Risks Inherent in Buying Recently Foreclosed Property

By Robert E. Danielson Esq.

With a significant amount of property being offered for sale that is owned by lenders who have recently foreclosed (“REPOS”), potential buyers need to be aware of the risks inherent in purchasing such properties.  In addition to the typical due diligence items such as title, financing and inspection, REPO’s are also subject to additional issues such as (1) whether the foreclosure was conducted properly; (2) possession issues and third party liens; (3) warranty of title or lack thereof; and (4) a seller dictated process that is clearly one-sided.

In Maine, foreclosure is a strictly regulated process in which failure to adhere to all of its requirements will result in a defective title, or worse, lack of clear title (14 M.R.S.A. 6201 et seq.).  A real estate attorney or title company should be able to provide a comprehensive review of such matters to be sure that everything has been done in compliance with the law.  Such a review would include determining whether the homeowner’s right of redemption has expired, whether all liens and junior encumbrances on the property have been extinguished, and whether any robo-signing issues may be a problem.  A bona fide purchaser for value without prior knowledge of any of these issues who purchases owner’s title insurance can take comfort that a comprehensive title review will almost certainly prevent them from being divested of ownership due to a faulty foreclosure and in the unlikely event proceedings are instituted, the insurance company can limit their damages.

Often a foreclosing lender has either evicted the prior homeowner or the homeowner has abandoned the property.  This leaves the potential buyer with no guaranty that no one else has the right to occupy the property and no assurance that there are no pending liens.  Such issues can be avoided with representation and indemnification from the REPO seller that the property is free of tenants and occupants and that there are no mechanics liens pending or assertable.  Maine law allows a contractor to file a lien against a property within 90 days of completion of work or furnishing materials (10 M.R.S.A. § 3251 et seq.) regardless of whether the property was conveyed during that 90 day period.  The execution of a “parties in possession/mechanics lien affidavit” by the seller at closing is sufficient to enforce a claim against the seller if it is later determined that possession or mechanics liens are an issue.  Further, a purchaser should always inspect the property closely to determine whether the property has been abused or damaged from lying vacant for a significant amount of time.  Vacancy and abuse often result in latent or hidden defects that are costly to address.

REPO sellers who acquired title involuntarily (i.e. through foreclosure or by a deed in lieu of foreclosure) are usually unwilling to convey it by warranty deed since they do not wish to warrant title to a new buyer.  Therefore, such seller may condition the sale on the buyer accepting a quitclaim or release deed.  While these deeds are not defective per se, they do significantly limit the buyer’s

ability to recover from such seller if there is a problem with the title that arises after closing.  Proper representation at the time of execution of the contract can prevent these types of deeds from being used or alternatively ensures the limits they impose are understood.

In addition to the conveyance issues noted above, sellers frequently impose conditions in the purchase and sale agreement which severely limit the buyer’s rights to terminate the contract.  REPO sellers often require that the buyer use their form contract which allows the seller to determine the type of title to be delivered (see above), the scope of services the seller must perform. Further, many form contracts require that the buyer use the seller’s title company to examine the title records and to accept the title insurance proffered by such company.  It may seem obvious that this is not a good practice for the buyer, but with the pressure of the sale, the lure of a good price and the opportunity to close quickly many buyers will be swayed to commit to a contract before realizing that they have little or no options in the event an issue arises.

The above described risks can be minimized or even eliminated with proper scrutiny.  First, have an attorney review any contracts or agreements with the REPO seller and its broker before signing. Second, have the title searched and the foreclosure process reviewed by an expert retained by the purchaser.  Third, purchase owners title insurance as it may provide you with the security needed in the event that a title issue arises. Finally, be sure that you can terminate the process and receive the earnest money deposit back if an unacceptable defect in the title or the property’s improvements is uncovered that the seller is unwilling to correct so as to minimize your risk and financial exposure.  Buying a REPO may look attractive, and if you minimize your risk and financial exposure there are great deals to be had. However, what appears to be a jewel in the rough can saddle you with unexpected problems and costs after closing if you do not proceed with caution.