How To Buy A Foreclosed Home
Real estate investing is often not straightforward. Perhaps you have found the perfect neighborhood but prices are way out of your budget. Or maybe you’ve settled on a property but lenders are saying that repayments would be through the roof. However, there is another way to acquire a home of equivalent value.
To save yourself some upfront funds, and potentially increase returns, foreclosed homes are an excellent way for investors to break into the real estate market. Why? Because foreclosed homes can be acquired for far less than the true market price.
Let’s take a look at why that is, and how you can capitalize on the opportunity.
What is a foreclosed home?
A foreclosed home is a property that has been repossessed by a bank or financial lender. When an owner cannot keep up with mortgage repayments the property is repossessed and moves under the ownership of the financial institution lending funds.
To recoup any losses that the lender may have sustained, the property is placed on the market – and quickly. The lender often wants to collect funds as quickly as possible so, to entice buyers, foreclosed homes are listed with a hefty discount. And that right there is the key benefit. Hefty discounts create more room for profits.
The process of foreclosure can vary slightly depending on the property. Sometimes pre-foreclosure the owner can apply to complete a short sale. The property is still listed at a discount but the owner deals with the process. This can be beneficial to the owner as it gives them slightly more control.
Alternatively, if the home is repossessed, the property will be listed by the lender. These are sometimes referred to as Real Estate Owned, or REO, properties. They are commonly sold via a Multiple Listing Service or offered for sale via auction sites.
Should I buy a foreclosed home?
This is a tricky question to answer, and one that is likely subjective for most investors. However, ultimately it will come down to the level of risk you are willing to take. So when you’re thinking about whether a foreclosed property might be right for you, here are a few factors to consider.
Firstly, if the owner decides to opt for a short sale, they will require written permission from the lender of the property. Gaining this permission can be a long process, which means you could be waiting on the sidelines while things progress. Even then, there are no guarantees the lender will agree – which could make the process even longer.
There is also, generally, no seller’s disclosure to rely upon. This disclosure usually contains all of the known issues that may affect a property’s value. Without it, a buyer is left in the dark as to what problems the property has suffered from in the past. And you might now be thinking that these problems can be caught with a property inspection, well…
In certain situations, you may not get the chance to complete a home inspection or building survey before purchase; a common practice when purchasing any other property. Even with an inspection, foreclosed properties are usually sold ‘as is’. Any repairs instantly fall with you.
While you should be aware of the above risks, each situation is unique. Some properties may not come with these risks attached. But, undeniably, foreclosed homes require a little more caution than your standard residential purchase. However, there could be bargains to be found.
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Buying a foreclosed home in 6 steps
Buying any property can be a daunting thought – especially for new investors. There’s usually plenty of paperwork involved and you have to be hot on your numbers. However, the process really doesn’t need to be a difficult one.
While buying a foreclosed home is similar to buying an average residential property, there are a few key differences which we will now show you. Tackle each of these seven logical steps and you will be well placed to start generating a healthy profit.
Step 1: Do Your Own Research (DYOR)
Research is everything when choosing the right property. You need to know your location and potential property like the back of your hand.
It is useful to start by asking yourself some basic questions. Where would you like your property to be located? Do you want it to be close to where you live? Or are you happy with it in a different city or state if it means returns could be higher?
To give yourself the best start read ‘How to buy a rental property’, particularly steps 2 and 3 (link is at the bottom of this section). These two steps will take you through all of the macro analyses that will help you decide on a city and then how to look for the best neighborhoods within that city. These are key research steps that every investor should complete to make a real estate investment work as hard as possible.
After settling on a location, it is now your job to collate as much information as possible regarding the local property market. Become familiar with rental incomes, local taxes, and, most importantly, property prices. The more knowledge you can gather during this first step of the process, the greater prepared you will be when purchasing a foreclosed home.
Read the guide: How to Buy a Rental Property
Step 2: Organize your finances
Even if you’re not a numbers person, you definitely can’t skim over your finances. Finances are where a foreclosed deal can be won or lost.
Start by determining how much money you can afford to use for upfront costs such as a deposit, legal fees, and any maintenance that may be required. Will you be purchasing the property outright, or will you require extra funding?
If you are not buying a foreclosed home outright, you should obtain a mortgage preapproval. This allows sellers to see that you are a committed buyer and not one to be passed by lightly. Many foreclosed homes are purchased in cash, by other real estate investors, so having a preapproval proves to a seller that you can move just as quickly. Begin working on your credit score as early as possible to give yourself the best chance of mortgage preapproval.
Step 3: Research how and where to buy the foreclosure
While purchasing a foreclosed home is similar to buying a residential property, finding opportunities is where the two processes start to diverge. Foreclosed homes can be listed in the same places that residential properties are, but it’s not the only place you can look.
- Direct from the homeowner. As previously mentioned, some homeowners can opt to complete a short sale if they need to find funds to pay off a mortgage. While not technically classified as a foreclosure, short sales can still provide a hefty discount in relation to market prices. These properties could be listed directly by the homeowner or through a real estate agent.
- Buying from an auction. Auctions are the most popular option that lenders use to sell foreclosed homes as quickly as possible. The process is quick but auction houses often require investors to pay in cash. Buying through an auction also means that an appraisal or building inspection cannot be completed beforehand.
