Why Does an REO Property Need an Inspection?

An REO property needs an inspection because the seller, a lender or agency that never lived in the home, sells it as-is and usually tells you little about its condition. The home has often sat vacant with the utilities off and the plumbing drained, so leaks, heating failures, and electrical faults may not show until the systems run again. The inspection period in the seller's contract, 15 days after HUD signs the contract on a HUD home, is your chance to find those problems and decide whether to go ahead, renegotiate, or cancel under the seller's terms.

Why does an as-is sale put the risk on you?

Three features of REO sales leave condition problems with the buyer:

• No repairs or warranty. HUD does not warrant the condition of its homes and will not pay to correct defects, and it urges buyers to get a professional inspection. Fannie Mae will not sign property-condition addenda that conflict with its own contract.
• Few disclosures. State seller disclosure laws may not apply to the lender. California, for example, exempts a sale by a lender that acquired the home at a foreclosure sale or by deed in lieu from its transfer disclosure statement.
• No help after closing. HUD's inspection notice for FHA buyers says FHA does not guarantee a home's value or condition, and if you find problems after closing, FHA cannot lend you money for repairs or buy the home back.

The appraisal does not fill this gap. HUD's notice states that an appraisal estimates value for the lender and does not replace a home inspection. How a lender evaluates a property explains what the appraiser does check.

What does vacancy do to an REO home?

HUD's rules show what happens to a vacant FHA home before HUD takes it over. The servicer generally must:

• turn off all utilities, unless state or local law, an HOA, shared systems, or equipment such as a sump pump requires them on;
• shut off the water at the curb and drain the plumbing and heating systems; and
• for a private well, shut it off, drain the pressure tank, and cap the supply line.

A home in that state cannot show whether its pipes held through the winter, whether the furnace lights, or whether the well pump works. An inspector can only test those items after the seller restores service. What an REO property is covers how a home ends up in this condition.

What should you inspect and test?

Hire a general home inspector, then add tests for the risks your home carries:

1. General inspection of the structure, roof, and major systems. HUD's notice says an inspector also estimates the remaining useful life of major systems and lists items needing repair or replacement.
2. Plumbing under pressure. Ask that the water be turned on and the system checked for leaks, including the water heater and fixtures.
3. Heating, cooling, and electrical, run with utilities on. If weather prevents running a system, have the report say so.
4. Radon. The Environmental Protection Agency (EPA) recommends a radon test whenever you buy a home and says to fix the home if the level is 4 picocuries per liter (pCi/L) or higher.
5. Lead paint, for homes built before 1978. The federal lead rule exempts the foreclosure sale itself, but not the later REO sale, so the seller must give you 10 days to test for lead before you are bound, unless you agree in writing to a different period or waive it. HUD makes its available lead reports part of each home's Property Condition Report.
6. Other items HUD names for buyers to ask about: mold, water quality, asbestos, urea formaldehyde insulation, and pests. Add a sewer line camera inspection, septic inspection, or well water test if the home has those systems.

Financing an REO property explains how findings like these can trigger appraisal repair conditions or call for a renovation loan.

How do you get the utilities turned on?

• HUD homes: your lender or you can ask HUD's field service manager to activate the utilities, and HUD may charge a fee. If HUD's appraisal was done with utilities off and you use an FHA loan, the systems must be checked with utilities on.
• Fannie Mae homes: if Fannie Mae winterized the home, its contract says the listing agent will have it de-winterized before your inspection and re-winterized afterward. Ask the listing agent to schedule this as soon as the contract is signed.
• Freddie Mac and bank-owned homes: ask the listing agent in writing, before the inspection period starts, whether the seller will restore utilities, how much notice it needs, and who pays to de-winterize and re-winterize the home.
• FHA loans on any REO: the appraiser must ask to have utilities turned on. If they stay off, the appraisal is made subject to a return visit, which can add repairs.

How do inspection periods in bank and agency addenda work?

Each REO seller sets the inspection terms in its own contract or addendum, and they can differ from the inspection clause in your state's standard purchase form.

For how foreclosure produces these homes, see how foreclosure works. For Fannie Mae's full purchase process, see how to buy a Fannie Mae foreclosure.