real estate attorney, and someone with knowledge who I can use to inspect the property?

6. What will I do if the seller threatens to cancel the transaction even though you have spent time and money on the expectation that the transaction will close?

V. How to Manage the Risk

A. As set out above, buying a foreclosed home involves risks not found in the same degree when buying a normal, owner occupied home. In order to help manage the risk, there are several professionals that you should consider hiring. Each must be willing to work as a team and understand their role in such a team.

1. Real Estate Broker/Agent. An experienced, knowledgeable real estate broker/agent can provide great help in determining the market value of the property help uncover information regarding the condition of the property and help you find other professionals that you may need.

2. Real Estate Attorney. An experienced, knowledgeable real estate attorney can help you understand the numerous legal documents that you are required to sign so you know what your rights are before you sign and it is too late. An attorney can also help when legal issues arise, in reviewing the title work and closing documents so that you get the best coverage and protection.

3. Tax Accountant. A tax accountant can help deal with the tax issues that often arise in the course of a real estate transaction or help you avoid certain tax consequences.

4. Property Inspector. The condition of the property you are looking to purchase is always of concern but it is of special concern when dealing with a foreclosure. A quick, visual inspection might be okay in the normal transaction but it is not sufficient when purchasing a foreclosure.

B. Determine what risks you are willing to take, have the purchase agreement drafted to manage those risks and, if the seller will not agree to those terms, you walk away.

1. The seller may accept some terms and not others. You need to know ahead of time which clauses are non-negotiable for you and be prepared to walk away.

2. How long are you willing to wait for the transaction to close?

3. How long do you need for a sufficient inspection?

4. What property issues are you willing to accept and what are you unwilling to accept (for instance, issues concerning mold).

VI. Conclusion

Many buyers only see the possibility of a “great deal” and overlook the risks and the ramifications of those risks when purchasing a lender owned property. The fact is that these types of purchases are high risk purchases that bear little resemblance to a standard transaction that the buyer may have previously experienced. Buyers must be willing to protect themselves and the best way to lower the risks to a more manageable level is through the use of a team of professionals that you can trust and help steer you through the process of purchasing a foreclosed property.

For more information, or if you have questions please contact the law firm of

Nash & Lodge, PLLP at 763.862.6100 or nash@nashandlodge.com.

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Nash & Lodge, PLLP

2507 Bunker Lake Blvd., Suite 107

Andover, MN 55304

763-862-6100

www.nashandlodge.com

nash@nashandlodge.com

This publication is designed to provide general information prepared by attorneys in regards to the subject matter covered. It is sold with the understanding that the publisher is not engaged to render legal or other professional services. Although prepared by attorneys, this publication should not be utilized as a substitute for professional service in specific situations. If legal or other expert advice is required, the services of a professional should be sought.