Foreclosures represent an excellent opportunity for real estate investors. After all, foreclosed properties are often available at a discount because they are often in a state of disrepair.
However, purchasing a foreclosure can also be challenging, especially if it is your first time buying a property in this manner. The foreclosure process can be complicated due to its legal nature. Not to mention that the process can vary from one state to the next.
With that in mind, the following guide provides an overview of the foreclosure process and how to invest in foreclosure properties.
What Is A Foreclosed Home?
A foreclosure property is a residential or commercial property that the lender has repossessed due to the borrower’s failure to repay their loan. When this happens, the lender will typically put the property up for sale to recover some of their losses. Because the lender will be motivated to sell as quickly as possible, foreclosed properties are often available at a discount.
However, the lender can’t just foreclose on a property overnight. There is a process that needs to be followed before the foreclosure can happen. Understanding the foreclosure process is essential if you want to invest in foreclosed real estate.
There are several ways to find and invest in foreclosures, and knowing how the process works will help you identify the best ways of doing so. A thorough understanding of how foreclosures work will make it easier for you to structure your deal and line up financing.
As such, the following are the six primary ways to purchase a foreclosure property:
The pre-foreclosure stage begins once a homeowner has missed several loan payments and has received a demand notice, or a notice of election and demand (NED), from their lender.
This notice informs the homeowner of the lender’s intent to foreclose and sets a timeline for when it will happen if the owner doesn’t make the necessary payments. The notice will also be filed with the county where the property is located.
In some cases, the homeowner may realize that they will not be able to bring their payments current. So, instead of being foreclosed on and losing their house (as well as earning a massive blemish on their credit history), they may decide to sell right away. In these situations, investors can buy properties in the pre-foreclosure stage directly from the owners.
You’ll be able to find pre-foreclosure properties on the multiple listing service (MLS) or in for sale by owner ads. However, some owners may not list their homes on the open market because they think they owe too much on their home to be able to sell it. Or sometimes they are too embarrassed to be forced into a sale.
Whatever the case, pre-foreclosure properties are public knowledge, which means you can track down homeowners in the pre-foreclosure stage and contact them directly. However, once the Trustee or the court auctions the property to the public, the pre-foreclosure stage ends.
2. Short Sales
If the owner owes more on the property than what it can be sold for, then the property is considered “underwater.” This happens if the value of the house depreciates after it was bought (which happened a lot in 2008 when property values plummeted).
A homeowner can only sell a house underwater if their lender agrees to accept less than what is owed to release its lien (meaning, to forgive some of the debt owed on the property). When this happens, it’s known as a “short sale.” It’s called a short sale because the lender receives an amount short of the full payoff. They do this because they’re essentially cutting their losses.
Short sales are a fantastic opportunity for real estate investors because the investment requires more work than most investors are willing to do.
As a result, you’ll have less competition. Although the process can be a little challenging because it takes some negotiating with the lender, lenders will often accept less than what is owed to avoid taking the house back. By negotiating a reduced payoff, you can create equity for yourself.
3. Sale Auctions
A sale auction is where the Trustee, or the county court, sells the house to the highest bidder, and the money is used to pay the lender. The lender has some discretion on what they want to bid, and can bid any amount up to what they are owed.
Depending on the state, any amount owed over the lender’s bid will still be owed by the borrower. This is known as a “deficiency bid” and allows the lender to continue attempting to collect the remaining amount due. If there are bidders other than the lender, the lender will receive cash up to their bid amount. If there are no other bidders, they will get the house.
Savvy real estate investors buy foreclosure homes at auction because of how straightforward it is. If you’re the highest bidder, you get the house. In addition, it takes away the work of locating sellers in foreclosure and all the back and forth with negotiating with lenders, agents, and sellers.
Redemption rights vary from state to state. Redemption is when the foreclosing lender is paid off in full after the auction. The property is in limbo during the redemption period. This is because although the property was sold at auction, the winning bidder will not receive a clean title until all redemption rights have expired.
There is very little competition using redemptions to purchase foreclosure properties, making this an attractive way to scoop up discounted deals.
5. Bank-Owned Properties
After the auction, if the lender is the winning bidder, the property goes to the real estate-owned (REO) department for liquidation. More often than not, the lender will remove the personal property, do a quick clean-up, and then list the house for sale on the MLS with the help of a professional real estate agent.
