Mon, June 23, 2008
Should You Be Shopping for a Foreclosure?
One of the consequences of the subprime debacle is a sharp rise in foreclosed properties. Some areas are especially bad off; in May, the majority of homes sold in the Sacramento area were foreclosures. Foreclosures nationwide were up 48% in May vs.the previous year (RealtyTrac.com), and in Massachusetts they were up 32% (ForeclosuresMass.com) over the same period. The rate in MA would have been higher but for a new law that went into effect May 1st, forcing lenders to delay foreclosure proceedings by an additional 60 days. There seem to be quite a few ads claiming that great deals are available through foreclosure sales. Is buying foreclosed property a "can't-fail" way to make money?
What is foreclosure, anyway?
A foreclosure takes place when a property owner defaults on his or her loan payments and the lender takes legal action to seize the property. If you look closely at your mortgage documents (they make great bedtime reading), you’ll see some provision to this effect. Laws vary from state to state, and many states, like Massachusetts, are trying to give homeowners in trouble more time to sort things out. However, when a property owner quits making payments and the bank has exhausted its other means of getting repaid, a foreclosure is the likely outcome.
Are these properties ever sold via some means other than foreclosure?
Sometimes “troubled” properties are sold in what are called “short sales;” in these, the borrower and lender typically agree, prior to foreclosure, that the lender will take a loss in order to avoid a prolonged process in which further price declines might reduce the amount the lender ultimately receives. The borrower, in turn, avoids the black mark of a foreclosure. In principle, a pre-foreclosure sale offers the greatest potential for a highly discounted price, but the risk of the deal falling through is also the greatest. You should be careful to investigate situations in which third-party companies claim to be handling short sales; not all of them are legitimate.
How do you buy a foreclosed property?
There are primarily three methods; the “short sale” or “pre-foreclosure” route has already been discussed. The second route is through the purchase of “REO” (real estate owned) properties; these are foreclosed properties purchased directly from a bank. It can be difficult to get a bargain on a REO sale, although a bank may offer attractive financing terms in order to get distressed property off its books. The third, and most common, method is making a purchase at an auction.
Can I get a loan to buy a foreclosed property?
This is one of those if-you-have-to-ask-you-can’t-afford-it questions. Usually if a property reaches the auction stage, the lender is looking for fast results and cash. Don’t count on being able to get a regular mortgage for an auction property.
Are there other risks in buying a foreclosed property?
You bet! For one thing, you often won’t be permitted to inspect a house sold at auction beforehand, so any damage or problems that are not visible from the outside won’t be known until you own the property. In some states, even after auction the owner has a chance to recover the home; in others, the previous owners may still be living in the house and will need to be evicted. In most cases, you can’t obtain title insurance until after you own the house. You’ll need to have a careful title search done before the purchase, and even then you may get some surprises after the fact. Be sure that there are no judgments or liens against the property that would become yours if you buy it. Finally, it’s not unusual for the homeowners approaching foreclosure to trash the house in order to get back at the lenders, but if you buy such a house, it becomes your problem.
How can I avoid making an expensive mistake?
Every state has different laws and you should be sure that you understand the laws in your own state. As a starting point, take a look at the Foreclosurepoint web site, which has some nice resources.
There is a guide to buying pre-foreclosure property called, aptly enough, “The Pre-Foreclosure Real Estate Handbook.” I haven’t read it, but it looks like a promising source of information for a newcomer. There are also some real estate agents who specialize in troubled properties; a good one can be an invaluable resource. Make sure, however, that you have someone who’s a distressed property expert. You need a person who knows the area where you want to buy property and who can guide you through the process; don’t hire a novice unless you have money to burn. About 6 percent of the properties for sale in MA are ‘distressed,” but the percentages vary widely when you look at specific locales. Be sure that you understand the area where you are buying and budget some reserve funds to pay for the cost of repairing unseen damage.
In short: this is not an investment for people who don’t have a good understanding of what they’re doing, for people who are thinly capitalized, or for people already living under stressful circumstances. You should have your own finances in order before undertaking this kind of investment.
The other big question you need to consider is, once you buy a foreclosed house, what are you going to do with it? If you’re hoping to make a few repairs and sell it for a profit, you need to know a lot about real estate in the area where you’re buying. In places like Sacramento, Denver, and Las Vegas, there are plenty of distressed properties available and they’re your competition. Moreover, prices in those areas are going to be in the dumps for a good while. If you’re are able to find a foreclosed home in a very desirable neighborhood where there are no other foreclosures, that could turn out to be a good investment. Still, you must know what you are buying. Keep in mind that there are real estate pros also looking for great foreclosured properties to turn around for profit; if they’re not interested in the home you want to buy and sell, you should wonder why.
Perhaps your goal is to buy foreclosed properties and rent them to tenants. If so, you need to learn how much comparable properties rent for and determine the after-tax payback you can expect, making allowance for expenses and periods of vacancy. If the numbers don’t make sense, follow the numbers and not your gut. Before you become a landlord, study the local regulations governing landlord-tenant relationships. Learn about the strength of the local rental market; if you’re buying in an area with lots of foreclosures that could soften the rental market, too. Finally - and I’m saying this from personal experience - be sure you have plenty of resources to deal with late-night furnace failures, broken appliances, and clogged toilets.
It’s true that there are investors who make great returns buying distressed homes, but this is also a great way to lose your shirt. Before taking the plunge, make sure that your overall finances are strong and that you can endure an unexpected setback without suddenly jeopardizing your ability to keep up with your mortgage payments.