Know how to turn a foreclosed home into cash? To borrow a quote from the stock market: Buy low. Sell high. Sounds simple, but let's arm you with some powerhouse weapons: Auctions, reaching potential home value, REO properties and knowing how to finance.
Foreclosures up for Auction
Not all auction foreclosures should have starred in "The Money Pit". Many are valuable. The trick is figuring out which is which. Start with an auction list. While online sellers will tout huge directories, start with the auctioneer. Auction houses provide bidders with the specifics from the owner, a lender who foreclosed on the property. But don't just take the lender's word for it.
Visit the Property
Some foreclosed property will not be accessible until the day of the auction, but the overwhelming majority will be opened for bidders prior to the auction. Take advantage. You wouldn't buy a car without test driving it. Don't bid on a house you have not seen inside and out, either.
Rarely, foreclosures can be inspected by a professional prior to the auction. Literature on the house will admit if an inspection has been made since the property was vacated.
Know what you are viewing. What should pipes under the house look like? What are the indicators a roof needs to be replaced? Can you tell if a wall has been patched? What are the signs of water damage? If you haven't seen an inspection in person, it is an educating experience.
Take Notes
You need to remember all the blemishes the house has to determine how much you are willing to pay for it and how much the house could potentially be worth at resale. This is how you determine on which houses you should bid. The equation for a winning house looks like this:
Your Maximum Bid + Taxes < Current Home Value
What is my "Maximum Bid"?
The opening bid is up to ten per cent less than what is owed on the foreclosed home. This ensures the lender gets most of its money back. Since you want to make money, you cannot bid up to the actual value of the foreclosed home. Your maximum bid needs to be at least ten percent lower than the current value of the home.
Is that set in concrete?
No. Some distressed homes, ones which need a lot of repair, are actually worth more in the long run. For example, 123 Hickory Street is 1,600 square feet, four beds, two baths. It is valued at $36,000 because it has not been updated since the 1950s. It needs a new roof and the carpeting replaced. A few new windows would not hurt it. And the porch needs to be repaired.
Its current value is almost nothing. With less than $20,000 in renovations to the baths and kitchen, you can increase the value of the house by more than $35,000. Small cosmetic changes will cost $5,000, but increase the value $15,000.
Paying a little more for this house is completely reasonable. You win with a bid of $40,000 and do $25,000 in updates to sell for $90,000.
What is "Current Home Value"?
Here again, don't take someone else's word as gospel. Start with the tax assessor. His valuation of the land will be accurate. The land value is a non-negotiable in the resale of the home. A $250,000 home on a $1,000 piece of land is not worth $250,000. The value of the home should not exceed six times the value of the land. If it does, you run the risk of pricing yourself right out of the market.
Next, look at the sale record for the home. You will see exactly what the bank loaned the last owner. Lenders only finance 95 per cent of the property's value. From the loan amount, subtract what you calculated for repairs.
If it has been more than ten years since the home's last sale, look closely at the neighborhood. Have the homes on Hickory Street been victims of neglect? Has the crime rate risen? Is the neighbor in 127 now a used parts, auto salvage yard?
All of these factors will affect the current value of the home, and certainly not in a good way. Crime decreases home value by ten per cent. Neglectful and undesirable neighbors can drag an additional ten per cent out of your home's value.
Have new sidewalks been installed? Is the neighborhood association planting flowers? Has a new shopping center opened within three miles? Is the firehouse within five miles?
All of these add value to the home. Fire and police protection reduce insurance rates and add up to ten per cent to a home's value. Convenient shopping, amenities and health care are great neighbors. Remember, you don't want them next door, but on the next block is great.
Here's the equation:
(Land + Home Loan Value + Amenities) - (Detractors + Repairs) = Current Home Value
Should I bring cash?
Oh, heavens, no! You don't want to be mugged! Bring a letter from your bank to the auction showing you have pre-approved funds. After the auction, you will have up to two hours to bring a cashier's check for your property.
Am I ready to go to work?
No. Do not do anything without first insuring the house. You need to protect yourself in case something happens. Whether the house catches fire or a contractor slips off the roof, you don't want to lose your investment to a catastrophe or lawsuit. Even if you have mortgage insurance, it will not cover any accident which may happen on the property before you sell it.
Have the utilities connected. You cannot run power tools or burn lights without electricity. You cannot clean up your mess without water. These are necessary expenses.
How do I reach the home's potential value?
You know how much it is worth now. You need to know what will make it more valuable to your buyer. After you do repairs and clean, the house will increase in value. No one wants to buy a broken or dirty product.