Buying bank-owned properties is the most common way to purchase foreclosures because it is the easiest and safest way. Once you contract on a home, you have plenty of time to inspect it, and you will get title insurance, so you know you are getting what you paid for.
The downside is that because they are listed on the MLS, there is a lot of competition. Since it is the most common way to purchase foreclosures, you will likely pay the highest price.
6. Government-Owned Properties
The only difference between government-owned properties and bank-owned properties is that the property is owned by the government. There are two reasons the government will own a home.
The first is if they were the lender. Fannie Mae and Freddie Mac, both of which are government-sponsored enterprises, are the two largest buyers of mortgage loans. Fannie- and Freddie-owned homes will look almost identical to bank-owned properties. I
The second reason the government owns a home is if they insured the loan. For example, FHA loans are federally insured. If an FHA loan is defaulted on, the government could end up with that property. These are called Housing and Urban Development (HUD) homes because the Department of Housing and Urban Development owns them.
If you’re interested in buying government-owned properties that were foreclosed on, you can search through a list of foreclosed homes on both Fannie Mae’s and Freddie Mac’s websites.
Why Are Homes In Foreclosure Cheaper?
In general, foreclosures are cheaper than any other type of property. There are several reasons for this, but it really comes down to seller motivation. For example, with a pre-foreclosure, there is a well-defined deadline. The seller is more motivated to take a smaller offer as that deadline gets closer.
Additionally, lenders are motivated to get their money back so they can loan it out again. They make money with loans, not owning houses, so foreclosures are considered “bad assets” on their books. Therefore, they are motivated to get properties off the books and into performing loans.
It is also important to point out that most foreclosure properties will be sold as-is, with faults and all. For example, very few owners continue to take care of their homes when they are losing them to foreclosure. As such, these properties often have deferred maintenance and sometimes damage and vandalism, which lowers the value of the property.
Finally, if you buy at the auction, you may find that assessments, taxes, or other liens must be paid. Investors will account for these other costs in the price they are willing to pay.
How To Find Foreclosed Homes
As you can see, there are several different stages and ways to buy foreclosures. Therefore, understand your strategy before spending time and money on locating opportunities. For example, you will want to market yourself as a home buyer to find pre-foreclosures.
You can get lists of foreclosure properties and send the owners mail, call them, or even stop by and knock on their door. With these lists, you can also track properties through the process and bid on them at the auctions.
Alternatively, you can wait and see what hits the open market with the help of your realtor. For more detailed information on locating foreclosure opportunities, check out our other posts here.
5 Factors To Consider When Buying A Foreclosed Property
At first glance, investing in a foreclosure might seem like a no-brainer, especially if you can find properties in the pre-foreclosure stage. However, just like anything in life, no investment is a sure thing. If you’re thinking about buying a foreclosed property, be sure to consider the following five factors:
1. The location of the property:
Foreclosed properties are often in a state of disrepair, so you’ll want to ensure the property is located in an area with potential for appreciation. If you buy a property in a neighborhood that is trending downwards, the value of the property might depreciate even if you buy it at a discount.
2. The condition of the property:
Foreclosures are often sold “as is,” which means you’ll need to pay for any repairs and renovations. Before making an offer, inspect the property carefully and conduct a thorough cost-benefit analysis. Doing so will ensure that you can still profit even after paying for repairs and renovations.
3. The type of foreclosure (judicial or non-judicial):
The type of foreclosure you’re dealing with will determine how long the process will be and what steps you’ll have to take. Every state has a judicial or non-judicial foreclosure system, so be sure to research the laws in your area.
A judicial foreclosure requires the lender to go through a court process, which can take several months or even years. A non-judicial foreclosure is faster and simpler, but requires you to follow specific steps.
4. Your financial ability to buy and rehab the property:
Buying a foreclosed property can be a great investment. However, it’s important to ensure you have the financial ability to buy and rehab the property. You’ll need to consider not only the property’s purchase price but also the cost of any repairs, renovations, and holding expenses. Not to mention the cost of marketing and selling the property.
5. Your exit strategy:
Before investing in a foreclosure, you’ll need an exit strategy. Will you fix and flip the property? Rent it out? Sell it to another investor? It’s essential to have a plan in place before you buy the property. This will help ensure you can make a profit on the investment.
