How to Buy Foreclosures
Climbing numbers of foreclosures are an unfortunate fact of life in the current economy. Unfortunately, that is, for the millions of people in financial jeopardy, but a unique opportunity for those who are properly positioned financially and are not afraid to exercise their "risk muscle".
RISKY BUSINESS
Purchasing foreclosures is clearly not for everyone. Many people will see and understand the opportunity; but not everyone who sees the opportunity is able to take advantage of it. And of those who are able, not every one should. There are many risks, and some people are just not in position to accept them.
There are important considerations for anyone considering entering the arena of buying a foreclosure property.
THE GREAT UNKNOWN
First of all, be aware that you are buying the unknown. And you are buying it "as-is". Most of the time, these houses need work. It takes a long time to go through the foreclosure process, and that means the previous homeowner had a long period of financial difficulty. People under long-standing financial stress often defer a lot of maintenance items. While many things may be quite evident to anyone looking; like peeling paint, falling gutters, or a really bad roof; many other things are less obvious.
Recognizing a bad furnace in the middle of July may require an expert. And a basement that is habitually wet in the spring may be quite dry in September. Not to mention the various types of insects which can damage a home. It's just not always so easy to see defects which can lead to expensive fixes. Surely there are some visible signs of many problems, but other things are much less obvious. At any rate, expect to find something unexpected, no matter how much you think you'll be able to see on your own.
HIDDEN PROBLEMS
Often foreclosure homes will allow you an opportunity to inspect them before the actual sale. Well, "inspect" is probably overstating it a bit. They will let you look at them. But if the property is in an auction situation, it is often only a couple of hours before the auction starts. This limits your investigation time and makes it even more important to bring and experienced or trained eye to look the property over. And sometimes the property is still occupied. If so, this brings another series of things to beware.
OCCUPIED PROPERTIES
Occupied foreclosure properties mean that you probably won't get to see the property interior. That's a risk in itself. If you opt to accept that risk, you'll have the problem of getting the occupants out. Eviction proceedings can be expensive, and difficult. An occupant losing their home may be angry and may intentionally damage the house before they go. Even if they don't, they often leave a lot of stuff behind and it could cost thousands of dollars to "trash it out" and clean up the property before you can begin working on it.
An option to avoid or minimize this risk is to offer the occupant money as an inducement to leave the property clean, undamaged, and promptly. If it leaves you without having to pay an attorney to handle an eviction process, or safeguards the property from intentional damage, it's well worth the cash outlay.
If you've considered the risks, and still want to proceed, then you do have a risk muscle after all. But there are still some more important facts to consider before you take the plunge.
THREE WAYS TO BUY
There are basically three ways to buy a foreclosure property. First, you can purchase a foreclosed property that the bank is marketing for sale in the more "conventional" fashion.
Second, you can purchase the property at an auction conducted by a bank representative; usually an attorney. And the third way you can buy a foreclosure is through an auction conducted by a professional auctioneer or a regional or national auction firm.
THE "CONVENTIONAL" SALE
Let's look first at the more conventional purchase option. What I mean here is that the property is probably listed with a real estate agent, the previous occupants are already out of the property, and the property has most likely already been emptied of all personal property and debris. In this way, it's not much different from any other house on the market. There are some differences, though.
If the property is in a cold weather region, and it's between October and April, the property is probably winterized to protect it from freeze damage. This means that in order to fully inspect the plumbing and heating systems, you will need a plumber on site, and you will incur extra costs. The property will have to be re-winterized at your expense after your inspection. Note that a winterized property doesn't always rule out all freeze damage. A property may be winterized by the bank after it has frozen in an effort to protect the home from further damage. If the house is damaged, expect copper pipes to have "pops" or "splits" in them. These are usually near the joints, but can also be behind sheetrock, especially near outside walls or un-insulated spaces in closets or the attic. In addition, a freeze-up can also damage the furnace itself, but you can't always tell about this until the rest of the plumbing system is restored to integrity.
