Foreclosures: The Cheapest Way to Buy a New Home?
With most buyers that I work with, it’s almost inevitable that the topic of foreclosures will come up during our search. “Are there any foreclosures that are available?” “Won’t it be easier to buy a home cheaper and then fix it up?” During my initial buyer consultations, I’ve already gotten an idea of what type of financial budget we’re working with and these questions scream one thing – champagne taste, beer budget.
Don’t get me wrong, there’s nothing bad about going after foreclosures, after all, most investors make their money off of foreclosures, but is it a good strategy for someone that is just looking to purchase a home for their family? This article will give you insight into the foreclosure process and what it’s actually like when you begin searching for a home that’s been foreclosed on. I’ve been in the business long enough to know that most people ask about going after foreclosures just to take advantage of a cheaper price, not because they truly understand the work that is involved when it comes to the transaction and future renovations.
The foreclosure process in a nutshell
We all know what causes a foreclosure so I don’t have to dive into that, but I do want to present the other steps in the process. After the homeowner has stopped paying their mortgage, they will a received a formal legal complaint from the bank which serves as their intent to foreclose on the property. They will give the homeowner one final chance to bring their balance current or they will begin with the court proceedings. These two steps in the process usually take about 30-60 days.
The bank can’t just take your property, they have to prove their case in court. It also allows the homeowner to prove their side of the story as well. If the homeowner doesn’t have a valid excuse that will cause the judge to even think about ruling in their favor, the judge will side with the bank and grant the bank the right to sell your home in a sheriff sale, aka, sheriff’s auction or auction. As both the homeowner’s and the bank’s attorneys go back and forth, this can cause delays in the litigation process. What normally should be a 4-6 month process from the bank’s initial complaint to sheriff sale, can easily be stretched to a 3 year period due to New Jersey’s backlog of foreclosures to process. In fact, the state of New Jersey has the longest foreclosure backlog in the country.
Yup, you read that right. There a people who haven’t paid a mortgage in a few years that are still living in their home.
During the public auction, the bank will try to sell the property for the amount of the upset. They’ll attempt to get every dollar back, but they also understand that it may be better to cut their losses at a cheap discount, especially if the home is in major disrepair. The sheriff sale is exactly how you see it on TV.
Actually, that’s probably the only thing these HGTV shows get right as far as a depiction of the real estate world.
If the bank is going to sell for an extreme discount, they want to know that nobody is wasting their time, which is the exact reason why they will want all cash. The sheriff sale is no place for someone looking to purchase with a mortgage. If you have all cash, cool, if you’re applying for a mortgage, you won’t be able to make an offer. This is the bank’s way of saying they don’t want to waste their time with a retail buyer using a mortgage. They would rather deal with an all cash offer, preferably one that doesn’t need a home inspection or an appraisal: the two speed bumps in any transaction. Both are usually waived with an all cash offer. The banks would much rather sell a home without the two major road blocks standing in their way.
Whoever the highest bidder is, they will be required to leave a 20% cash deposit on the property, usually before they even step out of the courthouse. They will then be responsible for the balance of the purchase price within 30 days after the auction.
If the property doesn’t sell in a sheriff sale, then the property reverts back to the original mortgage holder. This occurs if nobody chooses to bid on the property or if the bank does not receive a bid that satisfies the upset amount. At that point, the bank will decide to relist it for sale on the retail market. It’s at THIS point and THIS point only that the home becomes available to those looking to purchase a foreclosure with a mortgage. Although it will be listed at a discount, it won’t be near the discount that is available to cash investors at the auction. Banks know that as soon as they put it on the retail market, they’ll be able to reach thousands of people online compared to the limited amount of bidders at the local auction. The more eyes that see it for sale, the more appointments people will make to see the home. The more traffic a property gets, the better the bank’s chance of getting an offer close to their asking price or maybe even higher in some cases. Please understand that after the bank buys the property back from auction, it can take 5 weeks or 5 years to relist it for sale on the retail market. There’s a plethora of reasons why:
- The home is in disrepair and the bank may want to make minor renovations
- The bank has to clear any title issues
- The bank has to clear any liens or judgements against the property
- They want to hold the property on their accounting books as part of their “asset” column
- They have a feeling the market might bounce bank and the property will increase in value
These are just to name a few.
Nonetheless, once the bank finally relists the property for sale to the general public, that is when you will have the opportunity to consider purchasing with a mortgage.
Searching for Foreclosures
I get requests from clients all the time asking me to check out a property they saw on Zillow that they fell in love with only to find out that not only is it unavailable, there’s no telling when it will be! When searching websites only look for listings that say “For Sale” only. Any other statuses such as “foreclosed”, “pre-foreclosure”, “auction”, or “foreclosure” are not active listings.
“But Austin, if it doesn’t sell in auction, can you buy directly from the bank before they relist it for sale to the general public?”
I also get this question from clients. Hell, Zillow will even provide the bank attorney’s contact information.
In the earlier days of my career, I was bold enough to actually start contacting these attorneys. I’ve come to learn the hard way that there is no way a bank will sell you a property before it is relisted for sale.
I’m never the individual who tells someone they can’t do anything; I’ve seen some crazy things accomplished in the real estate world. I’m just saying it is extremely difficult and unless you’re willing to make a offer 5 times the current value, just to get them to listen to you, I wouldn’t waste my time.
