Making decisions about real estate investments can feel daunting, especially for first-time investors. On the surface, swooping in to buy properties you may not have otherwise been able to afford may seem like an investor’s dream, and while buying foreclosed properties presents great advantages, like most other things in the real estate world, there are key factors that should be considered before making the big leap.
What is a foreclosed property and why make the investment?
Real estate properties go into foreclosure when the owner(s) fail to make their mortgage payments. Foreclosed properties are typically sold for a much cheaper price than their original market price, and so property investors scoop them up for far less than what they are worth. There is a process, however, and there are specific stages to a property being foreclosed, each presenting different expectations, advantages, and disadvantages for an investor to consider.
Short sales happen when homes are about to go into foreclosure but are still owned by the homeowner, often resulting in less severe financial consequences for them. The homeowner often sells the property for less than the amount due on the mortgage, though it’s up to the mortgage lender to approve the short sale as well as forgive the difference between the sale price and the mortgage amount. While in some states, forgiving the difference is lawfully required, in most cases, it’s up to the lender’s discretion to do so.
Foreclosure auctions result in an opening bid on the property set by the lender, usually equal to the outstanding loan balance, interest accrued, and any additional fees and attorney fees associated with the Trustee Sale. Because foreclosure inventory is usually low, these auctions tend to be competitive. Lenders do not finance foreclosure purchases, so investors aren’t able to get a mortgage. The adage, “cash is king,” rings true in this scenario.
REO property, or “real estate owned” property means the property failed to sell at the foreclosure auction and is now owned by the lender—either a bank or entities like Fannie Mae or Freddie Mac. REO properties are either added to a bank’s portfolio to be sold through their loan officers, or banks recruit REO specialists to manage and market the properties.
Stages of a Foreclosure
There are several stages to a property going into foreclosure and the process offers the owner an opportunity to bring the loan current and avoid foreclosure altogether.
A Notice of Default (NOD) is the first stage and often occurs three to six months of missed mortgage payments. This alerts the owner that he or she is facing foreclosure and starts a reimbursement period that typically runs until five days before the home is auctioned off.
If the owner fails to bring the loan current within three months, he or she receives a Notice of Sale alert where the foreclosure sale date is established.
The Trustee Sale is when the property is publicly auctioned off to the highest bidder. As already mentioned, the purchase must be made in cash, oftentimes with a deposit upfront and the remainder paid off within 24 hours.
The Benefits of Scooping up a Foreclosed Property
The obvious advantage of purchasing a foreclosed home is that it’s priced below market value, but there’s more in it for the investor that goes beyond the selling price. If investors are buying foreclosed properties with a loan, less money will be borrowed since the property is already below market value. If buying directly from a bank, the bank could potentially give the investor better financing deals to sell the property more quickly, leading to lower closing costs and mortgage payments.
If an investor is purchasing either an REO property or a short sale, it leaves the investor room for negotiations. Home inspections can also be conducted—a luxury not offered when a property is bought at auction. Banks are also willing to hand out mortgages for REO properties since there will likely be renovations involved before the property goes on the market.
Additionally, the low selling price of a foreclosed property often results in a high return of investment (ROI) for the investor.
The Disadvantages of Investing in a Foreclosed Property
We’ve already mentioned that foreclosed properties are bought “as is,” and while that makes the buying process fairly quick and straightforward, it means time and money has to be put in any property that more than likely has some damage do it, some of which can be extensive. Prior homeowners often fall behind on mortgage payments due to job loss or health problems and financial hardships can extend beyond monthly payments to the bank. Needed repairs can easily fall to the wayside and become top—and expensive—priorities for the new owner, and since foreclosed properties being sold at auction can’t be inspected, investors always take a risk when making the decision to move forward with the purchase.
It’s important to note that buying a home “as is” doesn’t just go for the physical shape it’s in. If any liens—legal claims allowing holders to obtain access to the property if debts are not paid—are placed on the property’s title, they get passed to the investor upon purchase.
To Buy or Not to Buy?
You will learn quickly enough that when scouting foreclosed properties, not all cases are the same. Properties—like their histories—are unique and may present buyers with varying sets of challenges, but also great rewards.
Though the idea of buying a property below its market value seems appealing and like a cheap route to owning, it’s not ideal for those who have a strict financial budget or are looking to make a quick flip. Unforeseen costs and slow processing by the lender are just two examples of the kinds of common hurdles faced by investors buying foreclosed properties.
However, for the investor who has both time and a financial cushion to cover any impending costs, scooping up a foreclosed property might make the most financial sense—and lead to big gains.
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