How To Buy A Foreclosure

Foreclosures can be a real estate investor’s best friend. This is because most homes that are in foreclosure can sell on the cheap.  We bought our very first home as a foreclosure!  We got a heck of an deal.  I’m not just saying that because we loved the home either.

Foreclosures happen when a homeowner misses out on their mortgage payments and is unable to come up with the money to repay the lender.   Most of the time, the lender chooses to foreclose a home when there are several consecutive missed payments and infrequent communication with the borrower. Foreclosure can help the lender minimize losses on the loan.

Why are Most Foreclosures Selling At Discounts?

Most lenders are of course banks, and it is not their ordinary course of business to make a profit on real estate.  Banks want you to keep making payments to them.  They are in the business of loaning money not, owning houses.   So when a bank forecloses a home or any other real property, this becomes a non-performing asset for them. This is the reason why banks are eager to get rid of these properties.

Another reason why foreclosures are cheap is when the owner themselves are desperate to sell so that they can at least make a little profit before the bank acquires their property. Most homeowners would even allow buyers to assume their loan just to save them the headache of being constantly hounded by banks.   If a buyer assumes the loan of a person who would ultimately go through foreclosure the seller can save themselves a trip to credit purgatory.

Steps in Buying A Foreclosure

Buying a foreclosure isn’t as easy as it seems. There are a lot of factors to consider and more often the not, the situation is different for every property.   Plus, state laws are different when it comes to buying a foreclosed property. There is really no set of concrete steps when buying a foreclosure, but below are the general measures every investor has to take in order to start the process of buying a foreclosed property.

Do Intensive Research

This is the first step in getting your feet wet in the business. Foreclosures aren’t exactly widely advertised so it is important to do your research yourself to find a good deal. You can find properties in a multiple listing service however, the cheapest foreclosures can be found in places such as a trustee’s or sheriff’s auction, private auction, and from the bank itself.   Banks usually have a newsletter or magazine that lists the properties that they have foreclosed. When you do find a property, don’t be shy to make an offer, most banks are very welcoming to those who show interest in buying their properties.

Another way of getting leads is by affiliating with real estate agents. Since they are in the business, they are the first to know when a cheap foreclosure is available.  We used the real estate agent method to identify our foreclosure.   Our agent was crafty and lightening quick.   Just be prepared to pay them a finder’s fee (sometimes). And finally, you can also attract sellers by advertising yourself as a buyer. You can go online and post ads such as “Need to Buy A House Now!” You’d be surprised at how many calls you can get.


Perform Due Diligence

Buying a foreclosure can be tricky. There are usually a lot of issues that surround a foreclosed property. Before submitting an offer (and before buying the property of course!) it is important to do your due diligence.   The first step is to inspect the property. If the property is in need of repairs, bring a seasoned contractor with you that can estimate just how much you will be spending on repairing the property.


Then, check the title for any other liens and encumbrances. If there are any, ask your bank and your lawyer how these liens will affect your purchase in the future.   There are some necessary questions that you need to ask and are usually forgotten. Asking these questions can save a lot of time and money on your part should you buy the property and realize that there’s something wrong with it. Some of these questions are:

  • Is the property occupied?
  • How much is the annual real property tax and is it updated?
  • Are there any arrears on monthly dues? (For condominiums and subdivision houses)
  • Is the power and water already connected?
  • Are there any details about the property that would affect finding potential tenants? (For rental properties)
  • Is there any bad history of the property? (Such as suicides, murders, etc.)
  • Can the previous property owners buy the property back?

Buying Foreclosures

Wherever you may be, there are three ways to buy a foreclosed property. First is in a presale (before the lender forecloses), second is in an auction, and third is directly from the bank.   Although buying directly from a seller can give you the largest discount (about 30-40%), it can also be the riskiest method of all because most deals usually fall through and there are several instances of problematic titles. Pre-foreclosure buyers also have to add in the cost of property inspection and looking over real estate tax.

Auction buyers can expect a discount of 10-25%, but this can have some problems too such as not being able to inspect the interior of the house. Buying from the bank can allow more time for inspection and flexible payment terms such as taking on a mortgage. However, the prices in banks can are usually at market price but it’s nothing that an aggressive investor can’t negotiate.   Despite the many challenges it presents, buying a foreclosed property can result in massive savings for real estate investors and home buyers. The important thing is to always explore all avenues and to remain unfazed when obstacles come your way.

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Comments

  1. Aren’t home equity loans at a higher interest rate than a 30 yr mortgage? Instead of paying for the house in full and pulling out 70% in a home equity loan, why not just put down 30% with a regular mortgage?

    • The reason you can’t do that is b/c my homes are investment properties. The mortgage rates you typically see are for people who plan on living in the homes “owner-occupied” once you get to the real of “non-owner occupied” you’re in a different rate sheet. Most banks don’t offer non-owner occupied mortgages at all, but they do offer HELOC’s.

