The U.S. real estate market has been red-hot for the past few years. Sales prices continue to climb each month and bidding wars are common because of tight supply. As a result, many properties in popular locations are changing hands for well above the asking price, while median home prices will rise another 6.6% over the course of this year, according to a midyear 2022 forecast from Realtor.com.
There are several reasons why prices are soaring. The COVID-19 pandemic has changed the way people view their homes. With more than half of Americans now working from home all or much of the time, having more space is increasingly important. The nation’s housing supply has been tight for the past decade, and this is especially true for single-family homes as a lack of new supply has been developed in urban centers.
Lenders may have different standards for borrowers planning to buy a property via auction. … This could make it more difficult for a borrower to qualify or extend the processing time for the application.
There also has been increased competition from corporations looking to turn anemic supply into rental units at a premium price. Finally, the cost of a mortgage has increased over the past several months as the Federal Reserve has raised benchmark interest rates to help curb inflation. But the rate for a 30-year fixed mortgage today is still well below figures from the 1990s and early 2000s.
Home auctions that make the bidding process public are growing in popularity internationally. Transparent bidding could help to regulate home-price growth since buyers don’t have to blindly offer more than the asking price. This process, however, could have implications for mortgage lenders and originators as they may need to adapt standards and offer increased flexibility when lending on auctioned properties.
A better way
Many potential buyers get preapproved for a mortgage to know how much home they can afford and to help speed up the process if they find a property they want to buy. But the sales process can be opaque and confusing for these buyers, especially first-timers.
Frequently, real estate agents will use a technique called blind bidding, in which multiple prospective buyers bid on the property without knowing the value of other offers. For example, a house is listed for $750,000 and gets three offers. The first is for $765,000, the second is for $800,000 and the third is for $900,000.
The seller can choose any of these offers but likely picks the highest bid. In this case, the third bidder has no idea how much they overpaid for the property. These bidding wars inflate prices and force many participants to the sidelines.
But there is a more transparent way of conducting a home sale, which is beneficial to both the seller and purchaser — the open auction. This type of sale is prevalent in Australia and is gaining steam in Canada. It differs from a foreclosure or tax-default auction, where bidders hope to pay below market value for a distressed property.
Auction process
The process works like this: The seller has the property appraised to help set the reserve price, which is the minimum amount they are willing to accept to complete the sale. They hash out all the terms and conditions for sale, including the closing date. The property is then promoted through online ads and open houses.
Qualified buyers have an opportunity to view the property and decide if it fits their needs and budget. In the days leading up to the auction, interested parties need to register to participate. When registering, prospective buyers verify that they have financing, usually with a mortgage preapproval letter, and agree to the closing date, contingencies and other terms.
On auction day, bids are placed publicly, and as long as the reserve price is met, the highest bidder wins the home. Immediately after the auction, paperwork is signed and the buyer places a deposit on the home.
Auctions have benefits for both parties. For the seller, the sale is secure because it is a legally binding agreement, the buyer has verified financing and there is a good chance the property will be sold for more than the reserve price. For buyers, everyone has an equal opportunity to bid on the property and set the price, and they know what other interested parties are bidding. The transaction is quick for both buyer and seller because there are no negotiations.
Potential challenges
As auctions become more popular in the U.S., however, they could change how the mortgage industry conducts business. In the aftermath of the financial crisis of the late 2000s, lenders are more cautious about who is approved for a loan and the amount they are willing to risk.
Underwriters now have higher criteria for applicants, including a credit check, a verified employment history and the loan passing a financial stress test. They also scrutinize the property in question since it will serve as the collateral backing the loan.
Lenders may have different standards for borrowers planning to buy a property via auction. Underwriters could be more conservative and may conduct a stricter risk assessment. This could make it more difficult for a borrower to qualify or extend the processing time for the application.
Importantly, there is a growing dissatisfaction with the current home-sales process. Blind bidding and the lack of transparency are sending prices sky-high, making it impossible for many buyers to enter the market or secure a mortgage.
New sales methods such as open auctions can help control soaring prices and bring an element of fairness to the process. But mortgage companies will need to adapt to this change and review their underwriting procedures to ensure that buyers can secure financing. ●