How To Buy A Foreclosure
Although how you end up purchasing the foreclosure home will depend significantly on your strategy, there are still several steps you’ll need to follow regardless. Here are five steps to take before you make your offer:
Determine Your Budget
Figure out how much money you have to invest in the project and what monthly payment you are comfortable with. Once you have a budget, you can start working with a lending professional to find a loan that will meet your goals.
Get Pre-Approved For A Mortgage
There are a wide variety of loans that you can use when investing in foreclosures. Speak with multiple lenders to explore your options.
For example, here at Pine Financial Group, we make hard money loans for fix-and-flippers, but hard money is not always the best solution for every situation. We work closely with banks and conventional lenders to help real estate investors get the financing they need.
Speak with a few banks, a conventional mortgage banker or broker, and at least one hard money lender. With their help, you can develop a financing plan that fits your needs and complete your pre-approvals.
Hire A Real Estate Agent
The easiest way to start foreclosure investing is to look for REOs. As mentioned before, these are almost always found on the MLS. A real estate agent can set up filters to ensure that you are only sent deals that meet your criteria. They can also help make offers on your behalf, especially in the case of a HUD home when you will need their help doing so.
Additionally, a good agent can help you:
- Find comps: A real estate agent can help you find comparable properties, or comps, on the market. This is important for determining the market value of a home and setting an offer price.
- Give you valuable advice: A real estate agent has the experience and expertise to provide you with valuable advice when negotiating the purchase and sale of a property. Not to mention, they can answer any questions you might have about the local real estate market.
- Let you in to see other homes on the market: By checking out other homes available on the market, you can see what other investors are doing and get a feel for what the competition is like.
- Help you sell the property if your plan is to flip it: If your plan is to fix and flip the property, then you’ll need help selling it. A good real estate agent can provide valuable advice on pricing and marketing the property to help you get as much money as possible when it’s time to sell.
Make A Competitive Offer
There are many tricks to making your offer competitive but, with very little exception, nothing beats a high offer. Obviously, sellers want as much money as they can get.
Additionally, you can make your offer stronger by reducing your timelines and eliminating contingencies. This is one of the reasons hard money is attractive. Hard money loans allow you to close in days or weeks instead of months. If your price is lower, but you are closing in a week or two, the seller might accept your offer.
Limiting your contingency to an inspection only makes your offer look stronger compared to other offers. A contingency is a way to back out of the deal without losing money.
A standard contract is loaded with contingencies making it risky for sellers to accept them. If you are approved for a loan, you really only need a little time to inspect the home and make sure all the numbers work.
Purchase And Prepare To Settle In
Once your offer is accepted, quickly put together all the documents the lender requires. These documents might include your scope of work and repair budget, tax returns, bank statements, and anything else needed.
Give your lender as much time as possible in case any issues arise. You want to have everything lined up before the end of your inspection period to protect your earnest money.
The Different Payment Options
There are many ways to fund your foreclosure, which is why connecting with great lenders who understand the real estate investing space is essential. The following are five examples of how investors fund their foreclosure purchases:
1. Conventional Mortgage
A conventional loan will be sold to Fannie Mae or Freddie Mac. It’s the most simple type of loan because there is a clearly defined box you must fit into to qualify. Conventional loans are also the most affordable type with the best terms. For example, you can usually lock in an interest rate for 30 years if you use a conventional lender.
However, conventional lenders usually require significant down payments and do not fund repairs. Expect to put down 25% of the purchase price as a down payment and fund all repairs out of pocket. As a result, these loans are best for a long-term hold. A conventional loan is an excellent option if your goal is to keep the foreclosure purchase as a rental.
However, conventional lenders do not like quick payoffs. It could cost them money if you flip the house and pay off the loan in a short period of time.
2. Renovation Loan
A renovation loan is a loan that can be used to cover the purchase and repairs of a property. Most hard money lenders offer renovation or rehab loans, but so do local commercial banks. A bank can do this because they do not sell these loans. They keep them in their portfolio, which gives them greater flexibility.
They often loan 75% of the purchase price (much like a conventional loan) and 75% of the rehab cost. Using this loan is typically a better option if your plan is to flip the property because lenders are okay with the shorter loan term and can loan you more of your project costs.
