FHA Financing and HUD Foreclosures

First off, HUD is the U.S. Department of Housing and UrbanDevelopment. FHA is the Federal Housing Administration, an agency administered by HUD. For our purposes, they are one and the same.

An FHA mortgage is a mortgage made by any lender for which FHA is the mortgage insurance company (for more info on mortgage insurance, see this article). There are three types of FHA mortgages. All are available only to owner occupants, not investors.

203(b): This is the standard FHA loan. Borrowers may qualify with credit scores as low as 580, debt ratios as high as 56%, and down payments as low as 3.5%. The property can be any house, townhouse, 1-4 unit multifamily building, or FHA-approved condominium (more on this later). The property must also be in 100% livable condition with all systems functioning properly, no safety hazards, no mold, etc. It can be ugly as sin, as long as it works.

203(k): This is the "rehab mortgage" version of FHA financing. It allows the buyer to finance the purchase and rehab costs of a home. Rehab costs must exceed $5,000. Example: A house is currently worth $50,000 and is in need of extensive repairs. After those repairs it will be worth $150,000. The buyer makes a down payment and purchases the house for $50,000. The buyer's mortgage is $125,000, with the difference being held in an escrow account. As the repairs are made by licensed contractors who bid the project out before the closing, the contractors are paid out of the escrow account. Work is completed, the borrower moves in with a mortgage of $125,000, and the house is worth $150,000. The 203(k) loan is good because it allows for a great deal of flexibility, but it is a long and complicated process relative to a 203(b) and many lenders don't offer it. More info here and here.

203(k) Streamline: This is what it sounds like - a quicker, easier version of the 203(k) rehab loan. The buyer can finance rehab costs up to $35,000 into the loan, but money cannot be used for structural work. For more info, click here, then click on the "HUD Mortgagee Letter" link.

FHA-approved condominiums: Aside from any restrictions mentioned above, any type of FHA financing can only be used on a condo if the condo project (development, building, complex, whatever you want to call it) has been approved for FHA financing. The condo association needs to gather all of their legal and financial documents and submit an application to FHA, who will then review the file and determine if the association meets their criteria. These criteria include a minimum amount of cash held in reserve, maximum concentration of FHA loans in the complex, maximum number of rented units, and maximum number of units delinquent on assessments, among others. Once the project is FHA approved, buyers can use FHA financing to purchase there. Beware - many homes that appear to be townhomes are legally condos, which must be approved. Most people don't know there's a very easy way to verify whether an association is FHA-approved: the HUD database.

HUD REO: You already know what HUD is. REO stands for "real estate owned," and that's how banks refer to their foreclosed inventory. HUD REO refers to property that was mortgaged with an FHA loan that foreclosed; the property is now owned by HUD. HUD allows some extra leeway in financing their REO, and they provide more information than any other bank or seller pertaining to the property's value and condition.

Run a search in your state and ZIP code on HUD's REO website. Click on the property case number for one of the listings to pull up the details. Photos are shown at the far left; basic property attributes are shown in the middle; and on the right you will see some listing dates and deadlines and then the "As-is Value." HUD already had the property appraised in its current condition, and this number is the appraised value as of the "Appraisal Date" shown in the middle column.

Below the as-is value, you'll see "FHA Financing:" followed by one of three codes.

> IN (Insured): Property condition meets FHA 203(b) standards.

> IE (Insured Escrow): Property condition ALMOST meets 203(b) standards. Repairs of $5,000 or less are needed. Buyer can use 203(b) by posting a repair escrow (see below).

> UI (Uninsured): Property needs more than $5,000 of repairs to comply with 203(b) standards and is therefore not eligible for 203(b). Buyer must use 203(k) or Streamline if eligible (see below).

The next line down shows if the property is eligible for 203(k) loans. This almost always says "Yes," but it will say "No" if the property is a condo in a complex that is not currently FHA approved.

Keep moving down and you'll see the line "Repair Escrow" followed by an amount (if the status was IE). If the buyer wishes to use a 203(b) loan, they must post this amount into an escrow account at the closing, have the necessary repairs done to bring the property into compliance, and complete a compliance review before the escrowed funds are released back to them.

