Buying an REO isn't for the faint-hearted, but if you're willing to work with the bank, asset manager or mortgage clearing company, you may get a good deal.
An REO simply means that the foreclosure process has gone far enough that the bank has taken the property back from the homeowner, put the property for sale at auction, and had no bidders. The property becomes real-estate-owned or REO, meaning that the bank or an agent will handle the sale on the open market. That agent could be an outside asset management company or the bank could sell a portfolio of REOs to a mortgage clearing company to obtain the best price possible.
One advantage to buying an REO is that you don't have to pay cash or have a cashier's check ready like you would at a foreclosure auction. If the REO is listed with a real estate broker, you can obtain a bank loan to buy it, just as you would with any property.
The other advantage is that the REO has already been through the auction process and the bank is ready to find a buyer. The bank will still try to get the home sold for what they already have in it, plus interest and foreclosure costs, giving you the opportunity to buy the property for less than the bank loaned to the previous homeowner.
The home you want may have real issues, such as burst pipes, insect infestations, or other damage while the home sat unoccupied and untended over the years. If the homeowner couldn't pay the mortgage, they likely deferred maintenance, too. In the worst cases, angry homeowners destroy their homes, or remove fixtures, including the copper plumbing under the house.
In those cases, you may have extensive remodeling and repairs to take on, as the bank is unlikely to sell the property in any form except "as is." This means no repairs will be made. If so, you'll have to weigh that against getting a home in move-in condition at a much higher price.
Before you put a contract on an REO, take some pictures of areas that need repair and try to interview some contractors to get an idea of what it would cost to fix them. Many homes just need cosmetic work, a little paint and cleanup. Others have extensive damage, and may require a home improvement loan. Others simply need updated systems, like heat and air.
Next, talk to your lender and see what you qualify to buy. If you qualify for $200,000 and the home you want costs $140,000 but it needs $50,000 worth of work, will the bank loan you the money for the improvements?
When your offer is accepted by the REO agent, allow 10 days to get an inspection. Try to schedule the inspection as soon as you can so you can get an idea of the kind of work you'll have to do to bring the house up to code. You'll have plenty of time to get contractors into the house to give you firm bids on repairs and updates, as well.
Go back to your banker with your bids. The bank will appraise the house two ways for you, giving you a value for its current condition, and a second value based on the improvements you propose. If you're in line with neighborhood values, you'll likely get the loan.
Also, ask about the FHA 203K home repair loan. It is a conforming loan that allows you to make cosmetic updates and repairs. If you need to move any walls or have serious foundation issues, you may have to go with an in-house bank construction loan at a higher interest rate, but you can always refinance once the construction is complete.
An REO is only a good deal if you can buy the property and pay for the necessary repairs and updates it takes to bring the property up to neighborhood standards. If you can do that and stay within budget, you got yourself a very good deal.