How To Buy Foreclosure Houses

An Overview Of The Foreclosure Process

Before discussing foreclosure purchases, I need to explain the foreclosure process, in general. Understanding this process provides insight into how investors can purchase these homes with no money.

When you take out a mortgage loan, the home you purchase acts as collateral for that loan. Whether primary residence or investment property loan, the property itself serves as a collateral. And, the fact that home mortgages are secured loans plays a huge role in why borrowers can get such low interest rates.

Simply put, collateral reduces risk to lenders, because if the borrower stops paying or defaults on the loan the bank can seize the collateral. They can then sell it on the open market and recoup all or a portion of the outstanding loan balance. On the other hand, take a look at the interest rate your credit card offers on a cash advance. This is a form of unsecured loan . And, youll likely see double digit interest rates due to the increased risk for lenders in providing these loans.

Banks call this process of seizing the collateral of a borrower who has stopped paying foreclosure. And, it typically follows these steps:

Pros Of Buying A Foreclosed Home

There are few ways to pick up a property with a discount ranging from 10 percent to as much as 90-something percent. Sometimes an investor can pick up an entire single family home, rowhome, or townhome for just a few thousand of dollars. Purchasing foreclosures is a great way to see great profit margins, or acquire a rental property for very little money. Foreclosure opportunities are also fairly abundant year-round, if you know where to look. If you plan on turning the foreclosure into a rental property, your new asset can become a long term source of cash flow.

Cons Of Buying A Foreclosed Home

Foreclosed homes are usually in a state of disrepair and require a lot of work. Theres a reason why a home is being sold for a 95 percent discount! Sometimes they require more work than you think. Other challenges may include fighting off other liens or claims against the propertyeverything from disgruntled relatives of the former occupant to a mechanic lien for unpaid work to the former occupant themselves. Sometimes foreclosed properties attract crimewhich is a liability on the owner. Thankfully there are property preservation companies you can use to secure the home until you are ready to work on it.

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Find A Foreclosed Home

One of the easiest ways to find foreclosed homes is to make friends with real estate agents who deal with foreclosed properties. Many times, an experienced real estate agent will be able to tell you about available properties before they go to auction. And many times, if you are a cash buyer, you can purchase the home from a bank or lender before other investors know about it. Barring that option, you can look online at foreclosure sites or other real estate market sites to see foreclosed homes and when they are being auctioned. You can also drive around the neighborhood and look for signs about upcoming public auctions.

Financing Options For Foreclosed Homes

Potential buyers of foreclosures might feel intimidated by all the complexities around financing. The common assumption is that you have to pay all cash for a foreclosed home, but thats far from accurate. Your financing options for a foreclosed property ultimately depend on your financial situation and what stage of foreclosure the property is in. Here are a few standard options for financing a foreclosed house:

• Conventional mortgage: Bank-owned foreclosed properties can be purchased using this type of loan.
• Conventional renovation loan: If the foreclosed home you want needs many repairs, you can finance it with a renovation mortgage that combines the purchase price and the construction cost into a single loan.
• FHA loan: You can use an FHA loan to buy almost any type of home, including bank-owned homes and short sales.
• FHA 203 renovation loan: For people who cant offer cash, an FHA 203 loan may be a good option for borrowers who want to roll projected renovation costs into their mortgage.

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Find An Experienced Foreclosure Agent

Some pitfalls come with foreclosed homes, so youll want to work with a realtor or foreclosure specialist who has experience navigating the process and knows the local market. If youre interested in an REO property, youll likely work directly with the banks broker in many cases.

An experienced agent can help you determine when a foreclosed home is offered at a bargain price, and when its not worth the risk involved. Every state has its own set of laws and regulations concerning foreclosures, and an expert can help you understand them to avoid hefty costs down the line.

The cost of closing, repairs, and property taxes can turn a bargain house into a money pit. The bank may also hold you financially responsible for any property debt that wasnt paid by the previous owner. Working with an expert can help you understand what your financial obligations are beyond the mortgage.

It doesnt cost you a lot to use the right realtor, but it could cost you a lot to use the wrong one, Enriquez says.

Lastly, know that the previous owner might have the right to redeem a foreclosed property. Many states in the U.S. give homeowners this protection, which allows them to reclaim their foreclosed home as long as they can repay their debt within a certain period of time.

But it doesnt happen often. Many people whove gone through foreclosure arent typically able to come up with money quickly to repay the outstanding mortgage balance and any extra costs incurred during the process.