Below the repair escrow amount, you will see "Review PCR for Repair Escrow Items." Click on the "Addendums" tab. You will see a few links; the one you want is the PCR or Property Condition Report. Click the link and download the PDF. A HUD contractor tested various components in the property, including all the major mechanicals, and this report shows the results. Another file on this same page, usually titled Escrow report or PCR summary, shows the contractor's estimate of the repair costs and the total amount that must be escrowed.

In the Addendums tab you may also see a link for HUD's "$100 down payment" program. This means a buyer purchasing this property with any type of FHA financing can qualify for a $100 down payment instead of the usual 3.5%, during special promotional periods.

How cool is that? They tell you the appraised value, what's wrong with the property, and how much it will cost to fix. Find me another institutional seller (or any seller, for that matter) who will do that!

Bidding on HUD property is a different conversation, but unlike some bidding sites an offer can only be input by a HUD-registered broker. If you’re reading this article then you know a HUD registered broker, so check the website out, then talk to me!

How to use the MLS mortgage calculator

When considering buying or refinancing a home, affordability is often the most important factor - not the amount financed, but the amount of the payment. The concept of $300,000 isn't something we can easily grasp in everyday terms, but the payment we make every month is immediately applicable to our lives. I often quote estimated payments to home buyers to help them evaluate their decisions, because figuring a mortgage payment isn't exactly simple math. But better than giving you a fish is teaching you to fish, so here's a step-by-step guide on how to calculate estimated mortgage payments using the MLS mortgage calculator.

Depending on whether you're talking about a house or a condo/townhouse, and depending on what type of financing you're using, there are going to be three to five different parts of the payment. The first part is the principal and interest, which is the mortgage itself and is calculated just like a big, long, car note. You'll also be escrowing your property taxes and homeowners insurance, which means you pay your mortgage company 1/12 of the annual cost of each of those expenses every month, they hold it in a separate account (escrow), and when the bills come due the mortgage company pays them. If you're putting less than 20% down, you'll also be paying mortgage insurance. And if the property is part of an association with a monthly fee, such as a condo or townhouse association, you'll also have to figure in the monthly association fee. Although this fee is paid directly to the association, not to your mortgage company, mortgage companies include it as a part of the payment for qualification purposes and you should include it when determining how much you can afford.

Check out the screenshot below; this is the blank slate. We'll start with the simplest calculation and then add the other moving parts.

Example #1: $200,000 purchase, 20% down payment. Property taxes of $5,000/yr, and homeowners insurance of $720/yr. Here we will only have principal & interest, property tax escrow, and homeowners insurance escrow. Enter the purchase price, $200,000. Enter the down payment as a percent (20%), and the $ field will auto-populate. Enter the interest rate: As of today I'm entering 4.25%, but the day will come when that will seem utterly outrageous. Leave the Number of Years at 30 unless you're pursuing a 15yr mortgage or other term. Enter the annual property taxes of $5,000. Enter the ANNUAL mortgage insurance of $720 and click the ANNUAL radio button, or if you're premium was quoted as a MONTHLY amount, enter that number and leave the MONTHLY radio button selected. Click Calculate, and voila:

The calculator separates out the principal & interest amount, then provides the total estimated payment including taxes and insurance. Toy around with the interest rate and the price to see how the payment changes - for instance, how much will a .25% increase in the interest rate change the payment? How much will the payment change if you get the house for $195,000 or $190,000 instead of $200,000?

Example #2: Same as Example #1, except now let's say you're getting a 5% down conventional mortgage. So you'll change the down payment to 5%, and you'll have to add mortgage insurance. (For more info on what mortgage insurance is and how it's figured out, read this article.) Today I'm using .85% for mortgage insurance, but this rate will vary depending on the borrower's credit score, amount of down payment, and market conditions. Enter .85% into the PMI / MIP field, which stands for "private mortgage insurance / mortgage insurance premium."

The calculator has also separated out the monthly mortgage insurance amount here. What a nice mortgage calculator.

Example #3: Now imagine the property in Example #2 is a condo with a monthly association fee of $150. Just enter $150 into the Association Fees field, make sure the MONTHLY radio button is selected, and the calculator will include this amount in the total estimated payment. I won't bore you with a screenshot of this one, you get the point.

