The Pros and Cons of Foreclosures

SAN DIEGO, CA, September 12, 2006 - The slowing real estate market and higher interest rates mean one thing: foreclosures are hot. Real estate investors and novice bargain hunters are hot on the trail of homeowners who have fallen behind on their mortgage payments or homes repossessed by lenders. Nationwide, home foreclosures are up. So, how do you take advantage of this bumper crop of distressed properties?

Buying a foreclosed home is more complicated than the traditional home buying path. It can also entail considerably more risk, even for the seasoned investor. Homes in foreclosure come in several different categories: pre-foreclosures, bank-owned properties and government homes. All may offer below-market value to the smart buyer, but each should be approached with a healthy dose of caution.

Pre-foreclosures belong to homeowners who have fallen behind in their loan payments. The lender has not yet seized the property but may have initiated legal action to reclaim the home. The owner may have as little as a month after receiving a Notice of Default before the home is put up for auction. To avoid the negative impact a foreclosure will have on his or her credit, the homeowner may be very motivated to sell the property.

While many cash-strapped homeowners will advertise their home in the local newspaper under "For Sale by Owner" and "Home for Rent" in a last ditch effort to avoid foreclosure, the surest way to find a pre-foreclosure is to check with the office of the county recorder or clerk, since notices of default are public records. If you find a property that way, you will have to deal with the homeowner directly. Be sure to check with your local realtor who may have access to many pre-foreclosures through the Multiple Listing Service.

While some sellers may be highly motivated and might view your interest as a saving grace, others will be less enthusiastic. They may see your efforts as predatory, so tread lightly. Remember to take all the same precautions you would with any home purchase, including a thorough home inspection. In most cases, buying a pre-foreclosure from the seller can be a good investment for you and a fair solution for the homeowner. Be sure to move quickly, as you may have very little time before the lender puts the property up for auction.

Buying property at an auction or trustee sale is a tricky business. Frequently, the minimum bid at the auction is the appraised value of a home so bargains are rare. Buyers usually purchase the property sight unseen, and must rely upon the description of the property from tax roles. You will be buying without the benefit of an inspection that could reveal structural problems, mold or toxic materials that could cost a small fortune to repair. Financing auctioned properties is prohibited so you must pay cash, and to make matters worse, you’re not permitted to get title insurance. Remember that the home’s previous owner was unable to cover their mortgage, so there is a chance that they may also have a defaulted on their property taxes. If the property carries a tax lien, the new owner will have to pay it off. There are usually pros at these auctions, and they’re best left to the pros: With all the potential pitfalls of an auction, exercise extreme caution unless you’re a real estate mogul who can afford a mistake or two.

Auctions by municipalities are a slightly better option. These homes are sold to cover back taxes. Properties are sold "as is" meaning that you won’t have an opportunity to do an inspection and, again, you must pay cash. However, because the home is being sold to clear a lien as opposed to covering a loan, properties can often be purchased for a fraction of their appraised value.

If a property fails to sell at auction, the home is "sold" to the foreclosing lender. Foreclosed properties seized by the lender are called REOs or "real estate owned." The bank or financial institution will put the property up for sale. REOs are usually sold through real estate brokers, so check with your local agent.

Buyers considering a foreclosure should get as much information as possible. If the home has been vacant for some time, ask neighbors about the condition of the property. If there are contractors there, inquire about the work they are doing. Perform all the usual due diligence (inspections, appraisals, etc.) to ensure that you are fully informed. Some lenders will price a foreclosure at 30-50% below market to ensure a quick sale, rather than having the property on their books as a nonperforming asset, but larger banks will usually put homes up for sale at market value. Check online for comps (recent sold prices for similar properties in the same area) to be sure that the foreclosure is priced at or below market. After all, the goal in buying foreclosed properties is to get a discount.

Homes purchased with loans from the Federal Housing Authority (FHA), the Veterans Administration (VA), Fannie Mae or any other federal agency can be taken back by the government if the owner defaults on the loan. The VA’s foreclosure properties are often priced below market value and offer down payments as low as 2%. Check with your realtor about government foreclosures that may be available in your area.

Homes with FHA insured loans are transferred to the Department of Housing and Urban Development (HUD) upon foreclosure. They are often available for very low down payments, plus HUD will pay the broker’s commission up to 6% of the sales price. A note of caution: HUD homes are sold "as is." This means that limited repairs may have been made but no structural or mechanical warranties are offered. However, the price of a home in need of repairs is adjusted downwards to reflect the investment the new owner must make to improve the home. For the first 45 days, HUD listings are only available for purchase by homeowners who intend to live in the property, eliminating competition from big-time real estate investors. For more about HUD properties, go to www.hud.gov.

Everyone likes a bargain and foreclosed properties can often be a great investment under the right circumstances. As with any real estate purchase, your best bet is to do as much research as possible. Always hire a qualified home inspector to evaluate the home’s condition and consult with an experience, local realtor for valuation guidelines. The experience of these pros can prove invaluable in ensuring that you’re buying a bargain, not a money pit.

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