What To Expect When Buying Foreclosures
You can make millions as a foreclosure investor. Many people do. The key to investing in foreclosures with success is understanding the process and then focusing on a strategy.
Many people realize that foreclosures are opportunities for investors; however, you can invest in a foreclosure home in several different ways. For example, you can buy a foreclosure at a foreclosure auction or through an agent from a bank. While both can present a tremendous opportunity, they are completely different types of investments. Each stage of foreclosure has multiple buying strategies, each with its own unique risks and rewards. The question then becomes, is this the investment for you?
Should You Go For It?
If you love real estate like me, you will look at various ways to get involved. My first deal ever was a foreclosure. I found a gentleman that needed to sell his house – and fast. There was a looming foreclosure auction, and he had to pay off the bank. I was referred to him by my sister’s husband, Mark. Mark and I were catching up over a beer (actually, he was drinking a tequila) when the subject of foreclosures came up. At the time, I happened to be finishing up a foreclosure investing home study course that covered how to negotiate short sales. A short sale is when the owner owes more on their loan than the home is worth, and the bank agrees to take less than the full amount due, allowing the owner to sell the house and prevent the foreclosure.
I ended up getting the deed to the house, subject to the foreclosing lender and attempted my best short sale negotiation skills. I learned an awful lot about foreclosure investing in the first month of my real estate investing career. Depending on how you approach it and what you are looking for, foreclosure investing can have a considerable upside, but it does not come without risk.
It’s A Good Deal
It is generally expected that if you buy a foreclosure, you are getting a good deal. A foreclosure is when the lender attempts to repossess a property used as collateral for a loan. It is most common when a borrower defaults on payments. The lender’s recourse is to foreclose on the home and either get their money back or end up with the property. In such a situation, the original homeowner loses their home and is forced to find a new place to live. Lenders typically lose money on foreclosures, and it is a scary situation for the owner. No one wants this process, which creates motivation for real estate investors to work with owners and lenders concerning foreclosures.
Many successful fix-and-flip investors buy foreclosures. Foreclosures offer a plentiful inventory supply for fix and flippers because they are typically run-down properties that they can purchase at a discount.
Look Out For The Risks
Although there is a big upside to buying foreclosures, there are risks you should be aware of. Each phase of the foreclosure process carries its own potential downside. We will discuss the risks of buying foreclosures in each phase of the process in more detail, but in general, foreclosures are run-down properties, so there are risks with unseen repairs. There are also risks involved in getting a clean title if you are not using a title company and ending up with properties that are tough to finance.
Finding A Foreclosed Home
Before you can start your search for foreclosure homes to invest in, first understand the different stages in the foreclosure process.
The pre-foreclosure stage of the process is typically the longest. This stage starts when a borrower falls behind on payments and the lender demands that it be brought current. Once the demand notice is sent, the foreclosure process begins.
The demand notice is public record and easy to find. As a result, it’s easy for real estate investors to locate such buying opportunities. During the pre-foreclosure process, the owner of the home still owns the property. As such, you will need to purchase the house from the owner and not the bank. To do this, you will need to contact the owner and negotiate a deal directly with them.
Because the foreclosure is public record, many real estate investors get the foreclosure lists that enable them to market to homeowners facing foreclosure. Some send mailings while others call or knock on the door. The idea is to help the owner by buying their home. The foreclosure provides a tremendous amount of motivation to sell. Owners have a defined deadline to catch up on payments, which means that they will often accept discounts on their property to sell as quickly as possible.
One of the significant advantages of buying a foreclosure in the pre-foreclosure stage is that you can negotiate directly with the owner, allowing you a lot of flexibility to develop a winning situation for everyone. If the owner has not hired a real estate agent to help sell the home, there is a good chance that you might be the only buyer the seller has spoken to. This lack of competition makes it easier to negotiate a great deal for yourself.
The downside to buying at this stage is it is not always easy. It can take some time to find owners who are willing to talk to you. You might have to spend money on advertising to get them to call you, or you will need to dedicate time to tracking owners down. Not to mention that if the owner is in foreclosure, there is a decent chance they have not been maintaining their property, so be sure to inspect the home the best you can to try to identify potential problems.
A short sale happens when the foreclosing lender accepts less than the amount owed. Most of the time, you will need to convince the lender that it is in their best interest to take your offer instead of foreclosing on the home. You can persuade them with a short sale package. This package contains your purchase offer and support for why your offer is as low as it is. Such a package typically includes low comps to support the risk of a low value and a list of needed repairs. Additionally, the lender will likely want documentation that the borrower can no longer make payments. Such documentation includes bank statements, tax returns, and a hardship letter written by the owner.
