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Lately I have noticed more confusion and misconceptions around foreclosures than just about any other topic.
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Here's a post to try and shed some light on a topic that has been intriguing to many buyers over the last few years.
Enjoy the article!
Buying a Foreclosure? Here’s What You Need to Know
Everything you know about buying a foreclosure is wrong…
Or is it? Preform a basic internet search and most of the information you will find is conflicting and shockingly outdated. Mostly written by people who make a living as writers, with no real experience dealing with actual foreclosures for sale. A look at the facts and the real foreclosure market might surprise you, prepare yourself.
In most parts of the country home, prices seemingly increase by the month. Despite the fact that there are fewer available foreclosures today than there have been in the past few years, there is still a very strong interest from buyers considering buying a foreclosure. With the potential to save some hard earned money It probably doesn’t come as a surprise.
So what is a foreclosure? When different people mention foreclosures, they are not always referring to the same type of foreclosure. Let’s review the four main types of foreclosures and how they differ.
Pre-Foreclosure, Short Sale or Both
When a homeowner stops paying their mortgage, maybe due to a job loss or medical debt, the lender will issue a “Notice of Default”. At this point the property owner still has the option to bring the loan current. If the owner does not bring the outstanding mortgage current and continues to fall further behind on their payments the lender will then issue a Notice of Default. The property then is considered in Pre-Foreclosure.
Here is where it can get tricky. In most cases the owner will try and sell the property to avoid an actual foreclosure from taking place. If the balance owned on the loan is less than the value of the home the seller can simply sell the property and pay off the lender with the proceeds. In this case the lender has very little involvement in the transaction.
In a situation where the seller owes more than what the property is worth, they can perform a Short Sale. A short sale, in non-technical terms, is a lender agreeing to be shorted on the loan balance, in other words accept less than what is actually owned. The sale of the home is then considered a “pre-foreclosure short sale”. If an owner is trying to sell the home for less than the balance owed and they are current on their loan payment, then it is considered a standard short sale.
Foreclosure Auctions… Bargains?
If the home isn’t sold and no payments have been made on the property, a Foreclosure Auction is ordered. Technically known as a Trustee Sale. Foreclosure auctions rarely happen on schedule and are often postponed for months or even years. Foreclosure auctions take place before the lender takes physical possession of the property. These are the ones you hear about taking place on the courthouse steps.
This must be the best way to score a good deal right? Not likely. The auction begins at the amount that the lender is owed. The problem is, rarely does a home make it to auction where the balance is less than the market value of the property. But of course, some do.
Foreclosure auctions are not for the first time buyer. These auctions require all cash purchases and are attended by real estate pros. There are a myriad of intricacies that can trip up even an experienced foreclosure buyer.
Essentially what you’re buying is the loan itself. In many cases there are other liens on the property that you may still be required to cover. The home may have been vacant for years or very commonly the original homeowner may still occupying the property. Disturbing the occupant is illegal and no inspections are allowed. In either case vandalism is common. If the property is still occupied you are responsible for evicting the current occupant.
Government Owned Foreclosures
The process of buying a foreclosure can vary based on the seller of the property. Purchasing a HUD foreclosure is a pretty straight forward process. HUD will clean out the home, often remove the flooring. Perform a basic inspection, available to a potential buyer, and perform an appraisal. The HUD home is then listed on the local MLS at the appraised price.
HUD requires a licensed real estate agent to be on both the buying and selling sides of the transaction. In most circumstances they give a small window where they will only consider offers from buyers that intend to live in the property. In a competitive market this can give potential homeowners an advantage by barring competition from investors.
Other government agencies like Fannie Mae and Freddie Mac have their own process of listing foreclosures for sale. In the past, they would offer special financing for homeowners, but that’s rarely the case anymore. While they typically do a presale inspection, you will never see a copy of it. Fannie in particular, is notorious for overpricing and refusing to accept offers below their asking price. In locations where the market is favorable towards sellers, agencies like Fannie and Freddie will even perform updates to homes, like new paint and flooring, which doesn’t leave much room for negotiations.