Example #4: And for the grand finale, we will use an FHA loan. (For more information on what an FHA loan is and why it's different for this purpose, read this article.) Use the same information from Example #2, except change the down payment to 1.75%, and change the PMI rate to 1.25%. The minimum FHA down payment is actually 3.5%, however there is an upfront mortgage insurance premium for FHA loans (separate from what is paid monthly) that can be rolled into the loan as opposed to being paid at the closing. With interest rates so low, it's extremely common in today's market to roll the upfront MIP into the loan. The upfront MIP rate is currently 1.75% of the loan amount, so in order to account for adding that amount to the loan balance, we're taking it off the 3.5% down payment. Here's the result:

So you can see, when comparing Examples #1, #2, and #3, the difference in the affordability of the payment depending on the amount of your down payment and the type of financing you're using.

Hopefully this article allows you to figure out what you can afford when looking at a purchase or refinance. Of course, you'll still need me to set you up with an MLS account and a good loan officer to fill you in on the latest changes in interest rates, mortgage insurance rates, and financing programs available - but this is a start!

Pricing in a Declining Market

That's the title I give to a discussion I have with sellers before listing their home for sale. I long for the day when I can skip that discussion, but for the time being it is a crucial part of selling a home. Sellers commonly take the approach of, "Let's see how much I can get first, then we can drop the price." I can absolutely relate to the thought process that produces that statement as I have sold property myself and thought the same thing. As a real estate professional, however, I can tell you that statement is downright dangerous. There are three reasons sellers are hurting themselves by taking that approach, backed up by mountains of data.

Reason #1: The first three weeks on the market are the most precious. That's a known fact in the real estate community, and although it's founded in buyer psychology it's statistically proven. This is when all the buyers who have been searching for a home see your listing come on the market. If they look at the listing or perhaps schedule a showing and determine the home is overpriced, you've most likely lost that buyer for good. Because no matter how many times they see your listing pop up, such as with every price drop, they will always see it as that overpriced house they looked at awhile back. You remember that old adage about first impressions, right? If you lose the buyers who are already looking at the time you list, then you have to wait for new buyers to enter the market and hope one of them notices your listing. Would you guess there is a greater number of buyers currently searching for homes in your area than the number of new buyers who will enter the market in your area in the next month? If you guessed yes, you guessed right. Best to capitalize on that opportunity as a well-priced new listing.

Reason #2: As your market time ticks up and you repeatedly drop your price, your home becomes less appealing to buyers and you lose negotiating leverage. What do you think are two of the most common questions asked by buyers during a showing? How long has it been on the market, and how much have they dropped their price. In fact, buyers don't even need to ask anymore because that information is now visible to buyers on the MLS listing. Which of these two identical houses do you think generates more interest and urgency in a buyer:

• House A, which has been on the market 125 days and has dropped their price from $199,900 to $164,900, or... 
• House B, which just came on the market 8 days ago and is asking $164,900? 

The houses are identical and listed for exactly the same price, but House A looks like a desperate seller and House B looks like a listing that might get snatched up if the buyer doesn't make a move immediately. That also means House B is more likely to get a higher offer whereas House A will attract low-ball offers and have a difficult time negotiating them up. Ironically, the seller of House A has actually diminished the amount they can get for their home by trying to get more for it.

Reason #3: If you're not priced right when you list and the median value of homes in your area is still declining, you are faced with the challenge of dropping your price at a faster rate than the rate of market decline. The primary problem with that is that we don't know at any given point how quickly the market is declining. Contract prices are private until the sale closes, at which point 30 to 90 days have passed since the buyer made their buying decision. Since then, your toughest competition has lowered their asking prices. That means in a declining market, even if you price your home for exactly the amount the identical home next door just sold for, you are priced too high because you're at a "three months ago" price.

Consider the graph below. This shows a [hypothetical] listing that comes on the market for $149,900 at a time when it was actually worth $125,000. They drop their price $5,000 here, $10,000 here, wincing each time at the money they're losing. Meanwhile, the market has continued to decline. At the end of 12 months, there will be a very frustrated seller and an unsold house. They have dropped their asking price by 20% since they listed, but to no avail because the market value of the house has fallen by the same rate over the same time period and they started above the curve. Even with slightly more aggressive price drops they may not have caught up - they would have had to drop from $149,900 to $129,900 within 60 days of listing in order to have a shot at being "priced right," and I don't know too many people who are ready to stomach a perceived loss of that size, that quickly.

