What You Should Know Before Buying a Foreclosure Property
You found a great property for sale -- the price is very low.
But, there's a catch:
It's a foreclosure.
Foreclosures can be riddled with problems, putting the buyer at risk of hidden costs, legal complications, and issues with the property’s history and condition.
Here's what you need to know if you're thinking about buying a foreclosure property.
Should you buy a foreclosure property?
Ultimately, the answer to this question is more dependent on you than on the property itself.
To see if you're ready to handle the purchase of a foreclosed property, there are some key questions you have to ask about yourself.
The responses to these questions will tell you whether or not it’s wise to make this major financial move.
Analyze Your Ability to Handle a Foreclosure
Have you owned a home before?
Foreclosure properties typically come with a few legal concerns and require at least some repairs.
Although traditional homeownership is generally a bit more ‘low-maintenance,’ it still comes with hidden expenses, surprises, repairs, and periodic challenges.
Having already owned a home, you've likely gone through the somewhat stressful process of closing.
And, you have probably experienced some unexpected costs and repairs.
Going into a foreclosure purchase without ever having owned a home may be a rude awakening.
Practice doesn’t make perfect, but it does make challenges seem a bit less daunting.
"Buying a foreclosure is definitely a bit of a grind. It's not easy," Robert Jenson, a Las Vegas real estate agent, told MyBankTracker. "You're getting fantastic pricing, but sometimes it takes going through a lot of houses and writing a lot of offers to get the home you want."
Will the foreclosure property be your home or an investment?
If you’re planning to make the property your home, the risks involved are much smaller.
If, on the other hand, your plan is to invest and generate income from the property, it may be a very long time until you earn a return on your investment.
This can even be true for non-foreclosure properties in perfect condition.
Throw in hidden legal costs, massive repairs, and the low rent or sales prices common in areas with foreclosure properties, and you may not turn a profit for several years.
That’s not to say that foreclosures can’t make good investment properties, but you have to be realistic with your plans and timeline.
For example, if your plan is to slowly make repairs and then sell when home prices rise in the area, it’s important to make sure that you can profitably rent the property for the foreseeable future.
What is your current financial situation?
As mentioned earlier, hidden expenses should be expected when purchasing a foreclosure.
In addition to legal expenses and other costs involved with the actual purchase, foreclosure homes are often in a state of disrepair.
Damage can be the result of frustrated owners, vandalism, theft, or even just sitting empty too long.
Beyond repair costs:
These houses often come with judgments and liens attached to their titles. Then there’s the aforementioned declining market that usually goes hand-in-hand with a surge of foreclosure properties. I
f you don’t have the financial stability to deal with these costs, make necessary repairs, and hold on until the next market upturn, your foreclosure purchase may be your financial ruin.
Before buying a foreclosure, you should have:
- outstanding credit
- little to no debt
- sufficient equity in your primary residence
- access to liquid cash.
- Sellers of pre-foreclosure properties are usually motivated to sell quickly.
- Purchase price of pre-foreclosure properties is typically below market price.
- Pre-foreclosure sellers may be open to doing repairs, paying a portion of closing costs, and providing other concessions to expedite the sale.
- In pre-foreclosure properties, the seller is legally obligated to provide information about property history, repairs, condition, etc.
- Pre-foreclosure sales allow for most standard processes, such as inspections, and title research.
- If the foreclosure is being sold at auction, purchase price may be significantly below market price.
- If the foreclosure is bank owned, the title will be clear and the house will be vacant.
- Bank owned properties typically allow for traditional mortgage financing and inspections.
- Banks are usually quite motivated to sell and, therefore, willing to negotiate on price, closing costs, and down payment.
- Although pre-foreclosure properties come with less risk, they also might not be as good of a deal as banked owned properties. The sellers may be unable to negotiate below their outstanding mortgage balance.
- Pre-foreclosure buyers still have to wait for the sellers to move out.
- Lenders can be a hassle in pre-foreclosure sales. They may not approve an agreed-upon price, and they may refuse certain seller concessions, such as help with closing costs.
- If the pre-foreclosure sale is approved as a short sale, it may take up to 90 days to close.
- If the property is purchased at auction, the purchase price usually has to be paid on the same day as the auction, in cash.
- Auction sales are ‘as-is,’ which means no inspection is allowed.
- If purchased at an auction, the property may have liens, second mortgages, and back taxes attached to it. The buyer will assume these debts.
- Banks are unable to provide property condition and history disclosures for bank-owned properties.
- When purchasing properties at auction or from a bank, the buyers must find and pay for their own representation.
- Bank owned and auction properties may have extensive damage caused by disgruntled ex-owners.
Okay, so let’s say that you answered all of the above questions favorably and the list of cons doesn’t scare you one bit.
The next step is to consider your ability to actual buy the foreclosed property.
Do you qualify for a foreclosure deal? (Step 3)
With the right research, planning, and resources, investors can make a killing buying foreclosure properties.
You may not have access to many of these deals.
With short sales and foreclosure properties, demand is usually high. When demand is high, so is competition.
When investors are competing for foreclosure properties, banks are in a position of extreme authority.
And although it’s illegal to discriminate against a buyer who needs financing in favor of a buyer with cash, lenders do it all the time.
Banks today are more concerned with the speed with which they can offload foreclosure properties than with their bottom line. They would rather lose a bit now than get stuck holding a vacant property for several months, or even years.
Even when all potential buyers come to the table with financing, the banks can discriminate against the type of financing options available.
For example, common restrictions attached to foreclosure sales are, “No FHA financing,” and “No VA financing.” This is because government loans are often complicated and drawn-out, and banks simply don’t want the hassle.
Banks selling foreclosed properties are also lenders.
They don’t want to sell the foreclosed property just to see it go back into foreclosure a few years later.
Banks have adopted stricter policies, and they increasingly favor cash buyers, even when higher offers come in that involve financing.
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The most important rule:
Do your homework.
Buying foreclosure properties is a high-risk proposition for the average buyer. More so if you are purchasing the property as an investment, less so if you are purchasing it as your primary residence.
That doesn’t mean foreclosures are bad deals for average buyers, but it does mean that you should do extensive research, analyze your financial situation, and weigh the pros and cons before buying.
A lot also depends on the location of the property.
Fighting over an in-demand foreclosure property in Los Angeles is very different from buying a lonely foreclosure property in a town of 300 people in rural Vermont.
Not all foreclosure properties are created equal.
If you want to buy a foreclosure, make sure you know what you’re getting into and be prepared for the unexpected.
Take off your rose-colored glasses and play devil’s advocate.
Think of every worst-case scenario possible.