Bank Owned Foreclosures
When most people talk about a foreclosure, bank owned foreclosures is what they are referring to. In industry terms bank owned foreclosures are referred to asREO or Real Estate Owned. At this point the lender has officially taken possession of the property and paid off or removed any outstanding debts or liens associated with the home. No one will be living there and you will have the opportunity to inspect the home prior to making an offer.
Buying a bank owned home can vary greatly from one lender to another. Are you starting to notice a recurring theme? Keep two important points in mind. From a financial statement standpoint the bank has already taken a loss when they officially foreclosed on the home so anything they make by selling the property is pure profit for them.
In the past when they were faced with an avalanche of potential foreclosures, they were more willing to quickly sell even if it meant taking a loss. In some states they are still faced with thousands of potential foreclosures, but in most places that’s no longer the case. They are far from desperate sellers and have little need to quickly unload a property if it means leaving money on the table.
Second, banks are very good at determining local real estate conditions and current home prices. They are more likely to try and take advantage of a lack of inventory than be taken advantage by it. When determining their prices, getting a formal appraisal or at least a BPO (Broker Price Opinion) to assign a value in the local market is standard.
How to Buy a Foreclosure Tips
No matter the type of foreclosure. There are two things you must do before you consider buying a foreclosed home. First, you need an agent who knows the ins and outs of how these work. Not all foreclosed homes work the same and every bank is slightly different. Having an agent with experience in these types of transactions can mean a make or break for this type of purchase.
Second, you need to know how you’re going to pay for the home. Having your financing lined up before hand is not negotiable once it’s time to extend an offer. As an agent, when I get ready to write your offer, your loan pre-approval or proof of funds, must accompany any offer I send over to the bank. This ensures the seller that you are a serious buyer and can get the purchased closed.
Like any other purchase, you are entitled to a home inspection. Which is crucial. Prior to scheduling a home inspection, there’s yet another process of requesting to turn the utilities on. Sometimes this goes relatively quickly and others, it can be drawn out.
It’s important to know that utility activation for a home inspection may be a cost that you as the buyer are responsible for. If there is anything that will torpedo a bank owned deal, it’s usually a costly repair. In some instances the bank may discount for a serious problem. By serious I mean mold in the attic, crawl space or foundation issues. I have bought foreclosures with both. What, if anything the lender will do will vary by lender and even property.
Buying a Foreclosure vs. a Traditional Sale
So, how does buying a foreclosed home work? When you buy a bank owned property, you likely won’t be dealing with just one person on the other end of the transaction. There are still many channels an offer has to go through before you hear whether or not your offer was accepted. Patience is key here. With a traditional sale you will give a deadline to the seller to respond to your offer, hours are typical in Idaho. Banks on the other hand could take days and will completely ignore your deadline.
As mentioned above, know that when buying a foreclosed home it will be sold in “As Is” condition– the emphasis here couldn’t be stronger. The way in which you saw the home before you made the offer, is going to be the exact same when you close. So if there’s peeling paint, grimy carpets or junk in the yard- Welcome to your first home project!
Another important difference to keep in mind, you will likely need to be able to pay for your own closing costs. There usually aren’t many freebies that the bank is willing to part with. So consulting with your real estate agent and lender are key here so there aren’t any surprises come closing day.
Weighing Your Options
While purchasing a foreclosure can be a great option for those who are looking for an opportunity to earn some sweat equity. The reality is, it may not be everyone’s cup of tea. Knowing some of the potential pitfalls ahead of time may shed some light on whether pursuing a foreclosed home is in the cards for you. As my reader, I have two pieces of advice. Do your research and hire a real estate agent who not only knows the local market, but who is intimately familiar with how these transactions work. This could mean a make or break for your sanity and also for a potential deal.
Other Helpful Foreclosure Resources: