Inspecting and Negotiating on a Bank-Owned (REO) Property

In a typical sale, the seller has lived in the home and must disclose many known problems, depending on state law. An REO seller usually has never lived there, may know little about the home's history and often provides limited disclosures. Your inspection fills that gap.

Bank-owned homes also carry risks that occupied homes do not, from freeze damage and unnoticed leaks to stripped fixtures and years of deferred maintenance. The overview of bank-owned homes describes the conditions buyers commonly find. What it means for your inspection is that problems are often hidden: a leak that would have been noticed in an occupied home can run for months in an empty one, and systems that have sat idle may fail once they are switched back on.

Because the sale is as-is, the bank generally will not fix what you find. The inspection is how you decide whether to proceed, what price makes sense and how much to set aside for repairs. Skipping it, or rushing it, is one of the most expensive mistakes REO buyers make.

Many REO homes have the water, gas and electricity shut off, and homes in cold climates are often winterized: the plumbing is drained and antifreeze added to traps to prevent freeze damage. An inspector cannot properly test plumbing, heating, cooling, the water heater or appliances in that state.

Ask for the utilities to be turned on as soon as your offer is accepted. The process typically involves:

• A written request through your agent to the listing agent.
• Approval from the bank or asset manager, which may take a few days.
• De-winterizing by a licensed plumber, often at the buyer's expense, followed by a pressure test to check for leaks.
• Re-winterizing after inspection if the sale is not closing soon, which the bank may require.

Plan this around your inspection period, which is often short in bank addenda. If the bank will not allow utilities to be turned on, note that in writing, and consider whether you are comfortable buying without testing major systems.

A failed pressure test is valuable information. It points to leaks or freeze damage that would otherwise surface only after you move in.

Start with a general home inspection by a licensed inspector, then bring in specialists based on what the general inspection finds or what is common for the home's age and area. Bring the notes from your showing so the inspector can look closely at anything that concerned you. Pay close attention to:

• Plumbing. Freeze damage, leaks, missing pipes and the condition of the water heater. A sewer line camera inspection is worth considering on older homes.
• Roof and attic. Leaks, damaged decking and signs of past water entry.
• Foundation and structure. Cracks, settling and water in basements or crawl spaces.
• Electrical. Missing or damaged wiring, panel condition and unsafe repairs.
• HVAC. Whether the furnace and air conditioning work, and whether components are missing.
• Mold and moisture. Common in homes that sat closed with leaks or high humidity.
• Pests. Termites, rodents and other infestations.
• Environmental hazards. Lead-based paint in older homes and, where relevant, radon or other local concerns.

Also check with the city or county for open permits, unpermitted additions and code violations. In some places, those issues can transfer to the new owner.

As-is is often misunderstood. On an REO contract it usually means:

• The seller will not make repairs, or will make only those required by law or by certain loan programs.
• The seller makes few or no promises about the home's condition.
• You accept the home in its current condition at closing, apart from damage that occurs before closing as your contract defines it.

It usually does not mean:

• That you cannot inspect. Most REO addenda include an inspection period.
• That you cannot cancel. Depending on the contract, you may be able to cancel during the inspection period and get your earnest money back.
• That you cannot negotiate. Banks often adjust the price or give a credit if your findings are significant and well documented.

Read the inspection terms in the addendum closely. Note how many days you have, whether you must give written notice to cancel and what happens to your deposit in each scenario. If the addendum conflicts with your purchase contract, the addendum usually controls.

Not legal advice: if anything about cancellation rights or deadlines is unclear, ask your agent or a local real estate attorney before the inspection period begins.

Banks negotiate differently from homeowners. They follow internal guidelines, rely on their own valuations and rarely want to manage repairs. Requests that usually have the best chance:

• A price reduction tied to specific, documented problems.
• A credit toward closing costs, which reduces your cash at closing. Loan programs limit how large a seller credit can be, so check with your lender.
• Timeline changes, such as a later closing date to allow for a renovation loan.

Requests that rarely succeed:

• Asking the bank to make repairs, other than those required for financing in some cases.
• Changing the bank's addendum terms.
• Small requests for cosmetic issues that were visible in the listing photos.

Make your request in writing through your agent, and attach the inspection report and contractor estimates. Focus on major systems, safety issues and items that affect financing, and price the request realistically. A bank that has had the home on the market for a while, or has reduced the price several times, may be more flexible.

Be ready for a counter or a no, and decide your walk-away point before you submit. Investors can anchor that point to the after-repair value minus repair, holding and selling costs.

If you are financing, the lender's appraisal can raise two problems on an REO home.

A low appraisal. If the home appraises for less than your price, you can ask the bank to reduce the price, pay the difference in cash, challenge the appraisal with better comparable sales or cancel if your contract has an appraisal contingency. Banks sometimes agree to reduce the price, especially if other offers were also financed.

Required repairs. Appraisers for FHA, VA and some conventional loans may require safety, structural or habitability repairs before the loan can close. Missing handrails, peeling paint on older homes, broken windows, non-working heat and roof leaks are common examples. Since banks rarely repair, options include:

• A renovation loan such as the FHA 203(k), which finances repairs as part of the mortgage.
• Asking the bank for permission to make repairs before closing at your own risk and expense, which many banks do not allow.
• Switching to a loan type with less strict property standards, or to cash.
• Renegotiating the price to reflect the cost of repairs.

Talk with your lender about these possibilities before you make an offer on a home that clearly needs work. For how appraisal and underwriting fit together in any purchase, see inspection, appraisal and underwriting.

Your inspection period is also the time to raise title and association issues, since they can affect your price or your decision to proceed. Review the title commitment for unpaid taxes, any lien or open code violation, and exceptions the policy will not cover, and ask the title company about anything you do not understand.

If you are buying in a condo or HOA community, request the association's statement of dues owed and any special assessments. Unpaid HOA balances from the foreclosure period are common and should be resolved at closing. For more on lien review, see title, liens and due diligence.

Your inspection report also becomes the baseline for the final walk-through. Keep it, along with your photos, so you can spot anything that has changed since. What to check on that visit and what to do if you find new damage are covered in closing on a bank-owned home.