Real estate professionals weigh the pros and cons of scoring a deal on your next property investment.
Thinking about making a move? You might have added a foreclosure to your shortlist of properties to consider. As many state-wide foreclosure bans introduced during the pandemic expire this fall, searches for “pros and cons of buying a foreclosure” have risen 250%. But before you sign any paperwork, it’s important to know the special circumstances involved with purchasing a foreclosure.
Foreclosures are properties in which the homeowner has defaulted on the mortgage, and someone (often a bank) has legally obtained possession of the deed or title. According to Dr. Susan Jenkins, CEO of Better Homes and Gardens Real Estate Native American Group, a common misconception is that all foreclosed homes are in poor condition or in a poor location. “Many foreclosed homes are in average to good condition and only require minimum cosmetic repairs,” she says. “Most are what we refer to as ‘scratch and dent.’” New houses can go into foreclosure if an owner meets unexpected financial trouble.
“Foreclosures can be a great opportunity for those who are diligent, flexible, and persistent,” advises Jenkins. But before pursuing that perfect foreclosure on your route to work, you should know how the experience is different from a conventional real estate purchase, and what extra effort (and money) it might require.
1. Foreclosures Aren’t a Bargain Buy
Washington says another pervasive misconception is that people think they’re going to get a steal or a sweet deal when purchasing a foreclosure. Jenkins sees the same misbelief. “Buyers do their research on the mortgage balance or foreclosed amount and assume the bank is only looking to recover the loss,” she says. But these sellers know the market well, and they are looking to increase their return on investment, not simply recoup their loss. When putting in a bid or planning for financing, don’t make the mistake of believing the bank is only looking to recover the foreclosure amount. “You have to come prepared to be competitive,” says Washington.
2. Properties Are Typically Sold “As Is”
In most cases, foreclosed homes are sold “as is,” meaning the seller will not make repairs or concessions like they might in a conventional sale. This impacts lending options (see #5) as well as the time and money put into researching the property prior to making a purchase (see #4).
It can also mean spending more after the sale to remedy any issues. And it’s not just repairs that aren’t covered in “as-is” sales. For example, foreclosures sold by the United States Department of Housing and Urban Development (HUD) place the responsibility, and cost, of utility activation on the buyer, says Jenkins. Although it’s uncommon, some institutions may be willing to address certain issues or adjust costs or payments for some repairs. “However, one must always be prepared to adhere to the “as-is” language of the contract,” Jenkins says.
3. Sellers Don’t Have Much Information to Disclose
In a conventional property sale, homeowners are required to disclose their knowledge of the property. There is less transparency with a foreclosure. “Since the home has been acquired through legal proceedings, the bank or servicer has no or limited knowledge of the condition of the home, nor do they have any disclosure or inspections related to the home’s condition,” explains Jenkins. Sellers might also be exempt from certain disclosures when it comes to foreclosures. For example, Jenkins notes that many foreclosures are exempt from state-required disclosures and lead-based paint disclosures.
4. Research and Due Diligence Are Critical (and Potentially Costly)
The burden is on the buyer to investigate the property. “Research prior to submitting an offer,” counsels Jenkins. HUD homes, for example, list reports and escrow amounts on the addendum section of their properties. You can also do a title search to find out if a property has debt or liens attached. And while not traditionally available, it doesn’t hurt to ask sellers or listing agents about any assessments or property condition reports, says Jenkins.
The buyer also must make the most of the due diligence period. “It’s in your best interest to have as many inspections as you see fit,” says Washington. This could mean coordinating multiple inspections, including bringing in specialists, for a general home assessment or specific examinations related to the foundation, HVAC, roof, septic system, pool, termites, radon, or mold. These inspections are the buyer’s cost and are for informational purposes only since the property is sold as is. But the investment is worth it. “It’s on you to know what you’re getting into,” says Washington. “That $500 could save you $20,000 down the road.”
If you’re looking at a foreclosure during winter months, there’s an added factor at play: winterization. Foreclosures are often winterized to prevent pipes and water lines from freezing. If active utilities are necessary for an appraisal or inspection, this can translate to added costs to de- and re-winterize the property.
5. Understanding Financing Options Is Key
Both Jenkins and Washington make special note that not all loans can be used to buy a foreclosure. With standard Federal Housing Administration (FHA) loans, for example, if an appraisal indicates concerns that need to be addressed, such as mold or peeling paint, then an FHA loan cannot be used to purchase the property. FHA loans are commonly not applicable to foreclosures. However, conventional loans and the FHA203(k) loan (also called a rehab loan) can be used to purchase properties that need repair.
“One of the first steps in buying any home is talking to a lender,” Washington says. If you’re considering foreclosures, be sure to make that clear to your lender. A lender will help you determine what monthly mortgage payments you can afford and what financing options are available to you. Knowing this will help you be competitive (and comfortable) when making an offer on a foreclosure. Jenkins also advises strategizing with the lender prior to making a bid on a foreclosure so there’s a plan in case of inspection or appraisal issues.
6. Experts Can Share Valuable Insight
Perhaps the biggest takeaway is that working with someone with foreclosure experience can be a tremendous advantage. A real estate professional with foreclosure knowledge can make recommendations about lenders and inspectors, plus they have a sense of what issues might come to the surface when looking at foreclosure properties, says Washington. A lender with foreclosure experience will be knowledgeable about the intricacies of financing options. Both lenders and real estate professionals who’ve worked with foreclosures know what to expect throughout the process, too. They can help understand a seller’s terms and add important contingencies to a sale that reflect the buyer’s homeownership goals. This allows you to safely walk away if an appraisal doesn’t meet your needs.
Source: Better Homes & Gardens