3. Home Equity Line Of Credit (HELOC)
A HELOC loan is a fantastic and often overlooked method to finance foreclosure purchases. If you have equity in another property, your bank or credit union may give you a line of credit secured by your property.
The line of credit gives you access to cash, but you only pay interest if you use it. It also acts like cash when buying houses, so you can make a cash offer using your line of credit. Once you own the home, you can refinance it and pay back most or all of the money you accessed from your line so you can use it again.
This is also a great option to fund down payments, so it is feasible that you combine this financing method with another one to accomplish your goals.
4. Hard Money Loans
Hard money is an excellent source of money for your real estate investing business. Many hard money lenders, including Pine Financial Group, will fund your entire purchase, including repairs. Obviously, the numbers on the deal need to work, but this is true no-money-down financing for foreclosure purchases.
When you work with a hard money lender, you are working with someone who understands the real estate investing game. Most hard money lenders work exclusively with investors, which means you’ll have one more set of experienced eyes looking over your deal.
However, hard money is not always the best option. It is often very expensive, reducing your profit per deal. If you only want to do one deal at a time and have plenty of reserves, hard money is not a great fit. On the other hand, hard money is a fantastic alternative if you want to do multiple deals or limit your cash exposure to any one deal.
This may seem obvious, but it is certainly worth a mention. If you have cash or access to cash, you can always use that. Paying cash increases profits because you don’t have the cost of money. It is also extremely helpful in a competitive situation as you can make your offer stand out.
Are Foreclosed Real Estate Investments Worth It?
If you’re thinking about investing in real estate, then foreclosures are an opportunity worth considering. Foreclosures can be a great investment, especially since they allow you to buy properties at a potential discount that you can rent out or renovate and flip for a profit.
However, to ensure that your investment is successful, you must do your due diligence. Make sure you research the property, the current market conditions, and any potential risks associated with buying a foreclosure. Doing so will help ensure you make an informed decision and maximize the potential return on your investment.
4 Risks Associated With Buying A Foreclosure
Buying a foreclosure can be a great way to get a good deal on a property. But before you jump in head first, you should be aware of some of the risks associated with purchasing a foreclosure. After all, no investment comes without risk.
Knowing what those risks are will help you to make a more informed decision when deciding whether or not to buy a foreclosure. Keeping that in mind, the following are four risks that are associated with buying foreclosures:
1. The Property May Have Hidden Damage
One of the biggest risks associated with buying a foreclosure is that the property may have hidden damage.
Unfortunately, you may not have the opportunity to properly inspect the property. This can happen if the owner isn’t willing to allow you access and you’re bidding on the property at auction. As such, you may end up with a run-down property that needs much more work than you initially thought.
2. The Property May Not Be Up To Code
Another risk associated with buying a foreclosure is that the property may not be up to code. This is especially true if the previous owner neglected the property for an extended period of time. As a result, you may have to pay for expensive renovations and repairs to bring the property up to code before you can rent it out or flip it.
3. The Title May Not Be Clear
Additionally, the risk of buying a foreclosure is that the property title may not be clear. The title refers to who has the legal right to own and occupy the property. When buying a foreclosure, it’s possible that there could be unresolved liens or other legal matters that need to be cleared up before the title is clear.
If the title isn’t clear, it can create numerous problems, both in terms of securing financing and proving ownership once the property is purchased. Sometimes, it can take years to resolve title issues, and you may spend much more money than expected.
4. The Neighborhood May Be In Decline
The final risk associated with buying a foreclosure is that the neighborhood in which it is located may be in decline. This can create problems if you plan to rent the property or flip it. A declining neighborhood can make it challenging to find tenants, and you may end up with a lot of unexpected vacancies.
Plus, the property may not appreciate in value as quickly as you would like due to the overall decline of the neighborhood. Additionally, it could even depreciate in value, which can be costly in the long run.
Take Your Time And Invest Wisely
There are risks when buying foreclosure homes, so it’s essential to take your time and make smart buying decisions. Educate yourself, but don’t let the fear of making a mistake stop you. If you do your due diligence, there is a lot of money to be made in foreclosures.
However, you may not foresee all the risks, which is why it is advisable to work with lenders and agents that understand real estate investing and the foreclosure process. Here at Pine Financial Group, we have a wealth of experience dealing with foreclosures and work specifically with real estate investors. We help our clients make the best decisions when it comes to financing their properties.