The best way for you to search for foreclosures is simply setting up your search the same way you would for a seller-occupied home. If you’re working with an agent, they’ll be able to pull a list of foreclosed homes that are for sale. If you’re casually searching on your own, you can use keywords like “Reo”, “bank-owned”, “Hud”, and “Fannie Mae”, to help narrow down your search for foreclosures only. You can also look at foreclosure websites like Homepath.com, Hudhomestore.com, and Hubzu.com where you can search for properties for sale. These websites are helpful, however I’ve found that since most, if not all, foreclosures are listed with an agent, they will come up on the popular websites like realtor.com or your agent can pull the listings for you straight from the MLS.
Found a home? Ready to submit an offer?
STOP RIGHT THERE!
So you’ve found the home that you believe to be yours and it happens to be a foreclosure. The attractive price and future potential has you drawn and now the only thing that stands between you and your wreck of a dream home is your agent getting it for you, right?
Wrong. There are a couple things you’ll need to consider before placing an offer on a foreclosure.
To start, some homes that have been vacant for a long time are most likely “winterized.” A foreclosed property that has been winterized is a home that has had all of its plumbing systems drained of any water and the water utility will be turned off. During the cold winter nights of a vacant property, pipes that still have traces of water in them can freeze which can create massive complications throughout the plumbing system. In order to avoid another reason to bring the already discounted price further down due to additional repairs, the banks will require homes to be winterized. With plumbing completely out of commission, your home inspector won’t be able to conduct a thorough home inspection of the plumbing system without turning the water utility back on, an added step in the foreclosure buying process.
This is also the case if the electric and gas are off which occurs more often than not. Some banks will allow you to turn on the utilities for the purpose of your inspection and others won’t. If the utilities can’t be turned on, you’re taking a risk with the mechanics of the home. Make sure you’re able to turn the utilities on for the purpose of a complete home inspection.
Another thing to consider: What type of loan are you going after? A FHA loan is probably the worst option to go after a foreclosure with in my opinion. Why? The FHA appraisal process is notorious for being meticulous with their repair requests as part of the contingencies for you to obtain your mortgage. FHA likes to see the home in a certain “habitable state” before deciding to lend you hundreds of thousands of dollars on your new home.
If FHA can be a pain in the ass on homes in which the owner is still occupying the property, imagine a foreclosure. Chipped paint, loose railings, broken appliances, sidewalk cracks, clean pools, and rotted wood are just some of the things that may need to be addressed before you can continue on with your transaction – the utilities will also have to be on, for sure.
If you’re looking for a foreclosure, be on the lookout for these things as you, the buyer, will be responsible for fixing whatever your mortgage company wants you to in order for them to deem the home “lendable.” If you’re going after a conventional loan, you will have a much less stringent appraisal process compared to FHA.
I actually recommend going after a foreclosure with a conventional loan instead of FHA, if possible.
Keep in mind that these two loans only allow the purchase of the foreclosed property. They have nothing to do with the renovations or “personality inputting” of your new home.
“But Austin, what about FHA 203k? Doesn’t that allow renovations to be tacked onto the mortgage?”
Yes, this loan can be helpful when searching after a foreclosed property. It allows you to roll the renovation costs on top of your current purchase price if you don’t plan on paying for renovations out of pocket. Conventional loans also offer renovation loans so be sure to check with your lender to see what options are available to you.
Going after a renovation loan is acceptable when you stay within your preapproved mortgage range. For example, if you were preapproved for a $300k mortgage, saw a property worth $250k, but needed $70k worth of repairs, your renovation budget would be capped at $50k to fit within your $300k mortgage preapproval. The other thing you will need to keep in mind is that the property you are purchasing will also have to appraise for the purchase price and the rehab costs.
Let’s say you found a property for $250k and you wanted to finish the basement. You get a quote from your contractor and it comes out to $30k so you’re all in at $280k. What if all the homes with a finished basement in that area were only selling for $265k? That cuts your renovation budget in half. These scenarios are not to scare you away from foreclosures, just for you to understand what needs to be accounted for when looking to purchase. You will need to be strategic about purchasing a foreclosure. Your agent will help guide you.
All that to say….
On the brighter side, there are some foreclosed properties that are in immaculate condition. These are ripe with opportunities and feel free to go after these gems. Although 8 out of 10 times this isn’t the case, you can entrust your agent with the job of vetting out the foreclosures that are a good match to fulfill your home buying goals. Once your agent has properly vetted the property, you will be able to purchase a foreclosure in the same manner as an owner-occupied home. The transaction process can be relatively smooth if you stay 5 steps ahead.
This article serves as a guide to your foreclosure search. Don’t get caught up with the attractiveness of a property just by its price and potential. Most individuals start their search on a bad foot by searching for foreclosures that will not serve their needs. Most individuals also believe that going after a foreclosure will help them save a lot of money and will help them get the cheapest house in the best neighborhoods. The reality is, we are still in a seller’s market and the competition is too fierce to try to approach the home buying process with an idea of “getting the best deal”. While those opportunities are out there, for example, me getting one of my clients a home $40k under the original asking price, they are the exception not the rule. There’s nothing wrong with looking for a good deal, it just can’t be the primary focus. If you’ve financially prepared, and understand how much you can afford, your agent will guide you towards making the best financial decision when it comes to purchasing your home. Paying top dollar for a home doesn’t mean that you paid too much. It just simply means the home was worth top dollar. It’s all about matching the value you receive vs. the price you paid to receive that value. In this case, that value received is the best home that you and your family can afford.
Have you purchased a foreclosure or had any experiences dealing with a foreclosure? Comment your experiences below!