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How to Buy a Foreclosure

Updated on October 29, 2012
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Hurry Up and Wait

Now is the time to buy a home. With interest rates dropping almost daily, it's impossible not to be tempted with the dream of homeownership. It can become a reality, even with today's lousy economy.

It's amazing how many foreclosures are popping up on the market. It seems like each day that my husband and I were house searching there would be another foreclosure or short sale to look at, priced to please. We actually searched for about six months while moving to the greater Wichita area, scouring through thousands of homes online and touring hundreds in person. We made eight total offers, and we are proud to say that we now finally have a home we are proud to call ours. A foreclosure! Buying a foreclosure was the only way we could afford an incredible house at a fraction of the price of its worth. We build instant equity and will be able to increase the value of the entire neightborhood simply by remodeling, recycling, and upcycling our way through this house.

We learned a few things along the way. Let's walk through these tips so we know exactly what we are getting into when buying a foreclosure or short sale.

What is a Foreclosure?

A foreclosure is a home possessed by the bank or government because the former owners could no longer make the payments. There are several reasons a former tenant might not make payments, including but not limited to: severed income, death in the family, illness or other familial trauma, or even refusal or laziness. Many times banks will provide ample opportunities for the tenants to pay up, but if they are unwilling or unable, their home must be repossessed by the bank.

The tenants have another option before foreclosure, called a short sale. A short sale is when the home enters a pre-foreclosure state in order to help the family save their credit. If a real estate agent can sell the home in short-sale status within four months of the decision to sell, the homeowners can escape the embarrassment and shame of being foreclosed upon, while also saving face with the bank.

Generally short sales and foreclosures are priced to please for a few reasons:

  • The bank has to pay all taxes and insurance on the home while it is vacant and on the market, so they are eager to get rid of it.
  • The bank only needs to break even from the transaction, meaning they will sell the home at a price that reflects both its value at its current state (which may be neglected or even abused) and what the prior residents owed on the property.

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Pros and Cons of Buying a Foreclosure

Reasons to Buy a Foreclosure

  • They can be a true real estate bargain! Foreclosed homes may be priced thousands below the county appraisal for quick sale.
  • Build instant equity. Sometimes, foreclosed homes only need a paint job and new carpet, which will enable them to sell for thousands of dollars more than the purchase price.
  • Increase the property value of high end neighborhoods. Having a foreclosure in the neighborhood can decrease the value of the whole place, so when someone comes in and buys that foreclosure, makes their steady payments while fixing it up, they are actually increasing the value of the entire neighborhood, therefore boosting the economy.
  • There are tons of them on the market. In some major cities, there are more homes for sale in a foreclosed state than in an owner occupant state. This may be sad, but it reveals the truth about our economy today.
  • It might just be the right house for you. Many people are scared off by the label "foreclosure" and may not be giving the house a chance. At least look through a few to get a feel for what that price range of foreclosures will offer you.

It is not uncommon to walk into a scene like this when touring a foreclosure. Keep and open mind!
It is not uncommon to walk into a scene like this when touring a foreclosure. Keep and open mind! | Source

Reasons Not to Buy a Foreclosure

  • You have to be able to visualize the potential. many of these homes are chock full of potential but tend to scare off possible buyers because of funny smells or red flags that the real estate agent might point out.

  • The fear of the unknown. There is always the possibility that there is something gravely wrong with the home. We had made our 7th offer on a home and we were so excited about it, but after the inspections, we withdrew and got our earnest money back. There was mold in the basement, a crumbling foundation, and it needed a new furnace and air conditioner, among a host of other repairs such as new windows, reinsulation, and all new appliances. Yikes! Generally with a foreclosure, there is no property condition report, so what you see is what you get.
  • The lack of home warranty. Sometimes, individual sellers will include a home warranty in order to entice buyers, but it is rare that banks do. So if you purchase a foreclosure and the day after you close on it, the furnace goes out, no home warranty will cover that.
  • It has likely been used and abused. Even if the former owners took care of the home while they were living there, which is not all that common, they may be angry they were foreclosed upon and may take it out on the house by punching holes in the walls or cutting electrical wiring. Your inspector will inform you if he sees any of this. When my husband and I were touring a foreclosure, we opened the lid to a toiled out of curiosity only to find instant cement dumped in the bowl. We realized that the former occupants had poured cement down each of the toilet bowls to ensure that no one would be able to salvage the house.

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How to Buy a Foreclosure

Ok, here we are. You are convinced that buying a foreclosure is the right way to go, but you don't know how. Here are some tips that we have learned through our experience!

Getting Started

  1. Find a great real estate agent. See the links below for more help with how to find a hard-working, honest agent.
  2. Outline your expectations for your agent, as well as your expectations for the homes you will be searching. Be specific and honest. If you prefer a 2-car garage to a 1-car garage, say it! You'll be more likely to find what you want faster, plus you won't waste your time looking at homes you know you won't buy.
  3. Get to know listing agents. Some of these listing agents for banks are foxes: some (not all!) dodge loopholes in the law in order to get the most profit out of the foreclosure, so do your research. Find out which agents only accept cash offers. Find out which ones have marks on their records for manipulating offers. You won't be sorry!

While Touring

  1. Scrutinize everything. Not sure why there is a water stain on the ceiling? Better check it out. Why does the basement have a smell? Not sure, but you'd better be safe and bring it to the attention of the inspector. You can never be to careful.
  2. Don't be blinded by one great feature. If the house has a great kitchen, but the layout of the house is subpar, evaluate how important these things are to you. You don't want to regret your decision because you were so excited about one feature.
  3. Picture what it would take to get this house up to your standards. If the carpet is destroyed, calculate the cost of new carpet in with the cost of the house and evaluate if this is worth it. Figure what your can afford to put into repairs vs. what you can afford to put down in cash. Eventually, what we decided to do was find a more expensive home that demanded less work and put more down in cash to avoid high minthly payments.

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Making a Strong Offer

  1. Put a large amount of earnest money down. This lets your listing agent and bank know that you are a serious buyer and strengthens your offer. I recommend at least $1000.00, and you can get that money back if something goes poorly with the inspections.
  2. Have your pre-approval letter from your loan officer ready to go. Banks often expect quick turn-arounds on your end, so to be safe, submit a strong pre-approval lette from your bank with the offer. This will help you look better to the bank.
  3. Consider the purchase price. If you don't make a reasonable offer, it won't be considered. Offer at least 93% of the asking price if the home has been on the market less than a month. For every month after that it has been on the market, subtract 2% from what you can offer. So, if a house has been on the market for five months, you would offer at least 85% of the asking price. Please consider however, that cash offers are always stronger to a bank, because financing is risky for them; it involves trust. So if you can afford to make a cash offer, do so, and you will not only save money on the purchase price of the home, but you will also save thousands of dollars over the years by avoiding interest charges.
  4. Understand that you are just a file to a bank, not a human with a life. Be patient if you do not hear back immediately.
  5. Keep in mind that great things take time. Like I have said before, we made 8 offers before we finally got our house, and it was an incredibly painful time.
  6. Stay positive! When your offer does not work out, get back up on that saddle and keep sarching for the right house! you don't want to miss a great opportunity becuase you are too busy sulking. Of the eight offers we made, two of those offers were rejected completely, and the other six were accepted, but something always fell through. Four times the bank backed out on us, even after contracts were signed, once we backed out after a poor inspection, and the last time we finally got the house of our dreams. It is devastating when the bank is the one to back out, especially when you are moving to a new town and desperately need housing, but know that if that happens, it is for a reason and you must be meant to have another house.

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