  2. Great blog! Nice information here. I am glad you shared this. As an investor, buying foreclosures houses can be risky and at the same time can be the perfect deal depending on how you make out of it. What is important is you should have some idea of the mortgage foreclosure process and that you have a background check on the property that you are setting your eyes on.

  3. How do you search for these properties that are out of state. Do you do everything online and then go see the properities in person and decided to buy or not afterwards? I ask b/c I am looking for a home in a different state and find it extremely difficult to do via the internet.

    • The internet is you friend here. Back in the day you had to exclusively use a real estate agent to find properties listed on the MLS. My first search always starts with the MLS system. My second search is always indpendent brokers who do not list on the MLS service. When I'm ready to purchase a property are at least look at it. I contact my team. My team consists of my real estate agent and property manager which is located in the city. Before we even offer any money on the property I have my agent pull comps and my property manger perform a through inspection of hte property. My property manager is an ex-construction guy and can build a house from ground up. He is also an ex-inspector so he provides me a "What we need to fix report" the agent nails down the cost based on this report. We have gotten so efficient I can buy a property sight unseen if I want too. But, it's only 150 to catch a flight to where I buy properties so after we nailed down 3 properties we they give me a walk through. I select which property I want to buy by that weekend and after my leasing agent gives me an estimate on rents we can command.

      In summary,

      You need to have a team in place!

      • What advise would you give on a primary residential home purchase that is out of state?

        • For a primary residence purchase you have to fly out there and actually few the property. You can do as much as possible to narrow down the price to properties you would be comfortable with, but when buying a primary residence you have see it to close the deal.

          It's two different ball games when buying a home you will live in versus rent.

          For example, I don't care if the property is a mess for a rental I know it will come off the purchase price. For a primary residence factors I don't consider for rentals pops up.

          "How do I feel driving up to my home"

          "Is this enough space for my future family"

          It's essentially a lot more if not 76% emotional when it comes to buying a property to live in.

  4. Ohh.. now I know what you're referring too. Well a common misconception is that a foreclosure is in bad condition. In this recent housing downturn. A lot of properties were taken over that were in impeccable condition. The home I purchased was built in 2005 and foreclosed on 2x before I bought it. I essential bought a brand new home! When buying a primary residence I don't buy fixer uppers. I only buy severely distressed properties as rentals. But, I also buy my rentals all cash :-)

  5. When the appraiser comes out to the property, he makes sure that the property is in 'live-able' condition. I wish I could give you a list of the criteria's that bank's have, but I remember one of them was a water heater.

  6. If I'm not mistaken, there are certain criteria's that a bank has before they lend you the money to buy a distressed property. Sometimes the costs run a little high to make it a worth while investment.

  7. That's a great guide! Thanks! The only problem I see is that real estate is a really, really long term investment. The cycles are huge!

    • I agree but it depends on what type of real estate you own. For example primary residences usually take a longer investment term to pay off. But, rental properties bought at appropriate prices often pay > returns than other investments. Especially, rental properties in lower income areas.

      How would you compare equities vs real estate in risk? Also, do you think stocks are better than real estate due to your opinion of real estate being a long term investment?

  8. I have been toying with the idea of buying a rental (especially in this market) for several years. A few things stop me (my age, my spouse's aversion to owning rental property are prime ones). It wouldn't matter if it was a foreclosure, short sale or regular sale as long as the deal was right.

    You could do another post on this topic and include things such as: how to find a real estate agent that specializes in foreclosures or short sales, working directly with a bank on reo property, special problems that can arise – such as needing to evict current occupants and things to think about when hiring a property manager – how much does it cost, how do you find one and etc.

    • Great idea! It looks like I should do a post on how I purchase and maintain my rental properties My process will make you say. "damn I should go get rental". I literally do 0 work. I spend no more than 40 minutes a month on my rental portfolio.

  9. I'd be interested to hear about your specific experience buying a foreclosure. I looked at a few when I was looking for a home but most were so scary I didn't feel good about taking on the massive amount of work that it would require.

    I was a lender for 7 years so I have a few points about someone assuming your loan. Saying the bank won't care isn't always accurate. Of course this can vary by state but there is a difference in the types of loans that are available for homes (primary residence vs. rental property). Rental properties usually have higher interest loans b/c there is more risk (you don't live there so you are less likely to take care of it in the banks eyes etc). So when you go into a loan as it being your primary residence and then you decide to rent it out, you can't very well go get another loan if you find another house you want to buy and call it your primary residence. The fact that you already have another home loan will be discovered on your credit report and the bank will question that. I'm not saying it's not possible, I'm just saying there are things to be aware of and it's not just as simple as "the bank won't care".