By contrast, consider the next graph as an example of how it SHOULD look:

Here, the seller actually gets more for their house than they would have in the first example - they sell for about $125,000 now, instead of being stuck with the house for a year until it's worth only $100,000. Just like with Reason #2, pricing too high will result in selling your home for less.

As I mentioned before, the primary problem with this whole scenario is that nobody knows exactly where that green curve is until three months later, at which point value has already been lost. We do have information about how declining markets work, though, so if we (seller + broker) take that information seriously and adopt an aggressive approach to pricing, you can beat your competition and sell your home for the highest possible price.

New Down Payment Assistance Program in Park Forest, Chicago Heights

The Illinois Housing Development Authority (IHDA) is piloting a new housing assistance program called Illinois Building Blocks to help stabilize communities hit hard by the foreclosure crisis. The program has three parts:

1. Providing financing to local developers to purchase and rehab 10-15 homes to be resold to to low- and moderate-income families. In Park Forest this will be focused in the "W" and "M" streets. Starting this summer.
2. Providing a $10,000 gift as down-payment and closing cost assistance to home buyers earning less than $84,000/yr (for 1-2 person househould) to $104,000 (for households of 3+). Starting 3/1/12.
3. In conjunction with KeepYourHomeIllinois.org, providing foreclosure counseling, loan modifications, and financial assistance to homeowners unable to pay their mortgages due to unemployment or underemployment.

The communities involved in the pilot program are Park Forest, Chicago Heights, Riverdale, South Holland, Maywood, and Berwyn.

Your Home Is Not An Investment

I spoke with a new buyer yesterday, and one of the first questions I asked was, "Are you looking to purchase a home or investment property?" The buyer said, "Both." She wasn't talking about buying two houses - she wanted one house to serve both purposes. Anyone else see something wrong with this picture?

I had to get a little more specific by asking the buyer whether she intended to live in the property or not, at which point we determined she was, in fact, looking for a home. The difference is if you live in it, it's your home. If you bought it with the intent to flip it or rent it out - strictly for potential financial reward - it's an investment. But her attitude that her home ought to be equal parts "place to live" and "investment vehicle" has become increasingly common if not prevalent among current and prospective homeowners.

The wild fluctuation in prices and market conditions throughout the recent real estate boom and bust has perverted mainstream America's idea of the purpose a home serves in our lives. Many of us have been fooled into believing our home is an investment account, a commodity to be bought and sold based on market fluctuations. Your home doesn't have a stock ticker symbol, it's not traded on the NYSE, and it is a very illiquid asset. While it's true your home may gain or lose value over time, the primary purpose of owning a home is not - or at least shouldn't be - to make money. 

I've had a number of seller clients close recently for just about the same price they bought the house for, 10+ years ago. After you factor in selling costs, which are substantial, on paper it's a financial loss. But those clients have enjoyed their homes for over a decade, created lasting memories, molded the home to fit their lifestyle, and yes, reaped some financial benefit in the form of tax deductions too. They may not have come out ahead on the resale of the property, but ask them if they gained in other ways from living there and I'll bet their answer is yes.

People have historically bought and sold homes as a lifestyle decision. That means you buy a home when your family's needs change. That includes upsizing and downsizing, marriage and divorce, having children and emptying the nest, bringing in or kicking out extended family, retiring, relocating, or simply looking for a place to settle down. Obviously there ARE financial implications to owning a home, but we would do best to get away from the mindset of putting those implications above our families' needs. Especially now that most experts are predicting a relatively flat market for the foreseeable future, if you're buying or selling a home with dollar signs at top of mind, I'd recommend you reconsider.

How Is My Property Tax Bill Calcuated?

Property taxes in Illinois, besides being levied at exorbitant rates compared to most other states, are dizzyingly complicated. It's even worse for homeowners in the most populous county in the state, Cook County. I've always said the Illinois property tax system could be sufficiently explained in a 3-credit hour college course, but since most of us care but not THAT much, I'm breaking it down to what you as a current or prospective homeowner need to know.

Timing
Property taxes in Illinois are paid one year in arrears. So the taxes everyone is paying in 2012 are the taxes levied against the property from the calendar year 2011. The county treasurer sends out the bills in the spring (exact date depends on which county) and the bill is due in two installments, such as half on June 2 and half on September 2. The only exception, of course, is wonderful Cook County where the first installment bill is estimated based solely on the prior year's bill, sent out in February(ish), due March 1 (usually), and the actual tax amount is not figured out until they get their act together in the fall, when they send out the second installment bill which is due in November...ish.

