How to Buy a Foreclosed Home

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.

Abandoned, boarded up home by Jay Santiago on Flickr

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.

RealtyTrac

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.

Comments

  1. Would you suggest buying foreclosed homes or investing in corporations? I like to invest in corporations only because I am more knowledgeable in that arena. Should I stick with what I’m good at?

    • As a general rule, I say stick with what you are good at, but don’t forget about diversification. Ultra-diversification to me means being diversified across a number of investment types (not just asset classes) – stocks, REITs and/or physical real estate, cash, small business ventures, etc, etc.

  2. Do your homework and don’t assume anything with forclosures. In the Seattle area, multiple bidders have raised the prices to near market value, but they are not anyway close to being up to date with maintenance in most cases. Beware & don’t get pulled in with the bidding, Know your limit. – Gee, sounds like something outside of Real Estate; Huh?

  3. I am by no means a veteran real estate investor. I have 5 years experience and own 12 units, and I wouldn’t think of touching foreclosures. I’d rather speculate on commodities, frankly. At least then I know what I’m potentially about to lose. The topic is vast and not to be considered by anyone unless they have knowledge, experience, and a work ethic that would make Michael Phelps jealous. You are correct on one area in particular, though, and that is that the bidding pressure has pushed up prices to where it is almost impossible to make a quick (or any) profit from probably 90% of foreclosures. Most are not worth it. Professional investors who’ve been doing it for years are going to be your competition, and they are a rather cut-throat bunch.

    Most people are losing their homes because they had little equity to start with. They’ve refinanced themselves up to 100%+ the value of the house. If a bank is going to offer it for sale, they’ll want the majority of their money. And if an investor has to get a loan they’ll have to factor in closing costs, origination fees, loan points, a higher interest rate for investment property, as well as the ‘hidden cost’ of foreclosures. It takes many hours of looking at property and paying home inspectors thousands to find a single property that might make a profit, only to be outbid at the last second by a cash buyer. Most banks want 20% down minimum. I would never tap existing home equity. You said “not crazy” about the idea. I would strengthen that to “under no circumstances.” It’s far too risky and expensive and will eat up your profit.

    Also, unless you’re prepared to do a comprehensive inspection that costs thousands (not hundreds) of dollars, there are plenty of ways you can get into trouble investing in real estate. Lead based paint, environmental contaminants (i.e. asbestos), freon spills, etc. All sorts of stuff the ‘regular’ home inspection doesn’t cover, insurance doesn’t cover, and cost a lot of money to fix.

    I’m not saying people can’t make money, but I recommend starting where the experts do. Look for a minimum of 20% profit margin (5% is laughable) preferably 30-40% after rehab and fix up costs. Are you a skilled people manager (i.e. tenants)? Do you know the local laws and ordinances your property will be required to meet? Do you have a team lined up (plumbers, electricians, handyman) to deal with the multitude of issues you won’t have the time or expertise to tackle? Will your insurance company cover a rental unit or a vacant rehab? What kinds of permits will you need for repairs?

    There’s a reason we just had an economic downturn. Too many people with no money chasing real estate deals. There are still a lot of people to compete with, and if you’ve got time, money and a never-say-quit mentality you might make a fortune. But proceed with caution!

  4. I just went to WT direct to take advantage of the $100 bonus and it says the offer has expired. What’s up?

    • I just got notice of that this morning myself. Apparently the offer was too successful! Sorry you weren’t able to take advantage. I’m going to update that post with a note that the offer has expired.

  5. I am hesitant to buy a foreclosed in our area after all the damage the previous owner’s have been doing to the homes. If I had more money, I might be more willing to give it a try. However, I view buying a foreclosed home as kind of risky because of possible hidden problems, so I am not ready to dive in.

    • I put together this article with the same thoughts in mind. I lean more towards the idea of buying a small home with a large cash position (if not 100% cash) and renting the home. With foreclosures and flips, the money is made at the buy, and I’m afraid I am just not savvy enough to guarantee good results with the increased, professional-level of competition.

  6. My parents have bought a couple of foreclosed homes in the past (both as rental properties and personal homes), some things to consider, tax breaks and how long you live at a place, capital gains, etc. Know what you can do yourself (painting and tiling) and what you need a professional for (electrical and plumbing) for example.

  7. My first husband and I bought a foreclosed condo many years ago (after the real estate bust of the 80s) and had a very different because it was a HUD home sold at a sealed bid auction. We weren’t allowed to inspect with power on, for one thing, so we had no idea what might or might not work. And since it went via sealed bid, we basically got one shot at being the high bidder. Of course we used the winning bids of other HUDs in the complex as a guideline, but it was still a guessing game. It did turn out well for us though — we bought with $400 down (slightly more than 1%) and everything was in working order when we turned the power on. We just had to replace missing light fixtures and patch something like 900 (literally) little nail holes in the walls.