Reasons To Buy A Foreclosed Home

Foreclosures are appealing to many buyers for several reasons, including:

• Lower prices: In most cases, buying a foreclosed home will cost you less than buying a comparable home on the market.
• Better return on investment: Because of the potential upfront savings, homeowners can invest extra funds into home improvements — which can produce a significant return when it’s time to sell.
• Fewer title issues : Bank-owned properties are thoroughly vetted ahead of time. The bank will clear the title for you, and you don’t have to worry about any issues the homeowner may have. That’s not the case with properties that are still technically in the homeowner’s possession or up for auction.

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How Does Foreclosure Work

Foreclosure is the process by which a lender takes possession of a home when a homeowner fails to make their mortgage payments. It has several stages, which are important for a buyer to understand when considering a foreclosure.

• Payment default and notice of default:Payment default occurs after the homeowner has missed at least one payment, and after several months of missed payments, a homeowners entire mortgage can default. This typically initiates the preforeclosure stage of the foreclosure process. A notice of default is usually sent by the lender after 90 days of missed payments. Foreclosure referral timelines will vary based on the contract agreement as well as the policies of the lender and investor in the mortgage. A homeowner is often given time to work out a new payment plan with the lender before the home is foreclosed and put up for sale.
• Notice of trustees sale:The lender must record the impending sale with the county and publish news of it in the local paper. This is one way of finding a foreclosure to buy, although an online search will generally be more effective.
• Trustees sale:The lender attempts to sell the property at public auction.
• Real estate-owned: If the property does not sell at auction, the bank will become the owner. They will then attempt to sell the property. For most people looking to buy a foreclosed home, especially those purchasing with a VA loan, this is the stage of foreclosure in which they will buy.

Find a local pro.

Make Your Bid Or Offer

Your agent will help you write up a bid or offer and advise you on contingencies to include. For example, you can agree to an as is sale without requesting any repairs. But if the inspection turns up anything gnarly, with an inspection contingency, you can walk away from the sale. This is just another reason why having an agent by your side can ease the process. Because most auctions are all about cash offers, you typically cant get a mortgage or use a lender.

Some auctions take place entirely online, with photos and property details included. You compete with other online buyers and hope the property is represented well so youre not left with a house needing significant repairs. You can also bid in person, but real estate investors usually flock to any in-person listings and tend to outbid potential homeowners with high all-cash bids.

Auctions also have rules that youll have to follow to place bids, which can include:

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Know Your Fees And Taxes

Other than the downpayment and the propertys selling price, there are also fees and taxes charged to the buyer. For example, buyers must take care of notarial fee, registration fee, transfer tax, and documentary stamps tax, and if youre buying a condo or townhouse units, the buyer will also be required to pay monthly association dues.

Determine How Much Home You Can Afford

Budgeting matters when buying a foreclosed home. Yes, you might be able to nab your new home at a lower price tag. But foreclosed homes arent free. And despite what you might have heard, you cant buy a foreclosed property for $1 either.

Youll need to craft a household budget listing your monthly income and expenses to determine how much of a mortgage payment you can afford each month.

If you dont do this, you might purchase a home you cant afford even if youre looking for a foreclosure. By purchasing a home thats out of your budget, youll struggle to make your own mortgage payment each month.

As with any home purchase, its important to predetermine your debt-to-income ratio. As the name suggests, this ratio analyzes how much of your gross monthly income your monthly expenses will consume.

Most lenders want your monthly debts to take up no more than 43% of your gross monthly income. If your debt-to-income ratio is higher than that, youll struggle to qualify for a home loan.

Be especially careful when buying a foreclosed home. You might be tempted to buy a foreclosure with a price tag thats at the very top of your budget.

The problem with this is that the foreclosed home might require expensive repairs. If youve purchased a home at the top of your budget, you might not have enough money to afford those needed repairs.

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Conduct A Home Inspection

Before making an official offer, you must know what youre buying. Thats not possible at an auction sale. But when youre buying an REO or government property, it makes sense to order an inspection.

A home inspection will let you know if anything is wrong with the property. A qualified inspector will come to the house and make note of anything that needs to be repaired or replaced.

An appraisal is a less in-depth inspection required by your lender. The appraiser will evaluate the property to confirm its value. After all, your lender doesnt want to pay more for the property than its actually worth.

Pros And Cons Of Foreclosed Homes

As you look for foreclosed homes, be sure to keep the benefits and drawbacks in mind.