In Illinois we have a quadrennial reassessment schedule (triennial in Cook), which means every four years (three in Cook) each property is re-evaluated individually (supposedly) for changes in value. This is supposed to be more accurate than the generalization method they use in the "off" years. All assessment schedules are available on your assessor's website - check my Links page to find yours.

Who's Who?
The determination and collection of property tax is divided among a number of government bodies. The township assessor determines your property's value. The county assessor compiles all the information from the township assessors. The treasurer determines the tax rates, issues the bill and collects the money. The clerk takes over collection efforts on unpaid taxes and handles any tax sales.

Valuation
All property taxes start with the assessor's estimate of your property's value. They gather data from recently sold properties and apply that information in a very general fashion to arrive at their estimate. This is referred to as your "Estimated Market Value." This can be (and often is) inaccurate, so you are given a window of time after your assessment letter is mailed to you during which you can appeal your assessed value for that tax year. Keep in mind when you receive an assessment letter you're looking at the assessor's estimated value of your property as of January 1 of the billing year. So the 2012 assessment letter shows what they think your property was worth as of January 1, 2012. It's based on comparable sales from the calendar year 2011, going as far back as three years if more sales data is needed. If you think your property was worth less than they do as of that date, you can appeal.

Rates
The overall tax rate levied against your property is a cumulative total of all the taxing districts in which the property is located - everything from the village, school district, water reclamation district, library district, mosquito abatement district (seriously), etc. Each taxing body determines how much money they need for that year and turns that number in to the treasurer, who adds everything up, determines the tax rates, and issues the bills. Overall tax rates vary widely, from the lowest at around 6-7% (Orland Park, Cook County) to the highest at 18% (Park Forest, Cook County) or more. As for what that percentage means...

Formulas
Your actual tax bill is calculated by multiplying your overall tax rate by your equalized assessed value (EAV). In most counties, EAV is calculated by taking the estimated market value, dividing by three, and subtracting any exemptions (more on that in the next section). So if your estimated market value is $100,000 and your overall tax rate is 9%, it would look like this:

Estimated Market Value / 3 = Assessed Value
Assessed Value * Tax Rate = Tax Amount

100,000 / 3 = 33,333
33,333 * .09 = $2,999.97

If the property is your primary residence, you are eligible for a Homeowner Exemption which is knocked off of the Assessed Value before applying the tax rate:

100,000 / 3 = 33,333
33,333 - 6,000 = 27,333
27,333 *. 09 = $2,459.97

In this example, the homeowner exemption saves the owner about $500/yr. There are other exemptions including for seniors, people with disabilities, etc. The higher the tax rate, the larger the impact your exemptions will have.

Cook County, the ever-exception, does things differently. There, the formula looks like this:

Estimated Market Value / 10 = Assessed Value
Assessed Value * Equalization Factor = Equalized Assessed Value
Equalized Assessed Value - Exemptions = Taxable EAV

100,000 / 10 = 10,000
10,000 * 3.3 = 33,000
33,000 - 6,000 = 27,000
27,000 * .09 = $2,430

For a more detailed explanation about the Equalization Factor... Don't bother. Really, just don't bother. It's complicated, confusing, and there's nothing you can do about it.

Appeals
As I mentioned, you can appeal the assessor's estimate of your market value. This is something best left to the pros because of the complexity of the tax code. This is the one area in which it's GOOD to be in Cook County. Their appeal process is much easier, so there are tons of attorneys who specialize in property tax appeals and will represent you on a contingent fee basis, meaning they are paid a percentage of the reduction amount. As of this year, you can even appeal your assessment online. But in all the other counties, the appeal process is painstaking if the assessor disagrees with your case, and you're probably on your own since it generally isn't worth an attorney's time to put in all the work that would be required. But regardless of what county you're in, you can appeal the taxes based on overvaluation (meaning comparable sales indicate a value lower than the amount the assessor assigned), lack of uniformity (meaning other similar properties are assessed at lower values), vacancy (if the property is uninhabitable), and a number of other reasons. You can also file a certificate of error if you did not receive an exemption to which you were entitled, even after the bill in question has been paid.

