I have always had a desire to learn how to become a real estate investor, which is a little strange, since until just recently I leased or rented homes, or shared one with a family member. Buying our first home was confusing enough as a first-time home buyer, but considering how to buy a foreclosed home as an investor seems far more challenging.
Current trends in the housing market indicate that small investors might be wise to consider buying foreclosed property as their family home, for resale purposes, or for rental income. Savvy investors will also note that that the variety of foreclosed homes now available includes those found in affluent areas and seaside resorts, areas where home values typically see nice growth (until beaten down by housing bubbles such as the one we recently experienced.
How You Could Benefit from Buying a Foreclosed Home
While the majority of foreclosures are sold at 5% below market value, your savings may increase if you buy from a lender that is willing to lower the down payment or interest rate, or waive certain closing costs, because the mortgage is in default. Since an appraisal on the property has already been done, you might be able to avoid the appraisal fee, and much of the risk entailed will be removed if title insurance is also included in the purchase price.
If you have a good credit rating, your loan may equal the foreclosure’s full amount, and if you plan to use the home for rental income, the lender may only require a down payment of 10%. Obviously, lending requirements are different across institutions, geographic regions, etc, so investigate down payment requirements in your area.
If you have a substantial amount of equity in your current residence, you may be given a line of credit to make the purchase without even providing a down payment. Personally, I’m not crazy about the idea of using equity in my primary residence to finance the down payment, or significant percentage of the purchase price, of a second, foreclosed home.
What You Should Know
Many home owners who default on their mortgages have been in financial difficulty for about a year, and both regular maintenance and repairs that are needed in the home have probably been neglected on either a large or small scale. Since this can even happen in an affluent area and location really does count, if the resale value of the home seems promising, you might want to consider making a reasonable offer and prepare to invest in its upgrading.
In other words, keep an eye out for the ugly house in a nice neighborhood that is in need of mostly cosmetic upgrades, but is structurally sound. I don’t recommend novices get involved changing floor plans or repairing sinking foundations. If I bought a foreclosure in need of upgrading, I’d stick to new carpet, paint inside and out (if needed) and maybe a go so far as replacing the roof if it was in dire need of replacing. Beyond that, I’d leave it to someone with more time and money than me.
As a rule, banks try to sell their foreclosed home at an auction or work through a real-estate broker. If a property has been up for sale for less than a month, the lender will probably expect a full-price offer, but after that, they may be ready to sell at a bargain price.
A Word About Home Auctions
In the past, a foreclosed home was usually auctioned off for less than 50% of its fair market value, but today, attendance at these auctions has increased significantly. The hike in the number of bidders in attendance increases the competition, which results in a higher sales price. Consequently, foreclosures now often go for 10% to 20% less than fair market value, which makes them an interesting investment, but not the golden opportunity they were when buying foreclosures was done in more exclusive circles.
Note that if you buy a foreclosed home at below market value in a good area and it appreciates annually, this may turn out to be a wise investment strategy. The appreciation will be tax-exempt until you sell the home, and if it becomes your primary residence, it may also be tax-free. If you use the home as a rental property, it may build equity and increase in value while giving you a valuable tax deduction at the same time.
Cover All the Bases with a Home Inspection
Before completing any real estate transaction, especially a foreclosure, you should be willing to pay for a complete home inspection. This will cost between $250 and $400, but it will reveal anything that is wrong with the property’s systems or structure. Remember that you can only determine if the asking price is fair when you know what maintenance and repairs are needed. If you plan to make a direct offer to the owner, find out if there are any outstanding lines or other claims on the home.
Finally, I would recommend using a real estate attorney to help navigate the legal hurdles of buying a foreclosure. We used an attorney to buy our home, because a real estate agent was not needed, and I wanted someone representing my interests throughout the transaction.