The current market conditions make it a perfect time for an investor to purchase one or more foreclosure properties for their private residence, rental or resale. First, you have to decide at what stage of foreclosure you want to buy; pre-foreclosure , also known as a short sale, sheriff's auction, or repossession, called REO (for real estate owned by the bank).
For most consumers, however, the foreclosure process can prove daunting, Reed says. Good buys are available, but they require research, preparation, patience and persistence.
Pre-foreclosure(Short Sales): These homes are in the foreclosure process, but they have yet to be sent to auction. Owners are typically trying to unload them because they are "underwater," owing more on the homes than they are worth.
As a result, potential buyers must negotiate a deal with the lender as well as the owner. That makes buying at this stage of foreclosure complicated and slow. But, you have the advantage of being able to inspect the home before purchase -- which isn't the case in other types of foreclosure sales. More often than not, these properties sell for a higher price than if the bank were to take it through the foreclosure process and sell it as an REO.
Sheriff's auction: These sales yield the lowest prices, but they are the riskiest investments. The foreclosure process starts when a property owner falls behind on mortgage payments. Many owners of homes that go into foreclosure have been struggling financially for almost a year before they give up, which usually means that the house has not received needed repairs or general maintenance for a while. Often the house is unavailable for inspection, leaving buyers with a long list of expensive repairs -- and much larger bill than they intended. The buyer gets the property “as is”, caveat emptor (let the buyer beware) and that may include any liens or taxes due on the property.
There is no guarantee of clear title when you purchase a home through a Sheriff's auction and you may need to clear the liens on the property to sell if in the future. Make sure you have a thorough understanding of the condition of the property, the liens, and the cost for repairs. These are all out-of-pocket expenses and will need to be added to the purchase price of the property to get a true assessment of what you are paying for the property.
Repossession ( REO): This occurs after the home has gone through a sheriff's auction but does not sell and the bank gains possession of the property. Homebuyers may not get the best bargains during this stage, but they can nearly always perform a thorough inspection before closing, minimizing costly surprises. Plus, the property comes with a clear title.
An REO is the least risky way to buy a foreclosed home. Before a bank hangs a "For Sale" sign, it pays off all the existing debts and taxes, and in many cases, repairs the home to bring it up to the standards of the neighborhood. Best of all, you should be able to buy a bank-owned property with a traditional mortgage. In addition, the banks selling these places may extend preferential financing terms to the buyers.
"You can buy foreclosures for as cheap as 30% or 40% below market, but most foreclosures sell for 5% below market," said John T. Reed, editor of Real Estate Investor's Monthly, a newsletter based in Alamo, Calif. Banks order appraisals on the properties once they agree to a short sale or take the property back as an REO. The banks are fully aware of the market value of the property and tend not to discount too far off the appraised value.
Even in this safer stage, though, homes are still usually sold in "as is" condition. "That means the bank won't pay for cosmetic issues," said Adam Wiener, a spokesman for the Redfin, the online real estate marketer. "Although, they will often pay for some or all of repairs that are health and safety issues. That makes the home inspection even more critical."
Making an Offer.......
Usually the offer amount is somewhere below the market value but above the total outstanding liens and estimated repair costs. If the property is a pre-foreclosure or bank-owned, you could prepare an offer similar to a typical purchase offer, contingent on a full inspection and title search ( paid for by the buyer).
If the property is selling at auction, you will need to make your offer, or bid, at the auction. In many states, bidders are required to pay in cash in the form of a cashier's check at the auction. You probably won't be able to conduct a full inspection and title search when you buy at an auction, so it's important to do careful research beforehand.
Once you've decided which type of home to buy, there are several common mistakes foreclosure buyers should take care to avoid. These include:
Getting caught up in a bidding frenzy: The banks often under-price repossessions, hoping to generate excitement, attract multiple bids and sell them quickly. The problem is, as in any auction-type sale, bidders get excited and pay too much.
Underestimating repair costs: Take full advantage of the home inspection and don't delude yourself about much the repairs will cost.
Not knowing what comparable properties cost: This is important in any market but especially in this endeavor. In high foreclosure areas, prices can be eroding very quickly. You want to have the latest homes sale prices on repossessed properties and try to keep your bid comparable or lower.
Buying in a neighborhood flooded with foreclosures: This is most important for people buying for the short-term. Any neighborhood saturated with REOs and foreclosures may be headed for further price falls. If you're planning to relocate within a few years or buying a bigger house, that could mean selling at a loss. A better bet, if you can find it, is to buy the only foreclosed home in an otherwise stable community. That's more likely to hold its value.
Banks want to know that you have already secured the financing to purchase the home or that you are paying cash. Offers contingent on financing or selling your existing home are often summarily rejected by the bank. Individuals with a large amount of equity in another home may get a line of credit from their bank to purchase a foreclosure. When they convert the line of credit to a mortgage, no down payment may be required.
Whether you use cash, a home equity line of credit, resources from other investors or mortgage products, secure the money for your purchase in advance. Sellers only want to work with serious buyers who are ready to buy quickly. You could miss an opportunity if you don't have your financing in place.
Foreclosure homes bought in good areas at below market values that appreciate annually can be a sound investment strategy for many investors. The appreciation of the homes is tax-exempt until the home is sold. If the home is a primary residence, the appreciation may be tax-free.
Homes used as rental properties give most investors valuable tax deductions while the house increases in value and builds equity. Real Estate investment is a good way to diversify your portfolio.