  8. You have a lot of great information in this article. I’m glad that you mentioned that with so many more buyers, it’s not quite the gold mine it used to be. So many people don’t think about that aspect!

  9. We bought a foreclosed home three years ago, but it was by accident. We didn’t even know it was a foreclosure until after we decided we were interested. We simply saw the house, looked around, and decided to check into it…

    What a pain in the butt! It took 4-5 weeks to get everything worked out. We saved $21,000 on a $135,000 house but had to jump through so many hoops…I’m not sure if I’d do it again. Plus, we had to buy dozens of lightbulbs and every single appliance since the previous owners took every single bulb in the house and all the appliances (even the garbage disposal, dishwasher, oven/stove, and above the oven microwave. We know we got lucky since they didn’t ruin anything, but I’m still not sure if we’d do it again.

  10. My brother bought a foreclosed also, he seems to have had a huge headache as well. But in the end he saved a lot of money. As far as the repairs go, I know he replaced the flooring, roof, electrical, and I think plumbing…. But he also redid the layout of the building and built a huge fence. Obviously some needed, some not. Where I live, I’ve been looking heavily at foreclosures however, my downpayment and overall general savings still need to be increased before I buy any home. Not to mention, I’d like to have some of the debt paid down too. Sadly by the time I’m probably ready for a home, especially foreclosure, the market will likely be very different.

  11. Being a real estate investor some of the homes we own are homes going through foreclosure purchased at sheriff auction on the courthouse steps, 10 at last count and we are activel perusing the sheriff auctions for more good deals. If you have the stomach to purchase in this manner good deals are still available. We are seeing homes go for .40 on the dollar. Not all mind you, some are being offered over and above what the seller even owes, banks are not waiting to collect their money from agents after the sale they are hoping the buyer at the auction sale will help them make a profit. So you need to be diligent and do your homework. Mortgages are of public record, and while it makes you really no difference what the previous owner owed it is interesting to see what games the banks are playing. We have purchased homes that appraised for $80,000, the owner owed $50,000 and we paid $30,000 as an example.

    All homes that are going to auction have to by law be advertised in the local paper of the county they reside in 3 times before the sale. You can also go to your county courthouse and they will have homes on the board and scheduled dates of sale.

    Be careful what you buy. It is ‘as-is’ and most homes do not allow for inspections before the sale. We made a deal with the county sheriff to turn a ‘blind eye’ while we ‘broke’ into these homes (hey-no damage, i promise, well no more damage than what was already left behind by disgruntled homeowners) and having this extra knowledge did cause us to walk away from some homes that otherwise looked manageable from the street. By doing this we pretty know how much work a home is going to require and have put numbers to it. But keep in mind you can’t see everything and there could be hidden problems lying in wait. We have a real estate broker that we turn to who helps us in crunching numbers and running comparables so that when we go to the sale we are well armed with necessary information. While we do not ‘flip’ our homes and only rent, one day we will want to sell and get out of this business so we still have to buy for the right price in the right locations.

    You must also pay for the home immediately in cash, in our county within 24 hrs. So make sure you have the funds readily available and ready to dispense if necessary.

    One other very important consideration is liens. While mortgages are wiped out at the sale liens can become an issue. Most will be wiped as the 1st mortgage takes priority over all else the one to watch is IRS liens, taxes unpaid. I am not speaking of property taxes (which also could be due and payable so check that one out too), the liens i refer to are personal taxes that have not been paid. The liens can be attached to the home and if you purchase it, you purchase that lien also. So once again, CHECK public records. (and we re-check the morning of the sale as you never know when one can slip in at the last minute).

    OR: you could just make it easy on yourself and wait til the bank gets the home back and purchase through a qualified real estate agent. At least then you will be protected from any unforeseen problems that arise (and there usually are plenty, trust me)….

  12. Congress, in an effort to stabilize FHA has passed HR 5981 which Obama is expected to sign. This bill, “General and Special Risk Insurance Funds Availability Act”, is intended to allow FHA to increase its annual premiums for single family homes. What does this mean for home buyers today? It means it will cost you significantly more to finance your home if you get an FHA loan after 9/7/10. In previous posts I warned that FHA was going to make serious changes to its programs to remain solvent. I actually expected these changes in the first quarter of the year but they waited until the 3rd. This will permit FHA to increase its annual premiums from .55 percent to 1.55%. The rub is that the bill purports to save you money up front but boy do you get hit in the annual premium …read more.

  13. ok, total green horn here! (my ignorance is making me blush)
    Condo unit in my complex is in foreclosure. surrounding units are going between 82000-92000. this unit is advertised by the bank at 24,700 (!?) what’s my next step?

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