As you can see, working on a short sale requires a lot of effort, and there are no guarantees that it will be successful. It also takes a long time and can be frustrating dealing with all the paperwork.
However, the upside is that many real estate investors are unwilling to put in the work, so there is a good chance you will be the seller’s only option. Eliminating your competition offers many more opportunities.
Bank Owned / Real Estate Owned (REO)
Buying homes directly from the lender is the most common way real estate investors purchase foreclosures. Following the foreclosure auction and any redemption periods mandated by the state, the lender receives a clear title. In most cases, the lender will want to sell the home to free up cash to make more loans. They will likely hire a real estate agent to help them clean out the home and list it for sale. Because real estate agents can cast a wide net by listing the property on the multiple listing service (MLS), they will attract multiple potential buyers. The more buyers there are, the better for the bank since this will result in the best price. There are still fantastic deals out there when buying from the bank, but you will most likely pay more for the home in this stage of the foreclosure process.
The advantage is that these homes are super easy to find, and you are guaranteed a clear title when you buy it directly from a bank. Not much effort is required to find or negotiate for these homes because the real estate agents do this work for you.
Once the foreclosure property works its way through the pre-foreclosure process (which can vary by state), the home is auctioned off to the public. It is done this way to generate money to pay the lender. If there is no bidding at the auction, the lender ends up with the property, and it becomes an REO.
These auctions are held at the county level, and you can find all the information on county websites. The auctions are held once a week at the same location each week. Motivated investors attend the auctions looking for great buys. The rules on how the auction is handled vary greatly. Two counties, even in the same state, can have a vastly different process. However, most of the time, you will need to have the cash available if you want to participate in this game. Some counties may give you a day, some require the money on the spot, and some require that you deposit it with the county the day before.
The investors who purchase homes at the public auctions do so because they can get excellent deals with little effort. There’s no need to track down owners or negotiate with banks. They simply bid what they are willing to pay and will know immediately if they get the house or not. And because this strategy is so cash-intensive, many investors cannot afford to buy at the auctions, thereby limiting the competition.
However, the downside is that buying at an auction is the riskiest way to purchase a property, in my opinion. In most cases, you will not get an opportunity to inspect the property. The property could need expensive repairs. There could also be additional lien holders that need to get paid that you didn’t know about. There are times that the foreclosing lender is a junior lien holder. In these cases, whoever has a lien in a superior position, such as a first mortgage, would need to be paid off before you get a clear title. I have seen investors bid at an auction without understanding that the foreclosing lender was a second mortgage and that the first mortgage was more than the home was worth. In these cases, the investor lost all of their money. Foreclosure auctions are certainly worth considering, but understand the risks and be careful out there.
What To Prepare Before You Purchase
If you’re going to invest in foreclosures, then you need to start with a plan. You need to understand the different stages and then decide which stage you will focus on. Most investors will focus on lender-owned foreclosures because it is the easiest opportunity and can be reasonably safe. Let’s look at the different strategies depending on your plan.
Get Preapproved For A Mortgage
Obtaining a mortgage pre-approval is the best first step. If you are not buying at the auction, you can use a loan to purchase the property. First of all, you will need to understand the different types of available loans and then get approved for the best one for you. We will discuss the various loan options later, but for now, knowing you have money behind you should be your first step.
Hire A Trustworthy Real Estate Agent
Any real estate agent can help you find foreclosures, but you will not want just any agent. If you plan to buy lender-owned properties, I would do my best to locate listing agents for the lenders. If you can work directly with the listing agent, you might get better deals since they can bring deals to you. Additionally, they may try to help you more knowing you don’t have an agent. In such cases, the listing agent will not have to share a commission with another agent, so they will either make more money or use that extra commission to give back to the seller, making your offer stronger.
However, it does take time and effort to build these relationships, and you don’t necessarily need to locate foreclosures this way. If you find a great buyers agent (an agent that works mostly with buyers), they can help you find and negotiate foreclosures too. When you interview potential agents, be sure to ask them about their experience with foreclosures and real estate investing.
Inspect The Property
Unless you are buying at the auction, you will have time to inspect the property. I always recommend negotiating the best deal possible using an estimation of repairs that you feel is conservative. If you can get a house under contract, you can do a more formal inspection and nail down your construction budget. A seven-day inspection period is standard, meaning you would have seven days to do your diligence before you risk any of your earnest money. If you are not doing a complete remodel, I would recommend a professional inspection. With an official inspection report, you will know what repairs will be needed. While you are waiting for that report, get a contractor or two onto the property to give you bids. With those bids, you will have much greater success with your budget.
Prepare A Competitive Budget
Before the end of your inspection period, complete a budget for your project. This budget will include:
- An estimation of the completed value.
- The purchase price.
- Your construction numbers.
