Updated on December 10, 2007.>
LAST YEAR, 43-YEAR-OLD Daryl White and his wife Ren e 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.
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.
White, who just moved into his new home in California, had bought 14 pre-foreclosure homes as an investor (he flipped them within two or three months) before he bought a house for himself. He admits that approaching the owners is never easy. "They're in a distressed situation," he says. "They're a little hardened, so it's difficult to establish a rapport."
The Risks of Auctions
Auctioning the property, which usually happens on the local courthouse steps, is the next stage in foreclosures. And if buying pre-foreclosures is tough for the regular home buyer, buying at an auction can be downright impossible. For starters, you have to pay cash financing auctioned properties isn't allowed. You're also expected to buy the house sight unseen. And on top of that, you're not allowed to get title insurance: If the house has a $100,000 tax lien attached, the new owner will have to pay it off. "The auction is the most risky way to buy," says Foreclosure.com's Geisen. "We don't recommend it."
If no one shows up on the courthouse steps or there are no bids high enough to cover the outstanding loan, the bank will take ownership of the property and put it up for sale through a real-estate broker. This is the easiest way to buy foreclosed properties, but you are also least likely to get a discount, as the bank will typically put it up for sale at or close to market value.
However, the prices are still negotiable. "When a bank only has one or two foreclosures, they may try to get the best value," Geisen explains. "But when they're starting to get more inventory to compound, the banks want to get rid of these properties and you see them starting to negotiate and discount."
Bank-owned properties also known as REO, or real estate owned properties are usually sold through real-estate brokers. To find a REO broker in your area, search the REO Network's database, which represents over 8,000 brokers, agents and vendors (such as appraisers and contractors).
When homes that were bought with loans guaranteed by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA) go into foreclosure, they're put up for sale by the government itself. The listings are free and updated daily, but only HUD-registered brokers can place bids. Each listing comes with a detailed property inspection report and outdoor pictures of the house along with the contact information for local HUD brokers.
For the first 45 days, a listing is available only for homeowner occupancy, which means you don't have competition from seasoned foreclosure investors, explains Dick Esposito, owner of ADR Properties in Maryland, who specializes in buying and flipping HUD foreclosures. "You get the first chance at all the good properties as a homeowner," he says.