If you want to take advantage of the market and try to pick up a great deal on a foreclosure, and yes, you have enough credit or cash, there are few things you should know before making a purchase.
First of all, what is a foreclosure? It’s a bank-owned property, commonly called real estate owned (REO). For whatever reason, the original owner stopped paying their mortgage so the lender (e.g., Bank of America, Wells Fargo, Fannie Mae, etc.) legally repossessed the property and took ownership.
Next, it will be listed for sale by a local real estate sales professional in the Multiple Listing Service (MLS) along with listings of traditional sales and short sales. We are not talking about properties sold via a foreclosure auction at the county courthouse; those make up a very very small percentage of bona fide real estate sales to third-party buyers like you. Plus, they are extremely high risk, so let’s leave those to the pros who take huge risks.
When Foreclosure is Not a Good Deal
Let’s first talk about what foreclosure is not a great deal. A great deal is not necessarily the lowest-priced property on the block. Or, if it is the lowest priced, it’s because it needs lots of repairs. A great deal won’t be a property where there are several other properties for sale, or many vacant properties in the area. And a good deal on a foreclosure won’t be a home that is really run-down — unless you’re a professional — or a condo or house in a new subdivision that is only half sold out or one that can only be purchased by “cash” buyers because no bank will finance the purchase.
The fact is there are many things that can go wrong with a real estate purchase. You may think you are going to get some unbelievable deal, but the truth is there is usually a reason for a property to be really low priced. Most often, you won’t figure out that reason until after you close escrow, and at that point it’s too late.
What Makes a Foreclosure a Good Deal
When you are about to purchase a foreclosure, consider these 5 things:
1. “I love the property” is what you say after you’ve viewed it, driven the neighborhood, and investigated the property fundamentals. You love it because it is very close to exactly what you were hoping for in becoming a homeowner, or rental property owner.
2. “I plan to own it a long time” is what you say when asked. Regardless of how great a deal you think you are getting, the break-even point in ownership is really about five years. If you aren’t going to own it that long, you are most likely better off staying a renter. Remember the three most important words in real estate: long-term ownership
3. “It’s in pretty good shape” is what you say when your friends ask about the physical condition of the property. The vast majority of buyers have wildly low expectations of how much it costs to renovate a property. Renovations usually cost a lot more and take a lot longer than one believes, so let the contractors buy the fixer-uppers.
4. “The price is in line with comparable recent sales in the neighborhood” is what you find out when you do a comparable market analysis of nearby properties. Remember, if it sounds too good to be true, it probably is.
5. “Most of the nearby houses are occupied” by owners, or at least renters in the area. Neighborhoods with many empty houses can go into downward spirals that can become very bad areas with very low home values. Avoid that type of risk.
Confirm Your Suspicions
To further help you ascertain and confirm that the foreclosure is a “great deal,” you need to do the proper due diligence during your buying process. This is especially true since bank-owned properties generally do not come with the traditional seller disclosures of any material issues wrong with the property.
Before you sign, review comparable market sales, get contractor estimates, compare mortgage rates, and view at least 10 other properties so you know what the market has to offer. You should also review the HOA financial and legal condition and your title insurance policy for any issues as well as keep the proper amount and type of dwelling and liability insurance in place.
Taking those steps to reduce your risk is key to making sure what you bought was really a “good deal.”
Overall, when buying a foreclosure (or short sale, or even traditional sale for that matter), the first order of business is to buy a good quality property in a good area that you will own for a long time and will make you happy. It’s better to pay more for a better quality, lower risk property. This is the largest and riskiest purchase you will ever make, so make a smart purchase.
Finally, the prices these days on residential real estate are generally very fair, as is the financing, so it truly is a good time to buy – subject to the above due diligence tasks. But avoid the “I’m going to get the steal of a lifetime deal” mentality. Go for something that fits what you want, for all the right reasons, and for the long term, all of which are vastly more important issues than price.
Leonard Baron, MBA, CPA, is a San Diego State University Lecturer, the author of “Real Estate Ownership, Investment and Due Diligence 101 – A Smarter Way to Buy Real Estate”, and loves kicking the tires of a good piece of dirt! See more at ProfessorBaron.com.