- Closing costs when you buy and when you sell (if you plan to fix and flip)
- Holding costs
With all these numbers, you should be able to come up with a close estimate of the profitability. If your project does not appear to have a conservative profit, I suggest passing on the deal and getting your earnest money back. You will have to move quickly to keep that earnest money safe.
In almost every foreclosure case, you will need to renovate the property. It could require as little as adding a new coat of paint or installing new carpeting, or it could need a complete remodel. The longer the renovations take, the less you will make, so move fast here. Try to have your contractor lined up with all agreements in place when you close on the house. That way, they can get started right away. I also recommend visiting several homes currently on the market to get an idea of what kind of finishes other houses have in the same area.
Setting Your Expectations
The foreclosure business is a good one. There is the potential for a ton of profit, and it is a lot of fun. I love seeing the transformation of houses, and I love selling homes to excited and grateful buyers. But as good as this business can be, it does not come easy.
This business can be competitive, and it will take some effort. You might need to make a lot of offers to get just one house. You will also find that contractors can be tricky to manage, and there will be times when the house needs more work than you expected. You are risking both your time and your money when you invest in foreclosures.
Financing Option For Buyers
How you plan to finance your purchases is vital. It can make or break a deal. Without a plan on how you will purchase the foreclosures, there is no way for you to be successful. Here are some of the ways you can finance your foreclosure purchases worth considering.
If you have cash, you can use that. Using cash increases your profits because you won’t have a cost of capital, but your returns will be much lower, and you will expose yourself to more risk. Whenever you limit the money you put into a deal, you limit your financial risk.
Lines of credit
A line of credit is almost as good as cash. If you own other property, you may be able to open a line of credit that you can access. A line of credit that’s secured by a property is called a HELOC (home equity line of credit). With a HELOC, you only pay interest on the money if and when you use it. These are also rolling accounts, which means you can pay it off and then use it again. Having access to capital is a big advantage in this business, so a HELOC is an excellent tool for real estate investors.
Conventional loans are loans that are purchased by Fannie Mae or Freddie Mac. These two enterprises, owned by the government, are the largest buyers of home loans. They create liquidity in the market, allowing lenders to fund loans and then get their money back to fund more loans. Because of the liquidity created by Fannie and Freddie, conventional loans have the best terms in the market. You can get loans for 30 years at a fixed interest rate that are the lowest you will find.
Conventional loans can work, but it depends on your strategy. Because of the low rates and long terms, they need to be considered, but they do not work if you plan to fix and flip. The reason I say this is that these loans are not profitable for the first several years. Fannie and Freddie want these loans to stay out long-term, and with a fix and flip, you will be paying them off fast. If your lender or broker has too many loans that pay off early, it could hurt them. Also, conventional loans will not fund any repairs, so you would need funds to make your down payment and all the required repairs. That can be challenging if you are limited on resources. Finally, one of the qualifications for conventional loans is the house needs to be habitable. That is often the case, even with foreclosures, but sometimes the house needs too much work. In those cases, your project may not qualify for a conventional loan.
A portfolio loan is a loan that the lender keeps in its portfolio. A portfolio loan is the exact opposite of selling the loan to Fannie Mae or Freddie Mac. Because the lender keeps the loan, it has a lot more flexibility with guidelines. For example, a portfolio lender might have a loan specifically to repair homes, and they might loan a portion of the construction. They are also good with shorter terms and can navigate deals on houses that are not habitable. Portfolio lenders are most often local banks. I strongly encourage all real estate investors to build a relationship with a few portfolio lenders.
Hard money is private capital. Knowing it is private capital means this type of loan will offer the greatest flexibility. Like Pine Financial Group, some hard money lenders will loan 100% of the purchase and the repair funds to buy foreclosures. That is a real no money down loan for real estate investors. Hard money lenders focus on lending money to investors to rehab houses, making it a fantastic option for foreclosure investing. It is more expensive, but if you figure that cost into your budget and the numbers work, it is a great option. Hard money lenders can also close much faster than other options, so keep that in mind if there is a short fuse.
As you can see, there are multiple options for your financing needs, which is why it is smart to have relationships with different lenders. You may also use a combination of financing options. For example, you can use both a HELOC and a portfolio loan to get the perfect financing in place for your project. The most successful real estate investors work with a conventional lender, a hard money lender, and multiple banks, thereby giving them full coverage of financing options.
Final Thoughts Before Buying
Many investors are attracted to foreclosure investing for a good reason. There is a lot of money to be made in this business if you know what you’re doing. It does, however, take time and effort. It starts with understanding the process in your area, coming up with a business plan, lining up your financing options, and then executing your plan. We have been in this business for a long time and love talking about foreclosure buying and real estate investing in general. Let us know how we can help you reach your goals.