When Does a Foreclosure Become an Reo?

By: Dave Dinkel

A foreclosure becomes an REO at different times depending on how the bank acquired the property.An REO ("Real Estate Owned") is a home that a bank as taken back from a homeowner who stopped making his mortgage payments.In states where the homeowner has a Deed of Trust instead of a mortgage, the trustee is the one who repossesses the home and it then becomes an REO.

The most common way to repossess a property is by foreclosure.In this process, the bank takes legal action in "judicial states" where a court ordered sale is necessary to transfer title to the bank.In non-judicial states, the bank may require minimal or no legal filing to repossess the property and because of the shortened time involved for the repossession process, these are referred to as "short states".In these short states, the homeowner may expect to lose his home in as little as 21 - 30 days.

Once the official Trustee's sale or auction by the sheriff or county clerk is complete, the bank gets title to the property by court order.At this time, the property officially becomes an REO.Internally the lender has strict guidelines about when the property is considered an REO, which is actually before a deed has been transferred.This is one reason the bank does try to resolve the foreclosure before it goes to sale.The biggest reason foreclosures are not resolved before the sale is that homeowners do not speak with the bank's loss mitigation to attempt resolution of the problem.The second biggest reason is that the homeowner can't afford to reinstate the loan or make future payments.

The other way a bank gets an REO is by accepting a "Deed in Lieu of Foreclosure" from the homeowner.Just like it sounds, the homeowner transfers the deed to the lender in exchange for the foreclosure being closed.Closing the foreclosure does not remove it from the homeowner's credit report or increase his credit score.If it is done before the foreclosure is filed, the foreclosure will not be on the homeowner's credit report.

The bank may or may not want to take the deed from the homeowner if there are additional loans or liens on the property because they would be assuming these loans/liens.In this case, the bank will continue the foreclosure to extinguish these liabilities to the property. No matter how much the homeowner cooperates, the foreclosure will go forward.By cooperating with the bank, the homeowner may get an IRS Form 1099 instead of the bank getting a deficiency judgment against the homeowner by court action.However, there is no guarantee that the lender will file the Form 1099 in lieu of getting a deficiency judgment.

As an REO, the property becomes part of the bank's portfolio of properties to be sold as soon as possible.This is because the Federal Reserve that regulates banks, requires a cash reserve for any REO's.The cash reserve is dependent on the bank's financial condition but could be 5 to 8 times the entire loan balance, i.e. if the loan amount is $200,000, the cash requirement would be $1,000,000.This means that the bank is losing income from funds that can't be loaned, so the bank does not want any REO's on their books for any longer than is absolutely necessary.This does not mean that the bank has to have a "fire sale" to liquidate them if it means they have to take a huge financial loss.The type of mortgage insurance in place also effects the lender's decision as to how much of a loss he may have to take.

So as you can see, the issue of "When does a foreclosed property become an REO?" is straight forward as soon as you know how the property was acquired by the bank.

Foreclosures
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