BENEFITS OF BUYING CONVENTIONAL BANK-OWNED
The benefit of buying this type of foreclosure property is that the process can easily be guided by almost any experienced real estate agent. You usually have ample time to preview the home, and even an opportunity to request and complete a home inspection as a term in the contract if you choose. You also have a bit more time to determine the best price to offer on these homes based on their observable condition.
Be aware that banks will always request proof of funds or a pre-approval letter, and will also have their own contract terms or addenda which must be incorporated into the offer to purchase. Read these addenda very carefully! They favor the bank and are much stricter in their terms than the typical real estate contract. But if you want to buy their house, you must use their paperwork.
BANK CONTROLLED AUCTIONS
The second way to buy a foreclosure property is to purchase the home at a foreclosure auction. Depending on the state you are in, the foreclosure auction will take place most often "on the lawn" or the courthouse steps. It can be held at some other pre-arranged location if multiple properties are being auctioned on the same day by the same bank representative, although this is less common.
These auctions have an increased risk to the purchaser for a number of reasons. First of all, as mentioned before, your inspection opportunity is greatly limited; usually to two hours before the auction begins. Although somewhat rare, these are the properties that may still be occupied, leaving you the problems inherent in removing an unwanted occupant from a property.
The bank-controlled auction is usually run by a bank representative or a local attorney they have hired. This attorney is called the "Committee". Most often, this is the first attempt the bank makes to sell a foreclosed property. Because of this, the bank often has not finalized their ownership rights to the property and the sale must be confirmed by the court.
These auctions typically start at a minimum figure determined by the bank. More often than not, this figure represents the remaining mortgage balance PLUS accrued unpaid mortgage payments, penalties, interest and legal fees. It is usually a figure very near, if not over, the current market value of the property. If it were not so, the homeowner could have sold their home at market value and paid off their debt.
So.going, goingno bids! Well, that's not totally unusual. The bank will either try another auction on the lawn at a later date, or pass the property off to one of the other two types of foreclosure sale processes.
PROFESSIONAL AUCTION FIRMS
Another type of auction is that conducted by a professional auction firm. If the bank controlled auction didn't work, and a trial period of time for a "conventional" sale does not get the house sold, the bank may bring the property to an auction house. These auctions are usually the final attempt to get the house sold.
There are a few differences in this type of auction. First of all, the deposit is usually more "nominal"; a low amount to invite more people to participate in the bidding process. Usually this type of auction takes place after the bank has finalized their ownership to the property. This means the contract for this type of sale is not subject to court approval or a redemption period. More about that will come later.
ONLINE AUCTIONS
Another type of auction that is gaining popularity is the online auction. In such a case, the bidding is open for a set period of time; usually a number of days. Registration, deposit and auction terms are all described on the auction company website.
While an online auction may be scheduled to last exactly ten days, they will remain open past the final end time if the last bid was in the final minutes of the scheduled end time. It will remain open until a specific pre-determined period of time, such as five minutes, has passed without further bids.
IN ALL CASES: RESEARCH
If you've decided to accept the risks, it's still best to do some preliminary research. Find out if the property is being auctioned subject to other loans or liens on the home by checking town hall records. You don't want to be the high bidder at auction just to find out that you purchased a home from the SECOND mortgage holder, subject to the pre-existing first mortgage. While you may choose to not complete this sale if you discover this kind of error soon enough, you will certainly lose your deposit.
The next thing is to contact the attorney or "committee" for the sale, or the auction company to determine their terms of sale ahead of time. There ARE other costs involved in buying a house at auction, and you need to know what they are. Ask if there are other liens against the property like water liens, Home Owner's Association fees, a buyer's premium, or other hidden costs.
Finally, research the market value of similar homes in the area so you know what it will most likely be worth once you own it and everything has been fixed or renovated. Then estimate what it will cost to fix it, insure it, and what you are willing to pay for it in its current condition. If you're thinking of "flipping" it or re-selling it quickly, you'll have to also estimate carrying costs, resale costs, attorney's costs, and a profit margin. It's always wise to add 10% to your expected expenses to cover some of the "unknowns" that always creep in.