The basics for a resalable home are: Roof, windows, doors and exterior in good repair; sound plumbing and electrical wiring; working appliances (water heater, range hood); sound, termite-free structure; intact interior; insulation. What else are you willing to do? The more you do, the higher your resale value will be.
Consider all the home additions which make one home more attractive than the next: Fresh exterior and interior paint, nice flooring, counter tops, appliances (stove/oven, dishwasher), cabinetry, quality light fixtures, landscaping and outdoor lighting, new bathroom and kitchen fixtures.
Are these improvements worth it?
Absolutely. Landscaping and exterior work increase curb appeal and the home's value as much as 15 per cent. Landscape with native plants for a low maintenance, water-efficient yard. If you are not familiar with landscape design and indigenous plants, hire a landscape designer.
Bathrooms and the kitchen are the most important rooms to the potential buyer and account for one-third of the home's value. Fixtures should be energy efficient, aesthetically pleasing and low maintenance.
Quality flooring and floor covering are worth 15 per cent of the home's value. While there are no "hard and fast" rules to flooring beyond being level and well-supported, your flooring choices should reflect the interior design of the home. Putting a ceramic tile floor in a bedroom is not a commonly accepted choice.
Whatever flooring you choose, use quality products. Carpeting should be well-padded and stretched correctly. Wood flooring should be installed appropriately. This is not the time to test your flooring skills. Mistakes translate into lost money on materials and in the final sale price of the home.
Storage, especially in homes with few closets, reduces resident expenses on furniture. Cabinetry in kitchens, bathrooms and common areas increase value. Even simple, inexpensive steps, like adding shelving in a laundry room, add value.
Fencing, patios and decks extend the livable area of the home into the yard. If you are not adding these features, be sure to repair or dress up the ones which already exist.
What about specialty improvements?
These are risky. Not everyone wants a batting cage or a brick oven barbecue pit or a water feature. Installing specialty items will cut your pool of potential buyers. The more people interested in your home, the faster it will sell. Best course of action: If your buyer wants these, negotiate them into the price or let him install it himself after the sale.
Other items best avoided are retractable awnings, trendy paint colors and draperies. Any addition which requires maintenance, like a pool or awning, translates into future expenses for the homeowner. Styles change, and individual tastes vary. You want your home to sell quickly. Stick to neutral colors. Blinds are preferred to draperies, since draperies are a personal choice.
Should I add onto the house?
If it will pay good dividends. If your house is smaller than its neighbors, adding onto the house may be a profitable prospect. If the home has only one bathroom, consider adding a full, half or three-quarter bath.
When should I not add onto the house?
Do not add on if the house occupies more than one half of the lot or if the house is the largest on the block. Loss of the yard will actually decrease the value of the house. When the house is larger than the surrounding houses, the asking price will be too high to sell quickly.
Am I spending too much money?
You could be. Remember, you already have spent money on the home itself. Your materials and hired professionals are more money. You need to stay below the potential home value. And you don't want the quarter-million dollar mansion on the thousand dollar lot.
Should I save money by doing all the work myself?
Only if you are qualified. Roof repair, electrical and plumbing work and heating/cooling repair should only be done by licensed and bonded professionals. Each of these jobs presents danger for the person doing the work, and future danger for the homeowner when done improperly.
Where do I draw the line?
Two words: Profit Margin. How much do you want to make from this house? Be realistic. You are probably not going to make $80,000 on a home you spent less than $2,000 to acquire and repair. Not to say it has never happened, but the chances are remote. Reasonable profit is between 15 and 50 per cent of the final sale price.
How do I make 50?
Remember, buy low; sell high? Buy the foreclosed home at or below 25 per cent of the potential value. Spend 25 per cent or less on repairs and improvements. It is possible, but not always. And it only works when what you spend on repairs and improvements brings the house to its potential value.
How do I sell the house?
Before the house is completely finished, engage a successful real estate agent to list the house. Schedule an open house as soon as the house is ready. Here is a crucial place where you must stay on schedule. Showing the house before it is finished hurts your chances of getting full value for the home.
All construction tools, left-over materials and landscaper extras must disappear. The lawn should be freshly mown. The interior and exterior of the house should be completely clean.
Place a "For Sale" sign in front of the house. Keep fliers in the sign highlighting the features of the house, the asking price and the desire to close quickly. Including the price in the flier reduces the number of unqualified people who come to your open house. Quick closing attracts buyers who are ready to move today. Run a classified ad in the newspaper announcing the open house.
The most successful open houses are those which move a small amount of furniture, but no personal effects, into the home. The buyer can imagine what his furniture will look like in the home. You don't have to buy furniture. If the agent cannot secure some furniture, rent it for the open house.