On the positive side, commonly auction houses will need to market a property, either online or via other means. They may list foreclosed properties on their own website, through a local newspaper, or by placing a sign in front of the property. Check out the auction houses near your area of interest.
- Buying from the bank. To recoup losses efficiently, banks can often sell properties themselves. As previously mentioned, these properties are often referred to as ‘REO’, or Real Estate Owned. Once a bank has claimed the property as REO, the homeowner will be evicted and the property will be listed with a local real estate agent.
- Buying from the government. Foreclosed homes can also be sold by the government. Some mortgage loans are government-backed, which means that the government takes on ownership if the owner cannot repay. The process is very similar to that of a bank or lender. While resales are targeted towards first-time buyers, that doesn’t mean investors cannot get involved.
Usually, a government-registered real estate broker is required to complete the purchase. However, there are also examples of properties being sold on the steps of local courthouses. Referred to as ‘foreclosure days’, these days take place as an auction-style event with investors bidding on different properties. Check to see if there are any foreclosure days in your State.
Step 4: Hire expertise
Navigating short sales, auction houses, banks, and potentially courthouses can be overwhelming for a first-time investor. This is where a professional real estate agent can make your life far easier. With local links and up-to-date market knowledge, a good agent can often be worth their weight in gold.
However, that doesn’t mean you can choose anyone. Make sure your real estate agent is well experienced in foreclosure homes and REO properties. Do they have a track record that you can see? Are there any reviews from other investors? Do you know anyone that can recommend an agent?
This is a significant investment, which means you need to be comfortable with the person you are working with. If after the first conversation you don’t get a good feeling, trust your gut. Take the time and try to find someone else.
Step 5: Make a competitive offer
After working with your agent to find a suitable property, the next step is to approach with an offer that is in line with your budget. When investing in property, going over your budget is never a good idea.
If the property has been listed with a real estate agent reach out to them to make an offer. The bank or lender will have a good idea of what the property’s fair value should be, and will likely not move beneath a certain limit. Likewise, a short sale homeowner may also be unwilling to budge if they need a certain amount to repay mortgage providers. Make the offer a sensible one. If you can, add a clause that states you would like time to complete an inspection before closing the deal.
Alternatively, if you are tackling an auction, put your game face on. Remember your budget and stick to it. Don’t get drawn in by the heat of the event. Sometimes your budget may not meet the reserve price placed on the property. If that happens, move on to the next opportunity.
Step 6: Get a home inspection
Once an offer has been made, there will hopefully be a period where inspections can be carried out. If you have not already committed to the property this is your chance to find any deficiencies and walk away with investment funds still intact.
Foreclosed properties require a thorough check with a certified inspector. It can also be useful to bolt on any additional checks they offer such as assessing the structure, internal and external water and sewage, and gas and electrical safety.
Even if you didn’t get a chance to perform a home inspection before purchasing the property, carrying one out is still recommended. It will leave you in no doubt as to what you are dealing with moving forward. Remember, through either process you are buying the property ‘as is’. All repairs will rest on your shoulders.
During this stage, it is also useful to resolve any outstanding liens. Liens are claims or legal rights to an asset. Sometimes an owner may take out another loan to repay the first – often referred to as a ‘piggyback loan’. At this stage make sure that there are no outstanding loans remaining with any other lenders.
Step 7: Profit
Once you have untangled all claims to the property, and are happy with the inspections, you are now ready to close. This process is usually handled by your real estate broker.
Once the property moves into your name it is now up to decide how you make a profit. Are there any key repairs that need to happen? Make a start on them while you figure out what you are going to do with the property next.
Most real estate investors choose one of three options:
- Short-term rentals. Renting a property is a popular choice for investors. It provides monthly cash flow while allowing you to take advantage of long-term capital appreciation.
Short-term rentals can be attractive due to the increased level of control it gives an investor. Rentals may last from a week to several months. You may want the flexibility to use the property yourself, perhaps as a holiday let or base for work? Rental income can sometimes be higher on short-term rentals and you frequently assess how the property is maintained.
- Long-term rentals. On the other hand, long-term rentals provide investors with a different set of benefits. Firstly, long-term rentals provide peace of mind that cash flow will continue to flow into your pocket for a prolonged period. You can also be more selective over the tenant you have living in your property. This may help to reduce repair costs in the future.
Once a tenant is found, all utilities and small-scale maintenance costs can be handed over to them. Very little marketing costs are required and there is also a lower risk of having long-term vacancies. After all, if the property is empty, it’s not earning you any money.
- Flip it. The last option for most foreclosed property investors is the option of house flipping. This involves repairing the house and bringing it back to its former glory. This process works particularly well with more distressed properties.
The idea is to add enough value to the property that you are then able to sell for a profit. Foreclosed homes can be particularly well suited to this option due to the discounts offered.
Foreclosed homes are an excellent option for investors struggling to meet the upfront investment costs required for similar residential properties.
Although the process is not dissimilar to residential property investment, investors will need to search in slightly different places to find the best opportunities.
Align yourself with an experienced foreclosed real estate broker and discuss your finances early. Become familiar with short sales, REO properties, and don’t be afraid to tackle an auction house or two.
Foreclosed homes undoubtedly come with an increased level of risk, but there are bargains to be found. Follow Real Vision for more tips on real estate and macro investments.
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