Buying and Selling Property
There are special concerns with regard to property taxes when transacting property. When buying, it's important to look at the tax amount on the listing sheet of each property you're considering. One twelfth of that amount will be collected by your mortgage company with your mortgage payment each month, deposited into an escrow account, and used to pay the bill when it comes due. So the tax amount has a direct impact on the amount of your payment. When looking at the tax amount, keep in mind that the number and size of any exemptions held by the previous owner may be different than the exemptions for which you will qualify. The listing should indicate any exemptions applied, but as usual there can be errors and this information should be verified by looking up the property on the county treasurer's website.

Because taxes are paid a year in arrears, some math has to be done at the closing table to square up the buyer and seller. For instance, assume a house is scheduled to close on July 1, 2012. The 2011 tax bill is $3,000, and the owner has paid the first installment ($1,500) which was due June 1, 2012. The buyer will own the property when the second installment of 2011 taxes comes due on September 1, but that tax bill is from 2011 when the seller owned the property. So the seller gives the buyer a credit for that amount ($1,500) - meaning the amount of money the seller takes from the closing will be reduced by $1,500, and the amount of money the buyer brings to the closing will be reduced by the same amount. Further, the seller has owned the house for six months of 2012, so they have to settle up with the buyer for another half-year of taxes. The 2012 tax bill won't be issued until almost a year after this closing, so they estimate the 2012 bill by taking the 2011 bill and adding 5-10% (this is a point of negotiation during the offer stage), and a credit is given to the buyer. For this reason, the amount of money a buyer needs to bring to the closing is often less than what they expected, and the amount a seller takes from the closing may be less than they expected too. Remember that as a seller, you have a balance in your lender's escrow account which is earmarked for taxes, and those funds should be released to you or applied toward your closing costs.

It's been said that the two things you can never avoid are death and taxes, and in this case that statement is certainly true. Any unpaid property taxes will turn into a lien on the property that will bump any other liens (including mortgages) into second place. So make sure you pay your taxes, but more than that, pay attention to make sure you're not paying too much!

Common Questions Answered: Buying Short Sales & Foreclosures

Distressed property is all the rage these days. And it's a good thing: If it weren't for investors and bargain hunters snapping up low-priced inventory, we'd be in a whole different place (a much worse one).

When we speak of distressed property, we're primarily talking about short sales and foreclosures. In almost every initial conversation I have with any potential buyer, they inevitably ask me what the difference is between short sales and foreclosures. So I'll start there and pose a few of the most common questions I get, along with my answers. If you have a question I don't answer here, post it below and I'll get right on it.

Q: So what is the difference between a short sale and a foreclosure?
A: A foreclosure, also known as a bank-owned property or REO (real estate owned, which is how it shows up on the bank's books), is property the bank has repossessed from the owner due to nonpayment of the mortgage. The bank owns the property outright and hopes to sell it for as much as possible to recoup some of their losses on the deal.

A short sale is a situation in which, most likely, the owner has fallen behind on mortgage payments, the bank is moving to foreclose, and the amount owed on the mortgage is greater than the property's value (some call this condition "underwater"). The owner is trying to sell the property for whatever it's worth, hoping their lender would rather take a discounted or "short" payoff right now instead of seeing the rest of the lengthy foreclosure process through. So in this situation, the seller still owns the property, but their lender calls the shots.

Q: How long do these transactions take to close?
A: An offer on a foreclosure will usually get a response within five business days. After that, you can close within a normal time frame (30-45 days).

An offer on a short sale must be signed by the seller, then submitted to the seller's lender for review along with a litany of other documents. Depending on which lender holds the mortgage, how many mortgages and other liens there are, and the skill and experience level of the person handling the short sale (typically the seller's agent or attorney), buyers can expect a response to their offer within three to six months. That time frame is rarely shorter and occasionally longer.

Q: What additional risk is involved in buying distressed property?
A: Both short sales and foreclosures are sold "AS-IS." That means the seller is not going to do anything to the property and the buyer accepts it with whatever physical or legal defects it may have. Buyers CAN and always SHOULD have a home inspection done, and they can still back out of the deal if the inspection turns up anything unacceptable. The buyer is also responsible for passing any municipal inspections, purchasing all transfer stamps (even those customarily purchased by the seller), and ordering a survey if their lender requires one.

In the case of a short sale, the seller will provide the customary disclosures regarding the property's condition and any known material defects, as required by state law. A bank selling REO has likely never even seen the property; therefore it is exempt from those disclosures and buyers are truly on their own.

