Buying a foreclosure home in a seller's market is more challenging than buying when housing is weak. But the risk may be lower in a healthy market - if you can find the right property for the right price. Here's what you need to know to successfully buy a foreclosure home.
How to buy a foreclosure home
It's not hard to get your head around the basics of buying a foreclosure property. It's more a question of grinding away than rocket science. So, we'll be exploring:
- The two types of foreclosure homes
- The process
- Some risks
- What difference a seller's market makes
- Is it worth it?
By the end, you should be ready to decide whether you should be buying a foreclosure home.
Two choices when buying a foreclosure
Foreclosure homes come in two main categories:
- Bank-foreclosed homes
- Real-estate-owned homes (REOs)
The difference between the two is that bank foreclosures have not yet gone to auction. While REO homes have gone to auction without success and ended up on the bank's books. The bank assumes the responsibility of ownership and maintenance.
In healthy real estate markets, there are not nearly as many REOs. In 2009 and 2010, foreclosures were running at about 2.8 million homes a year. But by 2018, that number had plummeted to a 13-year low of 625,000, according to Attom Data Solutions.
Of course, the foreclosure market is like any other: it runs on supply and demand. So, with supply down 78% on its peak, it's a seller's market. Buyers who want to invest in foreclosures increasingly resort to purchasing property at foreclosure auctions. This is riskier.
Related: Short Sale Homes: Essential Facts
How to buy a foreclosure home at auction
Before you think of attending an auction, you need to check out your local rules and state and county laws. For example, you may need:
- Credible photo ID just to gain admittance to the venue
- "Proof of funds," which is evidence that you have the resources to follow through on your bid. A cashier's check is usually good. Cash is not always allowed, and a personal or business check won't usually get you very far
- No inspections, title checks or lien investigations
- Some or all of the purchase price
If you have to make only a down payment, expect to pay the rest very quickly, perhaps within 24 hours. These rules are frequently made by your county, so check with local government or the auction venue.
As you can see, buying a foreclosure property at auction is not for the fainthearted. And it can be particularly challenging the first time you do so.
Three types of auction
There are three formats of auction. From an investor's perspective, the most desirable is the absolute auction, followed by the minimum bid and reserve auction.
- The absolute auction is the purest experience. The bidder with the highest bid wins. Period.
- Minimum bid auctions set a floor for bids. So you know what the minimum cost will be before you bid.
- The reserve auction treats the top bid as an offer to the seller, who can choose to accept or reject it.
While absolute auctions are the most favorable to buyers, it may be worth attending the other auctions too, because there is likely to be less competition for the property.
In addition to foreclosure sales, you may also find properties at auction being sold by the county for back taxes, properties sold because of a bankruptcy, and occasionally properties up for sale because of death or divorce.
Information you'll need before bidding
The reason that buying at auction can net the biggest discounts is because you also assume more risk. The more information you can get, the less risk you take.
First, take a drive and go see the exterior of the home. If you are not an expert in home repair or renovation, take one with you. You probably won't have the chance to commission a home inspection, but do the best that you can.
Research the neighborhood home values to see what similar houses are fetching in traditional (not distressed) sales. You're looking for a healthy discount from the price of a traditional sale.
Get a title report on the property to make sure that the title is insurable and clear.
Then, set your maximum bid. Decide what profit margin you want -- say, 15%. Take your estimate of the property value if it was sold traditionally and discount it by your desired profit margin. For instance, if you believe that a home is worth $200,000 and want a 15% margin, your base price is $170,000. (15% * $200,000 = $30,000. Subtracting $30,000 from $200,000 = $170,000.)
Finally, subtract your estimate repair costs. If you believe that it would take $40,000 to upgrade the home to neighborhood standards, your maximum bid would be $130,000. (That's the $170,000 discounted price less the $40,000 estimated repair costs.)
Related: Home Loan After Foreclosure? Easier Than You Think
Financing auctioned properties
Can you get a mortgage for a property bought at auction? It depends on the venue and location. You might have to pay in cash and then complete a cash-out refinance to get some portion of your money back out. Or you may be able to bring a cashier's check for some percentage of the price and then close later with a mortgage for the balance. Some investors use private ("hard money") lenders for the upfront cash and then repay the loan with the proceeds of a sale or refinance.
In any event, if you plan on using a mortgage to finance a home, get preapproved for your home loan upfront.
How to buy an REO
Buying an REO requires a lot less adrenaline than going to auction. You normally have advance access to the home. You can commission a home inspection or have your contractor examine the property. And you get the opportunity to verify title and liens and do all the other due diligence you expect. It's not all that different from buying from a resident owner who's moved out.
However, you still need to convince the owner (the bank) that you're an agile and credible buyer. So you need to have your funds or your financing in place. With REO, the bank that owns the property may be willing to finance it for the new buyer.
Where do you find REO properties?
There are several sources of information about REO homes.
- Local MLS (multiple listing service), which local Realtors can access
- Listing sites often include REO properties and you can search for them specifically
- Larger banks often have REO departments and promote and sell their own listings
- REO specialists list only REOs
- Foreclosures of FHA, VA and USDA homes are listed on HomeSales.gov. And Fannie Mae (HomePath) and Freddie Mac (HomeSteps) also list foreclosures on their books
To bid on government foreclosures, you must be represented by a licensed real estate agent. And you may want the guidance of a buyer's agent no matter where you find your foreclosure property.
Related: How to Buy a HUD Home
Buying a foreclosure home in a seller's market
While the deep discounts of the Great Recession may not be common, you can still find bargains in today's seller's market. One way of competing with investors with all cash offers is to buy government foreclosed homes. They often give individual buyers looking for a home a window in which they can bid and investors are only allowed to jump in if there are no credible offers from owner occupiers.
And good deals for REO homes have not completely disappeared. But the relative safety of those homes comes at a price - a lower discount compared to homes sold at auction. One way of negotiating a lower price for an REO is to make your offer as clean as possible. You may be able to pay less with a high earnest money deposit and no contingencies.
Is it worth it?
You can still make money buying foreclosures and REO. Auction.com states in its most recent report that foreclosure auction properties sold for 20.8 percent below their estimated market value. However, this does not consider the amount the buyers had to spend on repairs to bring the properties up to neighborhood standards.
Your return also depends on where you buy. CoreLogic's latest report indicated that in the top markets, investors made 58.9% to 95.9% flipping homes. While in the bottom markets, they realized just 5.1% to 10.8%.
Top markets included Detroit, Philadelphia, Pittsburgh, Cleveland, Baltimore, Buffalo, Wilmington, Toledo, and Milwaukee. Bottom markets were Raleigh, Colorado Springs, Charlotte, Fayetteville, Kansas City, Austin, Phoenix, Nashville, Orlando and Las Vegas.
If you have the resources, skills and commitment necessary to make a success of your purchase, the answer is yes. It's worth it.
