Five ways to avoid foreclosure limbo

Tue Nov 9, 2010 1:04pm EST

Homebuyers who have been hoping to score a good deal by buying a foreclosed property have been left in limbo by the recent rash of foreclosure freezes. Reports that many recent home seizures were based on faulty documentation have prompted big lenders like Bank of America to suspend foreclosure activity. Title insurance powerhouse Old Republic National Title has stopped covering some foreclosures. Class action attorneys are readying lawsuits and attorneys general in most states are calling for a massive investigation of whether what happened was fraud or simply sloppy paperwork.

It could take weeks or many months to resolve, leaving would-be buyers without any clear guidance or solutions. "Depending on where you are in the process it could either be mildly annoying or incredibly disruptive," says Keith Gumbinger of HSH.com, a mortgage research firm. "You may have upended your life and made plans for moving, and have them come to a grinding halt."

Here are five tips from people who were on the buy side of the latest real estate mess:

Pick up the phone: If you've already contracted to buy a home, don't panic. There's a good chance the paperwork will be resolved, albeit on a slower schedule than you were expecting, says Rick Sharga of RealtyTrac Inc., a research and listing service. He's expecting that most of the homes affected by the paperwork problems were legitimately seized, and it's more a matter of cleaning up the documentation than it is seeing the whole repossession reversed.

But cover yourself: Call the bank that owns the property and find out whether it has a clean title. Get a title search done. And do not even think about going to settlement without making sure that you are getting title insurance. If problems arise later, the title insurance company would most likely cover it.

Stay away from the courthouse steps: Don't buy any real estate at auction right now, says Sharga. In the first place, you'll have to pay cash, and it is unlikely to come back to you if problems arise. You can't as easily ascertain whether the title is clean while you're standing in front of the courthouse, either.

Wait for a bargain: Regardless of the state of their paperwork now, the vast majority of these homes will come to market eventually; their owners were typically in actual default. And with other folks afraid to handle foreclosures, stalwarts who keep shopping may find the right deal if they don't rush, says Ethan Roberts, a Jacksonville real estate analyst and agent who specializes in foreclosures.

Prices on homes could rise in the near term, as many of the foreclosed homes (a quarter of the market in the second quarter, says RealtyTrac) get pulled back. But once the paperwork clears and the homes get listed again, prices could fall further than they are now. And it's best not to invest money in appraisals, inspections and surveys until you're sure the property you are eyeing is really going to make it through the process.

Go short: Shoppers who don't want to wait for a distressed property can look for short sales. In a short sale, the defaulting homeowner agrees to sell a home for an amount that is less than the balance due on the mortgage, and the bank agrees to take that amount as full payment for the loan. "A short sale should be 100 percent-safe," says Sharga.

Short sales may actually become more available in the current environment, suggests Brad Geisen of Foreclosure.com, a listing service. That's because banks already under pressure to clear out those mounds of foreclosure documents may prefer to get properties sold quickly and cleanly. The downside? The deals aren't quite as great. In the second quarter, foreclosures sold at an average discount of 26 percent when compared to non-distressed properties; short sales sold at an average discount of just 13 percent, reported RealtyTrac.

Sit tight at home: What if you've already bought a foreclosed property and are living in it? Roberts raises all sorts of scary scenarios, including one in which you are forced out of your home - after you've paid for it, moved in and spent thousands improving it.

But that's a highly, highly unlikely scenario. "There aren't very many precedents of foreclosures being overturned and it seems even less likely that a judge would throw out a homeowner who's bought a property to put somebody back in who hadn't been making payments anyway," Sharga says. That may be reassurance enough, but it would not hurt to call your lawyer for a little bit more.

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