Have the water and electricity still active for the open house. Water pressure is important to buyers. Testing the light switches and hearing the heating or cooling system are a buyer's prerogative.
If you do not have an offer from the open house, continue to run an advertisement in the newspaper and reschedule the open house two weeks later.
What is a REO foreclosure?
"Real Estate Owned" (REO) property is often a well-guarded secret, at least as far as the agents are concerned. These properties are owned by the real estate companies and the lenders. While they do not offer profit margins as large as auctioned homes, REO properties can be a lucrative, lower pressure solution. Let's focus on the foreclosure REO properties.
When a lender forecloses on a home, they are looking to get the money the original buyer did not pay, plus a little for their trouble. Don't be interested in their trouble.
If you are buying through an agent, stick to your guns. Agents try to convince you not to offer lower than asking price for an REO. Best case scenario: Ditch the agent. Warning: Unless you know how to use offer paperwork for your state, use an agent.
Banks no more want to own houses than the man in the moon. Help them out. Ask your loan officer at the bank what properties are for sale.
Calculate the current home value. Before you think about offering, find out how long the home has been on the market. The longer the home has been vacant, and earning no money for the lender, the more eager the lender will be to sell. A good guideline is deducting one half per cent per month the home has been vacant from the value.
Compare its current value to the potential value. This is where your profit margin is. How does it compare to the foreclosure price?
Is the house currently more valuable than what the lender is asking? Then, hurry. Is the home less valuable? Offer the current value, but don't be surprised if the lender does not jump at your offer.
Why would the bank decline my offer?
Banks are less desperate than lenders like mortgage finance companies. With more resources available to them (the money in bonds, savings and retirement accounts), banks can hold out for more money. When banks foreclose on valuable homes which had small amounts owed on them, they will try to turn a profit by selling the house closer to the home's value than its foreclosure amount.
Although less desperate, they are not stupid. If the bank has owned the home for more than six months, it is more likely to accept a lower offer than its asking price. When properties do not immediately sell, they become liabilities to the bank. Use this to your advantage.
Do I really need $80,000 in the bank to finance foreclosures?
Actually, no. If you are dedicated to reselling the home, you can qualify for a construction loan. This special type of mortgage gives you more than the purchase price of the home. The additional money is for repairs and improvements. One prerequisite to the loan is a specific plan and proposed budget for the home rehabilitation.
A construction loan comes with a grace period where no interest accrues on your loan, giving you time to make repairs without added expense. Some construction loans will have a grace period where no payments must be made.
To make the most of this loan, you must buy the foreclosed home, make the changes and sell it before the grace period expires. If you fall behind schedule, you run the risk of having to make mortgage payments before you sell the house.
If mortgage payments are due, you must pay them on time to protect your credit for future purchases. Best advice: Save enough money to cover three loan payments.
Can I just get a regular mortgage and use my money for changes?
Yes, but it will cut into your profit margin. Traditional mortgage payments are mostly interest for the first two-thirds of the loan. Interest does not reduce the amount you owe on the loan. It is what you pay the bank to loan you the money. Consider this money burned.
Should I get a "no-money-down" loan?
Probably. When deciding on a no-money-down loan, the terms are the determining factor. Average no-money-down loans carry higher interest rates. Remember, interest is money burned.
Another factor is points. Points are prepaid interest. While points will lower the overall interest rate, they are still interest. You are just paying it in advance to prove to the bank they will make money on your loan. Avoid points whenever possible.
Closing costs are the last factor. "No money down" does not always mean you do not have to bring money to the table. Be sure you know what fees are attached to the loan which you will need to pay the day you get the money.
If your credit score is high enough, especially over 750, you may qualify for a construction loan or a traditional mortgage with no money down. When you can, take advantage of "no money down".
Will I always need a loan?
No. Once you sell your first home, do not put all of the money in your personal checking account. Reserve at least half. Use this money to get your next house. You made $25,000 on Hickory Street. Save $12,500.
When you buy 987 Elm Street, you secure a construction loan. You sell before the first payment comes due. This sale netted you $45,000. By putting away $22,500, you now have enough money to buy a foreclosure without a loan. And you get your first bonus! By clearing two loans successfully, your credit rating has gone up. If you need another loan, your interest rate will be lower.
Will I make more money with each house?
This depends on which houses you buy. Auctioned houses have larger profit margins. The amount of money you invest in the house affects how much money you make. The availability of houses in your market will determine which opportunities are available.
Why isn't everyone doing this?
Because it is hard work. The theory is very simple. Lots of homework and hard work are requirements to making the theory reality.
It is not guaranteed. Not every foreclosure will live up to its potential. Not every house will sell the day it is ready. Each house is a gamble. Educated choices minimize the risk.