Pros

You could save a lot of money. A major perk of buying a foreclosed property is the savings. In terms of a foreclosure, the lender is strongly motivated to sell the home, giving the buyer a strong negotiating position.

Needed repairs could give you an opportunity to customize the home. If the house were perfectly move-in-ready, spending money on renovations may feel wasteful. But if you already have to make some repairs, spending a little extra to get exactly what you want may be worth it.

You could make a profit. Even if youre not a professional house flipper, selling a foreclosed property that you fixed up and lived in for a while can still net you some cash.

Cons

Buying a foreclosed home can be a long process. Purchasing foreclosed properties generally involves more paperwork. The average foreclosure process during the second quarter of 2022 took just under three years, according to ATTOM Data Solutions.

A foreclosed home can have hidden debts. Foreclosed homes can have outstanding taxes or unpaid liens on them that new owners will have to pay. The exception to this are REO homes. A title search should reveal if there are any issues, and title insurance will protect you from any new ones.

You may be competing with many buyers. Other homebuyers, professional home flippers and real estate investors can all smell a good deal. You might have some stiff competition.

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How Do I Get A Good Deal On A Foreclosed Home

When youre investing in real estatethe keyword there being investingyou make money by finding a good deal first, then selling at a higher price later. This means you want to buy something below market value.

One of the most important rules about buying foreclosed homes is that you must get a good deal. As an investor, you can generally consider a home to be a good deal if you can get it for 80% or less of market value minus the cost of repairs.

Even if youre taking the house as is, your offer should still account for the cost of repairs youll have to make after you buy it. You just need a home inspection and a good bid on repairs so you can apply the formula for getting a deal on the house:

80% of the appraised value minus the cost of repairs

For example, lets say you find a foreclosure listed at $125,000. You and your real estate agent agree this is a fair market value for the house in pristine condition. But its not in pristine condition and your contractor estimates repairs at $15,000.

Now do the math: 80% of $125,000 is $100,000, minus repairs of $15,000 equals $85,000. Thats the offer you make. Remember, the deal is made at the buy. That means you dont buy unless youre getting a deal. Youve got some room to negotiate, but dont go into debt to get the deal done.

Okay, so what if youre not an investor? Is it still a good idea to look at a foreclosed home as a first-time home buyer? Maybe.

Pay For A Home Inspection

Unfortunately, when buying a foreclosed home, you take on a certain amount of risk in regards to the quality of the property. This is because you arepurchasing the home as-is, which is how the previous owner left it. The lender selling the home will not pay for any repairs, so this is your responsibility. You may even need to take out a separatehome improvement loandepending on the severity of repairs needed.

To understand the extent to which the home needs to be repaired, you should pay for a home inspection. After you submit a purchase offer for the home, there is a period where you can arrange for home inspections before closing on the sale. A home inspection, which typically costs $400-$800, can uncover many problems and even change your mind about purchasing a property. It is a good idea to have an inspection contingency in your purchase offer, however, contingencies can make your offer less attractive.

During a foreclosure auction, you will not be given the opportunity for ahome inspection. This considerably increases the risk of buying a substandard home, so you should have significant experience with home repairs. Otherwise, its best to avoid buying foreclosed homes that do not allow for inspections.

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Review Your Appraisal And Home Inspection Carefully

Once your offer has been accepted, you’ll proceed to the next two hurdles: the home appraisal and inspection.

Unless you’re paying in cash, your lender will require an appraisal to ensure the home’s value aligns with your offer. If you’re paying in cash, you might consider ordering an appraisal to ensure the property you’re buying is worth its selling price.

Even more important, though, is the home inspection. As a buyer, it’s your responsibility to order a home inspection — this step is critical with a foreclosure. You’ll want to know about every potential issue because there’s a strong chance you’ll have to buy it as-is.

“Many banks and HUD will sell properties ‘as-is’ and will make no repairs after the sale,” says Bhatt. “But some banks will consider repairs after inspection and more so after appraisal, especially if they are lender-required repairs.”

Review your inspection results carefully to decide if the issues found are worth the discount you’re receiving on buying a foreclosure. Attempt to negotiate repairs for anything major, but be prepared to walk away if the damage is too extensive.

Establish Your Price Point

Before you start searching for a foreclosed home, you should think about what price range you want to stay within. Consider your monthly income, how much you spend on groceries, the average amount you can afford to put toward household bills, repairs and mortgage payments. This will help you determine what house price you can afford. From there, you can establish an overall price point to focus on.

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