August 25, 2010

Considerations When Buying a Foreclosure

I mentioned the other day that I'm looking into buying a foreclosure or short sale property in my town to use as a rental.  My wife and I already have some rental properties and we think another rental would be a good investment especially with the state of the housing market.   I've never bought a foreclosure and I don't know anyone who has.   I don't know much of anything about buying a foreclosure so I figured I'd better do some research on the topic.    Today I'll talk about foreclosures specifically.   Short sales are a bit different so I may address those specifically in another article.


No Auctions or Pre-foreclosures

I'm not looking at preforecclosure or auctions.   That is where you buy a property in default from the owner before it actually goes into foreclosure or buy the propety at an auction.   With those purposes getting inspections and title isn't always possible and you may not be able to get a mortgage.   I'm looking at just "REO" or Real Estate Owned properties.    Consumer Affairs article Buying a Home in Foreclosure: What you Need to Know  says that for REO properties you can "Fully inspect, demand clear title and subject to getting a mortgage"  which is what we'd want.  

Money Central discusses The Safest ways to Buy Foreclosures   The article cautions that "You can buy foreclosures for as cheap as 30% or 40% below market, but most foreclosures sell for 5% below market," said John T. Reed, editor of Real Estate Investor's Monthly, a newsletter based in Alamo, Calif.   It also says: "Good buys are available, but they require research, preparation, patience and persistence."  and "Bank-owned properties offer the safest deal for inexperienced foreclosure buyers, Beitler says: "There's no risk. There are no taxes, no liens, no tenants to evict."

I'm definitely only interested in a bank owned property since we'd want the assurance of clear title and an inspection and we'd need a mortgage.

Basics I Already Know

So right off theres a few things I know about buying a foreclosure (or at least think I know).   Foreclosures are owned by the bank.   At least the kind I'm looking at are.    The properties are going to be vacant and may have been damaged by the previous owner who may have been unhappy to lose their home.   A foreclosure will be sold "as is" without information on the state of the property or any guarantees.   Theres going to be higher need for repairs or improvements in the properties and less certainty about the home's history and state.   Because of all this you should be a bit more critical of the property and budget for more costs to get the home in a suitable shape to live in.

Title Insurance is particularly Important

I found a few references that stressed the need for title insurance.   If someone has a foreclosure on their home its also quite possible that they have other debts that may have placed a lien on the property.   You won't know about those liens unless a title search is done.   If you buy the home and there is a lien on it then you could be responsible for paying that lien even though it wasn't you who owed the debt in the first place.   There could even be a 2nd mortgage on the property that needs to be cleared before you buy it.   Title insurance is always important when buying a property but its especially important for a foreclosure.

Winterization and Decay Issues

A CNN article lists 9 tips for buying a foreclosed home

1. Budget carefully.
2. See the house for yourself.
3. Look at the neighborhood.
4. How long has the house been empty?
5. Was it winterized?
6. Look at the landscaping.
7. Contract for a private inspection.
8. Consider a HUD house.
9. Don't expect to profit from a quick sale.

Theres a lot of good points there and its a good reference.  

Items 4 & 5 raise important point to consider.   If the home has been vacant for some time then it may or may not have been "winterized".   If the home is winterized then this may mean that water is shut off and they might have added chemicals to the drains or done other measures to avoid pipes freezing.   If the home has not been winterized then it may have had damage to the pipes or other systems due to freezing in the winter.   You also run the risk that the home was improperly winterized which may have damaged the pipes or other systems.

In addition to possible winterization problems  a foreclosure home may be vacant and have other damage from the elements, vandals or other simple deterioration.  If a home is not lived in then it is much more likely to have some problems from lack of maintenance.  Its easier for things like mold to occur in a home if its not lived in.
 
Inspection is Important

Foreclosures are generally sold 'as is' and the bank does not know the history or real condition of the property.  If you buy from an individual they are legally required to tell you any known problems with a property.  But if you buy from a bank its "as is" and they don't know any problems.   This all makes it extra important for you to get an inspection on a foreclosure.   An inspection is not a guarantee they'll find everything but a good inspection should tell you a lot about the state of the property and find various things that could be wrong.  

Unknowns & Next Steps

I'm not really sure at this point how else buying a foreclosure might differ from buying a normal owner sold home.   I'm assuming I can deal with realtor's in the normal way and get a mortgage the same way.   I'm sure I'll be able to sort out other details about buying a foreclosure by talking to a realtor.  

Right now my wife and I are only in the discussion and research phase.   We have talked about looking at properties but haven't called any realtors yet.   Its not a given we'll even do that.  But we'll continue to look into it and discuss it more and then we'll see.

Bottom Line:  I plan on looking at buying a REO bank owned foreclosure and will make sure we get title insurance and an inspection and be more careful about assessing repairs needed and their costs.

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