Should You Buy a Foreclosed Property?

Updated on December 10, 2007.

LAST YEAR, 43-YEAR-OLD Daryl White and his wife Renée closed on their new home: a five-bedroom, four-bathroom 2,900 square-foot house in Valencia, Calif., a planned community 40 miles north of Los Angeles. They got quite a deal. The property was appraised at $830,000, yet they bought it for $660,000. "The house was only 10 years old, so it only needed light repair, like removing the wallpaper and painting, just some patchwork here and there," White says.

Why the bargain? The house had been in pre-foreclosure. This means the owners had defaulted on their payments and received a notice of default from their lender. They then had a set period of time — which varies by state — to sell the home or become current on the mortgage, until the bank took it back.

When White found it listed on Foreclosures.com, one of several web sites that specialize in listing pre-foreclosure and foreclosed properties, the house was about 30 days from being foreclosed. He drove there and approached the owners with a proposition: He'd buy it for less than its current market value, but still more than they currently owed the bank. With so little time left, the owners had a slim chance of selling the house on the market. And if it came to the lender putting the property at an auction — the actual foreclosure — they would be lucky if they got more than what they owed. Making a $660,000 deal with White, the owners were able to pay off their loan and walk away with $310,000.

Thanks to cooling housing prices and the subprime mortgage meltdown, many bargain-hunters are turning their attention to foreclosures. And there are plenty to be found. Web sites like Foreclosure.com, Foreclosures.com and RealtyTrac.com, which list foreclosed properties and charge monthly subscription fees for access to their databases, all report an increase in listings. Indeed, at RealtyTrac.com the number of foreclosure listings in October 2007 was up 94% compared with a year earlier.

Buying foreclosures is mostly the turf of investors looking to purchase properties at below-market-value prices, fix them up and then sell for a profit — a practice commonly referred to as "flipping." But with home prices in some parts of the country still prohibitively expensive, many first-time home buyers are looking into foreclosures, as well. Currently, RealtyTrac.com estimates that about 20% of its subscribers are first-time home buyers, and another 10% are homeowners looking to buy a second or vacation home.

"For the right buyer, foreclosures are an excellent opportunity to buy a house at a lower than market-value price," says Tim McCloud, a realtor with Kelley Realty in Green City, Ohio, who specializes in selling foreclosed properties on behalf of the lenders. He estimates buyers can shave anywhere between 10% and 20% off the market value of a house, but some will have to put in a bit of "sweat equity," as these homes can come in need of repair. Right now, you can actually buy a solid home for less than tax value, he says.

Needless to say, buying foreclosure properties is more complicated — and entails more risk — than going the regular home-buying route. Here's what you need to know.

Tapping Pre-Foreclosures
Buying property in a pre-foreclosure stage — the period between receiving a Notice of Default from the lender and the day the lender puts the property up for an auction — may offer the best bargains, but it's also the most difficult. "There's definitely an art to it," says Brad Geisen, CEO of Foreclosure.com. "Pre-foreclosures tend to be more for the seasoned investors."

For starters, you have to deal directly with the owner of the house, who may not even be aware that the house was made public in a foreclosure listing. "These people don't ask for their properties to be listed on our web site," says Alexis McGee, founder of Foreclosures.com. Rather, foreclosure web sites get their listings from county recorders' or clerks' offices — notices of default are public record — and add them to their databases without the owners' knowledge.