    You also have the issue of homeowners insurance. If you are insuring the home as your primary residence and you are not living there (therefore it's not your primary residence) you can run into some real issues with the insurance company covering a loss. (I also have experience w/ this as I worked in the insurance industry).

    I'm simply pointing out the other side of things as I have experience from a lenders perspective.

    • Jen,

      Thanks for chiming in. Especially, if you have worked on the lender side of the house. I will do my best to explain from my side as the consumer. My specific experience for buying foreclosures as a primary residence has been a great one. I purchased my home (primary residence) in January of 2008 and it was 3 years old. I purposely did not want an old home. I got one of those fancy McMansions for half the price the previous owner and current neighbors paid. The condition of the property was impeccable! There was only 1 issue with my home, in which, the bank promptly fixed. When I say impeccable, I mean it was like I was buying a brand new home. I would not have bought the home if it needed work. I am not handy and wanted a new home on the cheap.

      I currently own 2 rental properties as well. Now, this is where I buy my foreclosures, estate sales and the like. In this scenario, I buy the home with all cash, fix it up, then pull my cash out via a home equity loan. My rental properties are in a completely different state. In my experience, the bank will make you sign a form which confirms you COULD live in the property at some time in the future. I asked my loan representative about the form. You know what i was told. "You have to say you COULD live there if you needed to or we can't give you the loan. it's the regulation" So in experience, the banks don't care. But, I do not go into these loans saying this will be my primary residence. I clearly state this is an investment loan.

      I know all too well about the primary vs rental interest rates. But, in my specific scenario we are not talking about mortgages. I buy with cash, fix them up then pull the cash out via an home equity line of credit. It is much much much easier to get money this way. The trick is to have enough money to buy the first home. My credit union allows me to take 70% equity out on investor owned properties. So I bought 1 home.. fixed it up (no more than the market will bare).. pull equity. Buy 2nd home.. fix it up.. pull equity. It's rental property snow ball.

      In my response I didn't say the bank won't care if someone assumes the loan. I say assumable loans still do exist. From my experience the bank doesn't care if they're getting their checks from someone else on your account as long as the check clears.

      As I read your response, we are speaking on this from two different perspectives. It seems that you assumed that I was buying the homes under the guise of saying it's my primary residence with the intent to rent them out. This isn't the case in my response to funancials I provided examples on how the banks don't care who pays your mortgage. If your intent is to live in the property and 5 years later you buy another home using a mortgage. You have to fill in all that paperwork again. The bank will ask you about the first home. Tell the truth. Your ability to get the new loan will depend on a number of metrics. Credit report, debt to income ratio, income, etc etc. As for insurance, when you move out of home 1 you need to update your insurance to specify this is non-owner occupied and so on and so forth.

      In summation, for the examples I provided to funancials. The bank only cares in the beginning when you're trying to obtain a loan. In my scenario of getting equity. The bank only cares if I could live in the property at one point in my life. I hope this clears up a few things.

  10. In the article you mentioned that a homeowner would be okay with someone assuming the loan. I want to say most loan docs have some sort of disclosure about the loan not being assumable. Answer me this – what happens if the bank finds out that the loan is being paid by someone else and the homeowner moved out?

    They're still getting their payment so they can't be too upset. Right?

    • You're absolutely right most loans these days do have a non-assumable clause which requires the entire loan to be paid if another person wants to purchase the property. But, some loans do exist which are still assumable. It is not common practice but it is around.

      To answer your question of what if the homeowner moved out and loan is being paid by someone else. The short answer is the bank won't care.

      The long answer: Think of it this way. Many home owners start out with the intent of living in their home forever. But, what happens when 10 years pass and they find their dream home somewhere else? They rent it out. Say they have a property manager in place who pays the mortgage out of rents received. Will the bank care? Nope. Your scenario and the scenario I described are similar in the banks eyes. As long as the mortgage is paid according to the contract the bank could care less.

      Great question by the way.

  11. Interesting and useful. Agree with KrantCents that now is the time to buy those and will have to research how does it work in the UK.

  12. Now is a great time to buy a foreclosure and turn it into a rental. You can build equity and it is a great investment.

    • I agree.. but, I say it's always a good time to buy if you can get a good deal based on actual rent received.

      Do you currently have rental properties are looking to buy some? If not why aren't you pulling the trigger?

  13. Although I haven't purchased a foreclosure, I have looked at them. Many do need a lot of cosmetic work to get into habitable condition. At the time, I didn't have a lot of time, but did find a short sale in good shape.

    • Great job on finding an alternate home. Did you get a good deal on the short sale? How long did it take to close on the short sale? Was there more than one bank involved?

  14. Thanks for the detailed breakdown. I was thinking about it for the discount, but worried about the extra headaches. You get what you pay for. What's the difference with a foreclosure and a short sale?

