There's one key difference between a house that's in foreclosure and a house listed as "real estate owned," or REO. A home in foreclosure is being taken back by the mortgage lender; an REO home has already been taken back, but the lender hasn't been able to sell it. In either case, if you want to buy one of these homes, you'll be dealing with a bank, not a homeowner, and that may limit your negotiating room.
Foreclosure occurs when a mortgage lender seizes a house because the owner has stopped making payments on the loan. Foreclosure procedures vary from one state to the next, but in general, lenders don't get the ball rolling on foreclosure until the owner has missed several payments. In some states, the lender has to go to court to get permission to foreclose; in others, the lender already has the authority. The homeowner has the right to challenge the foreclosure and usually gets a "last chance" to get current on the payments. If all that fails, the lender evicts the homeowner, takes the property and tries to sell the house.
When you see a house listed as being in foreclosure, that means the lender is in the process of taking it back. Once the lender repossesses the property, it will put the home up for auction. At foreclosure auctions, the lender sets the minimum price it will accept. The minimum is usually the amount that the (former) homeowner owned on the mortgage, plus the legal costs of foreclosing. Depending on the rules of the auction and the laws of your state, the winning bidder may have to provide a cashier's check for the full amount on the spot, or for a significant portion -- say, 10 percent of the bid -- with the rest due soon after. If there are unpaid taxes or other liens on the house, the winning bidder will have to pay those. If no one offers the minimum bid, which is common, the property goes "REO."
REO is industry shorthand for "real estate owned" -- owned by the lender, that is. REO homes are also known as "bank-owned" homes. The lender is responsible for maintaining the home and paying the property taxes. Lenders, of course, aren't crazy about having to do this. Their business is lending money, not property management, so they want to sell their REO homes. Mortgage lenders' asset managers work with real estate agents to try to sell the homes.
Buying an REO
Just because a lender wants to unload an REO doesn't necessarily mean you can get it dirt-cheap. The lender's primary concern is getting back the money it loaned on the house in the first place, so it may stand firm on the price. Your best bet is to work with a real estate agent experienced with the local REO scene, who knows which banks will be willing to negotiate and which ones won't. In general, though, you will be buying an REO "as is," meaning that if there's anything wrong with it, that's your problem. The lender won't give you a discount, and it might not make repairs.