One thing that is NOT different about buying distressed property is that the seller (if it's REO) or the seller's lender (if it's a short sale) WILL provide the buyer with clean title and a title insurance policy, just like a traditional sale. That means they clear up any known liens on the property and pay or credit the buyer for any unpaid real estate taxes. You may open a can of worms fixing the place up, but at least you know it's yours!

Q: Should you include foreclosures and short sales in your home search?
A: It depends.

I almost always advise buyers to include foreclosures. They are frequently priced below-market and present great opportunities for instant equity. The only time we have to be careful with foreclosures is when a buyer only qualifies for FHA financing. When FHA appraises the property they expect everything to be intact and fully functional; they won't lend on it if anything is broken or missing (e.g. windows, a bath vanity or kitchen cabinets, a furnace). An ordinary seller might offer to get the property into "FHA condition," but if it's owned by a bank you can pretty much forget it. There are exceptions, but that's a whole other discussion.

I advise buyers to include short sales when their circumstances allow it. Due to the time frame they take to close, short sales are often a consideration for people who are not on a timeline: Those who don't have to sell and buy at the same time, investors purchasing multiple properties - in general, buyers who aren't in any sort of hurry. For buyers who need to close before their lease is up, live in a certain school district or area by a set date for school or work, or in general have to be moved by particular date, short sales are not recommended. Same goes for anyone who lacks patience!

Q: Which is a better deal, short sales or foreclosures?
A: Ah, the million dollar question. Where can you get the best deal? There are two schools of thought on this, but I believe foreclosures most frequently present the best opportunities. Why? Primarily because of the way the bank determines what price they'll take for a house when they already own it, which is different from how they evaluate it when the borrower still owns it.

With short sales, once an offer is received and submitted to the seller's lender, they hire an appraiser to give them the current, as-is market value of the property. They will usually accept a certain percentage of that value, commonly about 90%. If there are other liens on the property, such as a second mortgage or delinquent property taxes, those liens need to be satisfied too - after the lender who holds the first mortgage gets their 90%. So the best deal you're going to get is 90% of the property's current as-is value, as determined by an appraiser, but you might have to cough up a little more depending on secondary liens.

With foreclosures, the price is determined by an asset manager who bases his/her decision on a BPO - that's a broker opinion of value, a report completed by a real estate agent who is often going to be the one listing the property for sale. It's in the agent's best interests to get the bank to list the property for an attractive price. In fact, many banks request the BPO agent to recommend a "30-day sale price." So when these listings come on, they're often at hot prices.

A few years ago when short sales were just coming on the radar, banks used desktop valuations or BPOs for short sales instead of appraisals, and they didn't have the procedures and rules they have in place now. It's those appraisals, procedures and rules that have changed the game with short sales and made foreclosures more attractive in my experience.

I did a little research to back up my belief, for those who might disagree. I looked at the median sale prices of all foreclosed and short sale residential property that has sold in the past 12 months in Oak Lawn, Matteson, Tinley Park, and the Loop (as of October 2011). In every case, the median sale price of foreclosures was lower than the median sale price of short sales - by anywhere from 3% (in Matteson) to almost 30% (in Tinley Park). Further, in all three suburban areas, foreclosures sold for a larger discount off their asking prices than did short sales. That didn't hold up in the Loop where foreclosures sold for a median of almost 107% of their asking prices - but that was still 19% lower than the median short sale price.

So if you have any general or specific questions I didn't touch on here... Fire away!

So what the heck IS mortgage insurance anyway??

Mortgage insurance, or what you may have heard referred to as "PMI," is not to be confused with homeowners insurance (which is also known as hazard insurance, property insurance, etc.).

Mortgage insurance is an insurance policy that benefits mortgage lenders in the event they have to incur the costs of foreclosing on a property. Lenders require this insurance if the borrower is putting less than 20% down, due to the lender's increased risk in making such a loan. The borrower pays the premium on a monthly basis as a part of their mortgage payment, and the mortgage insurance premium is sent to a mortgage insurance company. If the borrower defaults and the lender has to foreclose, the mortgage insurance company kicks back a portion of the loan amount to the lender.