    • Buck.. In a short sale the owner still has the property. You also have to have your offered accepted by multiple people. For example, The owner needs to accept offer and anyone who has a lien on the property has to accept your offer. This can be a headache! Especially, with lien holders in the 2nd position.

      Because of the aforementioned approval process, short sales often take 6+ month's to get approved.

      Foreclosures are homes that are owned by the bank. Foreclosures move real fast since, the bank is not in the business of property management. Foreclosures require 1 approval which is often streamlined. For example, on my home we put in the offer on January 26th, 2008. Our offer was accepted January 28th, 2008. Mind you this is during the Christmas Holiday!!!!

      A common misconception on foreclosure is you get what you pay for and the bank won't fix anything. This is also not true. Everything is negotiable just like a regular sale.

      Are you looking into buying a foreclosure? What is preventing you from pulling the trigger?

  15. I have definitely thought about these in the past. They are still something that my husband and I would consider as an investment. The main thing would be to make sure that the work required on the house would still be less than what you could make on it. In Canada our housing market has risen if anything so we would have to be extra careful to not end up paying more than it is worth. Foreclosures aren't free.

    • Not all foreclosures require work. Before the housing bubble. Yes, foreclosures required work but now.. you can practically get a brand new house at a reduced cost. But, you're right foreclosures aren't free. So, I say treat them no differently than buying a regular house.

      So when are you gonna dip your toes into the foreclosure market? How many unit were you looking at buying? Single family, duplex, etc etc…

  16. My wife was thinking about buying a foreclosure, but I shot the idea down. The property belonged to her cousin, and that would have been too awkward.

    • Why would it be akward? Treat it like you would buy a house from a stranger. check comps, order inspection, negotiate. I think that if the home was being bought from family that would give you leverage on pricing.

      What did you guys do in lieu of buying the foreclosure?

  17. Occupied units are especially dangerous. Well, foreclosures in general have a caveat attached. Have you ever seen what some of the owners have done? Taking appliances out, stripping out wiring, the filth and grime? It's embarrassing to know that people can stoop so low.

    You're right that it's important to have a thorough inspection done, because the price may be right on the front end, but the costs to make all of the repairs, and the time that is may take could push the cost beyond reason.

    • I was lucky I didn't have to do any fixes to my place. But, shortly after I moved in my neighbor who had bought at the height of the market, stripped his place of the appliances/cabinets then filed and insurance claim before letting the bank have it.

      I'm just glad the insurance company put everything back and someone bought it for more than I paid for my place :-)

      Would you buy a foreclosure which required major repairs?

      • It would depend on the purchase price compared to the current market value of a particular area. I'm pretty handy, and have done basic plumbing, closet remodeling & hanging light fixtures in my condo, but major work like sheetrocking, electrical and the like are not my thing. If the repairs added to the purchase price still came to less than the current market value, I would would seriously consider it, especially if I was able to rent it (and therefore not go all out on the materials-maybe a step above contractor grade)

        • Eric, that usually is the case with foreclosures if their are major repairs you simply reflect it in the price. I treat foreclosures like my investment properties I have a total payment amount in mind. Which, is usually well under market price then I cut further and start my negotiations.

  18. I live in Phoenix and there just may be more foreclosures on the market than regular homes for sale! That is an overstatement of course but the market is saturated with short sales and foreclosures. I personally know someone that bought a foreclosure and now has a $500 per month mortgage.

    • 500 dollars a month sounds like a good deal to me. Is the neighborhood one of the better areas in Pheonix? Has this persons home increased or decreased in value?

  19. Foreclosures can be a good opportunity, but you definitely need to do your research. There were a lot of people pretty hyped up about buying cheap property in the states at one point, but just because it is cheap, doesn't make it a bargain!

    • I could not agree more! Some markets are still rapidly declining. I would make sure you offer price matching the condition and the market trends in your area. Fortunately, I bought the right foreclosure :-).

      Have you purchased a foreclosure or estate sale? If not would you?

Trackbacks

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  8. olddogg.com says:

    How To Buy A Foreclosure | Your Finances Simplified…

    Foreclosures can be a real estate investor’s best friend. This is because most homes that are in foreclosure can sell on the cheap.  We bought our very first home as a foreclosure….

  9. [...] • Looking for a new home? If you do it right, you can get a good deal on a foreclosed property. Here’s a guide to help you buy a foreclosed home. [...]

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  11. fwisp.com says:

    How To Buy A Foreclosure | Your Finances Simplified…

    Foreclosures can be a real estate investor’s best friend. This is because most homes that are in foreclosure can sell on the cheap. We bought our very first home as a foreclosure! We got a heck of an deal. I’m not just saying that because we loved the …

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