Buying a foreclosed home is fraught with risks. Before you jump on the bandwagon, learn whether you’re a good candidate to do so, as well as the risks and benefits of buying at each stage of the foreclosure process.
Whether or not you should consider buying a foreclosed home depends on several factors, including your homeownership experience, your financial situation, and whether you have access to professionals with experience buying foreclosed properties. Ask yourself the following questions:
Do You Have Prior Homeownership Experience?
Think hard before making a foreclosure purchase your first home buy. Owning and maintaining any home presents challenges — and a foreclosure home may be in a serious state of disrepair and come with legal concerns that make regular homeownership look like a walk in the park. It helps to have already learned the many lessons about the true cost (in time and money) of owning a home (beyond the monthly mortgage payment) and to have developed relationships with home contractors and other professionals who can help you.
Will This Be Your Primary Home or an Investment Property?
If you’re buying the foreclosure for investment purposes, realize that the finances may not be as simple as they first appear. For starters, you probably can’t count on fixing up the place and then flipping it at a profit — the level of repairs required, plus the fact that in areas with bargain foreclosures, home prices may not bounce back for some time, means you’ll have to make sure you can profitably rent the place for some years to come.
How Solid Is Your Financial Situation?
A foreclosure deal may be loaded with surprise expenses. Even before you begin to negotiate, the homework necessary to research the market and property can cost you. More significantly, foreclosed properties were often neglected for months by struggling homeowners or even trashed when the frustrated owners were forced to leave. And if the property has been sitting empty, there’s a chance it’s fallen prey to thieves, vandals, and squatters. Stealing copper pipes and fixtures has become a popular pastime in areas with many foreclosed homes.
Such properties also can come with titles encumbered by judgments, liens, and other attachments that you may have to pay off to seal the deal. Finally, a surfeit of foreclosures typically signals a declining market with the inherent risk of property value declines yet to come. You should have the financial wherewithal to see you through to the next upturn.
Existing or prior home ownership can give you the equity stake you need to cover foreclosure purchase costs, provided you have a solid equity position available in your primary residence. Otherwise, some source of liquid cash to tap, along with low debt and outstanding credit, are all essential.
Do You Have Access to Experienced Professionals?
The arcane foreclosure system is populated with professionals who’ve learned the ropes. Unless you are likewise endowed with foreclosure acumen, get one or more experienced professionals on your side.
You’ll need competent assistance from a real estate agent, attorney, investor, or other professional familiar with local laws and the real estate market, specifically as they apply to your market’s foreclosure system. Your point person should also have ample connections with other savvy professionals, such as a home inspector, appraiser, and perhaps a general contractor.
When you buy a foreclosed property is as important as what property you buy. Here are the pros and cons of buying a foreclosed home at each step in a typical foreclosure process.
Buying a Preforeclosure Home: Pros and Cons
“Preforeclosure” is the period after a homeowner goes into default (typically when a payment is 90 days or more past due), and the lender files a public notice to that effect (notice of default or lis pendens). You can find these notices in your local public records office, or get them from the local newspaper or on- and offline firms that track this data.
Pros. Experts say that preforeclosure is often the best time to buy one of these properties. Here’s why:
• You’ll have more time to get a comparable market analysis, research the title, and have the home inspected. This is because the default notice typically gives the borrower several months to bring the loan current.
• This is a time when the seller may be most accommodating, especially if he or she can walk away with something to show for any equity in the property and avoid further ruining his or her credit standing.
• If the home isn’t up for sale, you’ll avoid open market competition that comes with homes on the multiple listing service. That means there’s a greater chance you can negotiate a favorable price.
Cons. Here’s what to look out for in preforeclosure properties:
• If someone has been unable to pay their mortgage for several months, chances are they also haven’t been able to afford upkeep. That means the home will likely sell “as is” and may need costly maintenance and repairs.
• The title could be tagged with judgments, say, for an unpaid second mortgage or home improvement loan. The judgments could include late fees and other fines.
Buying at a Foreclosure Auction: Pros and Cons
Months after the buyer first defaults, assuming he or she doesn’t bring the loan current, the lender attempts to auction off the property. Foreclosure auctions vary from state to state, but they are typically held on the courthouse steps, in a county office, at the foreclosed home, or some other location.
Pros. The auction can represent the highest potential return for an astute buyer who has done the necessary homework, inspected the property, and verified the home’s value. Here’s why:
• The selling lender is usually motivated to sell at a fair market value.
• Auction terms typically disclose the closing date, removing the guesswork that comes with some contingency-based home sales.
• Many auctions also come with a due diligence packet of comprehensive information on the property, which the buyer can compare with his or her own research.
Cons. Auctions often attract hard core investors who have the cash to flip the property (sell within a short period for a profit) and others who’ve been around the foreclosure block a few times. Having professionals on your side is key.
Here are some other disadvantages to buying foreclosed homes at auction:
• If you make the winning bid, you must pay with cash or cashier’s check (drawn upon a line of credit). All sales are final for the total amount of the bid.
• A bidding war that includes savvy investors could leave you empty-handed or the new owner of a property worth less than your bid.
• You typically can’t inspect the property (unless you already inspected it during preforeclosure) so you will have to rely upon the due diligence packet (the information provided by the seller about the condition of the property). You won’t have time to run comparables or do a title search.
• By foreclosure time, the property has likely been vacant for some time. In addition to preforeclosure conditions, it is not unusual to find filth; missing appliances, toilets, sinks, and even electrical wiring and plumbing; unacceptable floor coverings; and climate-related deterioration.
• Things could get nasty if you have to evict lingering residents from their lost home. The eviction process gives them plenty of time to trash the home or strip it for financial gain.
Buying a Real Estate Owned (REO) Property: Pros and Cons
Lenders repossess homes they can’t auction off. The properties are called “real estate owned” properties or “REO” properties for short.
Pros. Here are some of the advantages of buying an REO property:
• When the bank holds the property you once again have time to arrange for an inspection and a title search, which removes some of the risk from the cost. (However, buyer’s agents report that sometimes it is difficult to arrange for an inspection of these properties.)
• Banks may be more likely to finance a home they own — they have an interest in unloading the home in order to eliminate the costs associated with ownership.
• Gone are the owners and, with them, the need to evict.
Cons. There are several big disadvantages to buying an REO property: namely price and dealing with the bank.
• Banks want top dollar to cover their costs and to recover what the previous homeowner owed on the loan. This may be more than the value of the home in the current market, especially if the homeowner had an “upside down” mortgage — one where the outstanding loan balance was greater than the home is worth.
• Buyers’ brokers report that working with banks as the seller can be inordinately difficult. Banks are notoriously unresponsive. You can expect extra work, unreturned phone calls, and to wait several weeks after you make an offer to receive a reply. Buyers’ agents make less money (banks often reduce their commissions) and have to work harder to get a deal for their clients.
Interested in learning more about buying a foreclosure? DIG University offers an all-day seminar on purchasing foreclosures at auctions and sheriff’s sales. Check back this summer to see our schedule of classes for DIG University Fall 2019.