7 smart moves for buying a foreclosure
Roughly 10 million homes have been foreclosed on since the housing bubble burst.
But the flood of repossessions that rampaged through the recession looks more like a trickle today. A strong job market is the main reason foreclosures have become much less common, according to the mortgage purchasing giant Fannie Mae. Unemployment is a major reason why homeowners fall behind on mortgage payments.
Foreclosures have also dropped as lenders have become more willing to modify mortgages for struggling borrowers, according to HOPE NOW, an alliance of mortgage market participants that addresses challenges in the market.
The number of bank-owned homes has dropped by 40.6% since last year, according to RealtyTrac.
But there have been bumps in the road. Last November, the number of bank-owned properties was up 66% over the previous year as a wave of homes that had been grinding through the lengthy foreclosure process hit the market.
The National Association of Realtors says the percentage of home sales that are foreclosures and short sales has hit its lowest point since it began tracking the data in October 2008. Just 4% of July home sales were foreclosures.
CoreLogic, a data and analytics company, reports that just 1% of all homes with a mortgage were in foreclosure in June 2016, marking a return to September 2007 levels, before the housing bubble burst. It reports that the number of foreclosures on the market has declined for 56 straight months.
Shopping for a foreclosure can still help you find a bigger, better home than you might otherwise be able to afford.
But whether you'll be able to find a foreclosure largely depends on where you live. Foreclosure rates are highest in New Jersey (3.4%), New York (3.1%), Hawaii (2.0%), District of Columbia (2.0%) and Maine (1.9%), according to CoreLogic.
If you’re looking to buy a foreclosed home in Minnesota, Colorado, Utah, Michigan or Nebraska — all states with foreclosure rates of just 0.3% — you may have a hard time finding one.
These 7 smart moves can help you buy the right foreclosure for you.
Smart move 1. Never buy a foreclosure sight unseen.
When you buy a repossessed home at auction, you usually can't enter the property to assess its condition before you bid.
At best, you might be able to view the exterior, peek in the windows and chat up a neighbor about the property's recent history.
Without going inside, and without an inspection, you won't know what shape the home is in until you get the keys. At that point, any unexpected costs are yours, and they can run into the tens of thousands of dollars.
Frustrated former owners facing eviction have destroyed plumbing and electrical systems, ripped out carpeting, punched holes in walls and stripped homes of kitchen appliances, light fixtures and water heaters.
It can be truly awful.
It's safe to assume that foreclosed homeowners weren't keeping up with routine maintenance, either.
So here's the one inviolate rule of buying a foreclosure: Never commit to a home you haven't thoroughly inspected, inside and out.
The good news is that fewer foreclosures are sitting vacant before they are sold these days — just a little under 5% as of the third quarter of 2016, according to RealtyTrac. So you may be less likely to come across a seriously damaged property than homebuyers a few years ago.
Smart move 2. Buy repossessed homes through a real estate agent.
When the home goes to auction and no one bids enough to cover the outstanding mortgage, the bank that holds the loan gets title to the home.
These become what are known as real-estate-owned (REO) properties.
The bank will usually repair the worst damage and hire a real estate agent who specializes in foreclosures to market the home.
That selling agent will allow you to see what's inside so that you know exactly what you're buying.
Smart move 3. Know what it will cost to make the home livable.
Good foreclosed homes are merely houses that have sat empty and neglected for months, with dead lawns, peeling paint and other relatively minor problems.
Others are so trashed that you can't live in them before making repairs.
For $300 to $500, a home inspector can help you spot many of the problems.
Just make sure you have realistic expectations about the home inspection.
Home inspectors are generalists, not specialists, and they can't see behind walls, under floors or in ceilings (unless the previous disgruntled owner punched large holes in them).
Also, while a home inspection might pay for itself in a regular sale, banks are less likely than traditional sellers to lower the purchase price or make repairs. They mean it when they say they're selling the property as-is.
Owner-occupants who sell their homes have to tell you anything they're aware of that's wrong with the property.
But banks and government agencies that have repossessed homes don't, and they're unlikely to have in-depth knowledge about the property's condition.
The American Society of Home Inspectors or the National Association of Home Inspectors can help you find a qualified inspector in your area.
For an estimate of repair costs, you'll need a licensed contractor.
Build a cushion — at least 10% — into your repair and remodeling budget. This work always seems to cost more than you think it will.
Smart move 4. Know what similar homes are selling for.
You can find "comps" for the property you're considering on Realtor.com.
You'll get actual sales prices for similar nearby properties that have sold recently, not asking prices or unreliable estimated values.
You won't always be able to tell the condition of the homes that recently changed hands — though sometimes listing photos are still available and can give you an idea — but you'll be able to establish a range of prices, a typical price per square foot and an average price.
Eliminate any comps with extremely low prices. These may be transactions between family members that don't reflect market value.
Make sure your offer includes a "subject to" clause that lets you out of the deal in case the appraisal your lender orders once you're under contract comes in low or the home inspection reveals major problems.
Smart move 5. Bid competitively.
The main reason buyers think they should shop for a foreclosure — to get a bargain — isn't always valid.
According to the National Association of Realtors, the average foreclosure sold for 18% below market value in July. You can use this metric along with comparable sales as a guide when deciding how much to offer.
That's a national figure, though; what really matters is your local market.
The NAR’s most recent report on the cities with the biggest foreclosure discounts, based on RealtyTrac data, says homes in Pittsburgh offered the largest foreclosure discount, at 63%, while Milwaukee and Cleveland foreclosures were close behind, selling at a 59% discount.
In any case, you can take advantage of two things working in your favor:
- The bank is not emotionally attached to the home and has no irrational expectations about price.
- The bank is losing money every day the house sits there.
Remember, the home's real cost is the money you pay the seller, plus what you'll spend on repairs and renovations.
Set a firm maximum price that's within your budget and near the property's actual value. Be prepared to walk away if the bank won't accept it. And don’t forget to factor in closing costs if you're getting a mortgage — they can add thousands of dollars to your transaction.
Smart move 6. Line up your financing and earnest money in advance.
With any home purchase, it's important to know what you can afford before you start shopping.
And if you'll be using a mortgage to pay for the home, having financing lined up is one of the best ways to prove to the seller that you're a serious buyer and increase your chances of having your offer accepted.
When you're buying a foreclosure, taking this step is not optional. Banks will expect to see a preapproval letter with your offer.
Taking this step will put you ahead of the pack if other bidders are less prepared. And if you're up against cash buyers and you're using financing, being able to prove you can close is your only shot at a winning bid.
Smart move 7. Understand the financing restrictions on foreclosures.
Most banks won't lend you money to buy a home that's in terrible condition.
In a typical sale, the seller might make any repairs your bank requires. But foreclosures are different.
The bank selling the home probably won't be willing to do the repairs, and the bank lending you the money may not be willing to close the loan without them.
One of the only ways to get around the catch-22 of lender-required repairs is to use a 203(k) loan from the U.S. Department of Housing and Urban Development.
If you will occupy the property as your primary residence, you can use this program to finance a fixer-upper with one long-term loan. The money comes from a traditional lender, but HUD guarantees it will be repaid, making it easier and cheaper to obtain.
But 203(k) loans come with lots of red tape, and not all lenders offer them. The easiest way to find one who does is with HUD's search tool.