Once you determine what you are willing to pay for the house, write it down. And when the bidding starts, stick to it. No matter what. The worst decisions are made when you get caught up in the auction mentality.
HOW TO BID
When you arrive at the auction site, you will have to register to bid. At that time, the registrar will ask you for some basic information as well as your minimum deposit. This is an amount that is published with the auction information, on the property foreclosure sale sign, and appearing in newspaper print ads. In many cases, at least with the bank-controlled auction, it is your first clue to what the bank may believe the property to be worth, as it is often approximately 10% of a fairly recent appraisal; although that appraisal is usually not based on having viewed the interior condition of the dwelling.
Your minimum deposit check is usually required to be a certified or cashier's check, although I am aware of one auction firm that accepts a more nominal deposit by personal check. If you are not the winning bidder, your check will be returned to you at the end of bidding. If you are the successful bidder, it will be retained.
In either type of auction, you can generally expect the bidding process to take less than fifteen minutes. The auctioneer or attorney controlling the auction process will explain in advance all the necessary terms and how the auction will be run. They will also let you know what minimum bid increments will be accepted.
The opening bid can be a nominal figure with an auction firm, or it can be a minimum figure that the bank wants to recoup. If the previous owner had no equity, sometimes the bank's figure is too high to generate any bids. In this case, the bank "buys" the property back for their starting bid and the auction is over. These properties may come to auction on the lawn again sometime in the future. More likely, however, these properties will be transferred over to a real estate agent for conventional marketing.
WINNING BIDDER
If you are the winning bidder, you will have to immediately sign a contract to purchase the property; before you leave the auction site. Don't take that sigh of relief yet. There are still a few hurdles before you own that property.
If you're buying the property for all cash (no mortgage) you are one of a small percentage of buyers. Things should proceed very smoothly. Remember, this is an as-is transaction, so there are no allowances for inspections or contingencies. Just contact your personal attorney promptly, and they will walk you through the process to closing.
With the bank controlled auction, the attorney for the bank will immediately take the newly signed contract to court and petition the court to approve the sale. This can happen right away; usually in less than seven days, although occasionally it can be longer. Once the sale is approved, the buyer has 30 days to close the sale.
Why 30 days? This is usually to accommodate the 20 day redemption period. If your state is a redemption state, the previous owner still has an opportunity to "redeem" their property within 20 days after the court approves the sale. They can do this by paying all of the monies they owe the lender. This doesn't usually happen, but it could. If so, your contract will be cancelled and your deposit returned.
FINANCING HURDLES
If you are purchasing the property by obtaining financing, however, it is a bit riskier than the average real estate transaction. The process of obtaining a loan often takes longer than 30 days, putting your deposit money at risk of loss.
In order to minimize this risk, make sure you've had some thorough discussions with your experienced mortgage originator or personal banker. Make sure they know you are buying a foreclosure property. Make sure they know they are on a three-week timeline to mortgage commitment and your deposit money is at risk. Make sure the condition of the property is not going to prohibit or delay a mortgage commitment. And above all, make sure this conversation all happens BEFORE you show up to bid on the property at the auction.
If for any reason the financing doesn't come through, you won't be able to close within the required 30 day window. And if you don't close on time, you will incur substantial financial penalties; whether they grant you an extension and charge you a "per diem" for each day you exceed the contractual closing date, or a forfeiture of your deposit money tendered at the time of the auction.
If you meet all your deadlines, and close the sale, you have now purchased a foreclosure property. If you prepared well, bid wisely, and figured your rehab costs accurately, then you are well on your way to a financially rewarding transaction. Your work is not done unless you have considered the final disposition of the property.
EXIT STRATEGY
Knowing how you are going to get out of the property is just as important as understanding all the risks of buying it in the first place. A mistake in your exit strategy can be expensive and stressful.
Will you occupy the property? Will you rent it and hold on to it for an extended period of time? A quick resale, or "flipping" your property, entails another set of risks to traverse in market conditions that can change for the worse with little recourse. So how strong is your risk muscle?