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Buying a Foreclosure

Steps to make the foreclosure buying easier

8 smart moves for buying a foreclosure

by Sally Herigstad
August 30, 2011

You can save big bucks by purchasing a foreclosure.

Distressed properties can sell for up to 30% less than comparable houses or condos you might find in any neighborhood.

There also seems to be an endless supply of repossessed homes to choose from.

Lenders have seized and resold 6.5 million homes since the housing market peaked in 2006.

Another 4.3 million more homeowners are currently “seriously delinquent,” which means they are more than three months behind on their payments and probably headed for foreclosure.

But a foreclosure only makes financial sense if you avoid all the other costly pitfalls involved in purchasing a distressed property.

These 8 smart moves can help you do that and make sure you get the best deal:

Smart move 1. Don’t buy sight unseen at an auction.

Buying at an auction comes with several disadvantages.

It’s harder to get financing arranged. If other people are bidding, you may catch auction fever and pay more than you intended. And at an auction, you have to decide fast, with little time to research everything thoroughly.

But the biggest risk to buying foreclosures at auction in today’s housing market is getting burned by foreclosures in dreadful condition.

When you buy at an auction, especially an auction at your local city hall or courthouse — right on the steps, weather permitting — you usually aren’t allowed to look inside before you bid.

That means it’s impossible to know what shape the home is in until you get the keys. At that point, the house and all of the unexpected costs are yours.

So here’s the one, inviolate rule of buying a foreclosure: Never commit to a home you haven’t thoroughly inspected, inside and out.

Smart move 2. Buy REOs through a real estate agent.

Instead of buying at an auction, look for real-estate owned (REO) properties.

When no one bids, or no one bids enough to cover the outstanding mortgage, the bank or mortgage company gets title to the home. It generally turns around and hires a real estate agent specially trained to sell REO properties.

Working with a real estate agent, you can tour the home, see exactly what you’re buying and do all your homework before making an offer.

Also, lenders usually repair badly damaged homes before they sell them as REOs.

Be sure you have a real estate agent who knows a lot about the foreclosure market in your area.

“If you go to make an offer and you don’t have representation, you’re the fool,” says Mary Tootikian, author of Stunned in America: Sub-Crime Mortgage Crisis. “It’s just like having an attorney in court.”

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.

Other homes, however, have been trashed. Some people about to be evicted sell the cabinets, appliances, chandeliers and water heaters on Craigslist — and because that’s strictly illegal, they sometimes wreck the house trying to make it look like an outside burglary.

Hire a home inspector to help you catalog the damage. The American Society of Home Inspectors or the National Association of Home Inspectors can help you find a qualified inspector in your area.

Then ask a couple of licensed contractors how much it will cost to fix everything on your list.

A few years ago, you might have had trouble getting contractors to bid on fixing a house you didn’t own. Times have changed. Many contractors now will be happy to give you a bid, even before you make an offer on the house.

Smart move 4. Know what the house is worth.

You need to know what the home you’re looking at sold for the last time it changed hands and what similar houses in that neighborhood are selling for now.

That info is all online, in both public and private databases you and your real estate agent can easily tap.

Use, for example, to check out recent sales.

Just don’t depend on what Zillow estimates the property you want to buy is worth; its method for cranking out home values is not that reliable.

Most buyers don’t go to the expense of hiring an appraiser until after their offer is accepted.

“If you make an offer on property and you are getting a mortgage loan, you no longer get to choose the appraiser,” Tootikian says. “Under the new HVCC (Home Value Code of Conduct), all appraisals are ordered through management companies, and they in turn assign an appraiser to do the work.”

But when you make an offer, add a “subject to” clause that lets you out of the deal if the appraisal comes in for less than you offered.

Smart move 5. Bid low.

The whole point of buying a foreclosure is to get a great price, and bidding low is an essential step toward that goal.

Take full advantage of three things working in your favor:

  • The seller is not emotionally attached to the home and has no irrational expectations about how much it should be worth.
  • The bank or mortgage company has a large and ever-growing number of foreclosed homes to get rid of. It’s losing money every day that house sits there.
  • In this market, you may be the only potential buyer the seller has.

Also, remember that the actual cost of the house is the total of the money you pay the seller and what you’ll spend on repairs and renovations.

So take what you think is a fair price for a similar but well-maintained home. Subtract the cost of all repairs and offer 80% of that amount.

Example: If you think the house is worth $200,000, but needs $30,000 worth of repairs, then you’d bid $136,000. ($200,000 minus $30,000 times 0.8).

If you really like the house, you can increase the bid up to 90% of its fair market value less repair costs.

But set a firm maximum price and be prepared to walk away from the table if the lender won’t accept it.

Smart move 6. Don’t put all your cash into a down payment.

Make sure you have enough for critical repairs without having to borrow. You don’t have to paint every room or replace every appliance the moment you move in.

But you should have more than enough on hand to ensure that the home is secure, with solid doors, windows and locks, and has all of the essentials, such as a working furnace and leak-proof roof.

Smart move 7. Arrange buying and refurbishing financing together — in advance.

Depending on how much work the house will need, you might want to consider a 203(k) loan from the Department of Housing and Urban Development.

It lets you finance the purchase and repairs 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.

Fannie Mae has a similar program called HomePath that requires low down payments and waives the need for mortgage insurance.

You should start working on your financing as soon as you start looking for a home. Here’s our step-by-step advice for finding the best mortgage with the lowest rates and fewest fees.

Smart move 8. If at first you don’t succeed . . .

. . . keep looking.

There is no shortage of repossessed homes. Take advantaged of what you’ve learned from your first unsuccessful bid and try again.

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