How much is that premium? It depends on many variables such as property type, credit score, location, current market conditions, etc. But for conventional loans, the range is from about .8% to 1.25%. Example: Take the initial loan amount, let's say $100,000. Multiply it by the rate, for instance .85%, and you get the annual mortgage insurance premium, in this case $850. Divide that by 12 and that's the monthly premium (about $71/mo in this example).

The Federal Housing Administration is essentially a public mortgage insurance company. So when you hear about an "FHA loan," that means the mortgage insurer is FHA. For an FHA loan with a minimum down payment of 3.5%, the annual mortgage insurance rate is 1.15% - higher than MI rates for conventional loans. Additionally, there is an upfront premium due at the closing in the amount of 1% of the loan amount. The upfront MI can either be paid at closing or rolled into the loan. Why pay more for MI by choosing an FHA loan? Because they offer better interest rates and less stringent credit and income requirements than conventional loans, and if you have a non-traditional job/career you're more likely to qualify for FHA.

In some cases, a borrower may qualify to buy out MI (on conventional loans only) by paying a fee at the closing. If the borrower's credit score is high enough (at least 700) and their debt ratio is low enough (45% or lower), they might be able to pay a fee of 1-2% of the loan amount in lieu of paying a monthly MI premium. Using the same numbers in the above example, this would be an upfront fee of $2,000 that would allow the borrower to get out of the $71 monthly premium. In this example, the borrower saves money if they keep the loan for more than 28 months.

Another way to avoid mortgage insurance is to get one mortgage for 80% of the purchase price and a second mortgage for 10% or 15% of the price, which still allows the borrower to put only 5-10% down. This strategy was used, abused, and squeezed to the last drop during the credit bubble, and it is much less common today because of the problems it caused. The problems came about because the second mortgage is always either an adjustable rate mortgage or a variable line of credit with a balloon date - aka "ticking time bomb." [You may have heard of an "80/20" - that's a first mortgage for 80% of the price and a second mortgage for 20%, with no down payment from the borrower. These were all the rage in 2005, then the rates on the second mortgages adjusted 3-5yrs later, payments skyrocketed and homeowners tried to sell. But they owed more than their house was worth because housing prices had already peaked. Enter housing meltdown.]

There is at least one loan program out there that allow borrowers to put down less than 20% but not pay MI. It is called HomePath Mortgage - special financing offered by Fannie Mae only on their foreclosures - and it comes with a minimum 3% down for owner occupants or 10% down for investors, both with no mortgage insurance.

Even if you can't avoid MI, not all is lost. The Homeowners Protection Act of 1998 laid down federal laws that require the cancellation of MI after certain conditions are met. A borrower can request MI cancellation after the loan balance reaches 80% of the initial purchase price, but the lender doesn't have to grant it. However, once the loan balance reaches 78% of the initial purchase price the lender must automatically cancel the MI. Of course there are exceptions - for more detailed info on those, check out this article on the FTC website.

And lastly, the MI premiums you pay may be tax deductible due to the Tax Relief and Health Care Act of 2006. That law created a tax deduction for MI premiums on policies issued on or after 1/1/2007 and was extended for policies issued through the end of 2011. Of course, again, there are exceptions summarized in an article on Bankrate.com, but you should speak with a tax professional to get specifics.

Mortgage insurance isn't looked upon favorably by the public, but it's a necessary evil and I'm glad it's here. Otherwise, every buyer in the nation would need 20% down and the housing market would be infinitely worse off. I'll leave you with a heartwarming, redeeming feature of mortgage insurance companies: MI companies have an interest in preventing foreclosures, because foreclosures mean they have to cough up cash to lenders. So if you ever get behind on your mortgage payment, call the MI company directly and see what they can do.

A New Venue

At last, I've arranged my own little corner of the Web where I can disseminate all the information I want, however I want! I like to write and post articles about real estate, explaining the mysteries I'm most often asked about (such as, "What is mortgage insurance?"), providing tips for buyers and sellers, and sometimes just relaying the ridiculous things that happen in the life of a real estate broker. I started doing this on my Facebook business page, then Facebook eliminated the "Discussions" tab. Then I switched to a profile on a real estate investment website, but the content is restricted (no links allowed, limit on word count, had to wait for administrator approval which sometimes never happened). So I felt it was time to carve out a domain where I can post whatever the heck I want, on the off chance you want to read it. I'll be posting my already-written content first, then moving on to the fresh stuff. If there's anything you want to hear about, just let me know!