Few investments are better than real estate. However, all investments inherently involve some degree of risk. This risk is even more pronounced in investments such as real estate with very low liquidity.
Many investors consider property acquisition to be relatively safe, but this can change dramatically when buying a property that has been foreclosed on by a previous owner.
In this article, we’ll take a closer look at the risks of buying a foreclosed property and what, if anything, you can do to mitigate or eliminate those risks.
Foreclosure type
The three most common types of foreclosures in the United States are:
- Powers of Foreclosure on Sale
- judicial seizure
- strict foreclosure
In the case of a foreclosure of the right to sell, also known as a statutory mortgage, some state mortgage contracts contain a right to sell clause. This allows the lender to put the property up for auction to enforce the foreclosure. This does not require judicial involvement, Allowed in a total of 29 states.
In judicial foreclosure, the lender must file a lawsuit to initiate the foreclosure proceedings. This is then communicated to the buyer and he is usually given 30 days to activate the loan. If that fails, the property will be auctioned either by the county sheriff or the court.
Hard foreclosures are only allowed in Vermont and Connecticut and require the lender to sue the defaulting borrower. The court then sets a deadline for mortgage payments, and if it fails, ownership of the property automatically transfers to the lender.
This is the only foreclosure that does not require a formal sale.
5 risks of buying a foreclosed home
As with any investment, buying a foreclosed property comes with certain risks that you, as a buyer, should be aware of.
1. Easy to overpay
A common risk when buying a foreclosed property is paying more than the current market value of the home. This risk can be exacerbated if you are buying at auction. In an auction, competing buyers can push the price up “despite bidding”.
Setting a maximum bid at auction or setting a firm budget when buying off-market can greatly reduce this risk.
2. You may need cash
Financing is nearly impossible if you plan to purchase a foreclosed property, especially if you plan to use traditional financing options or an FHA loan.
You may be able to find a rehab loan with decent terms, but it can take quite a while and make the flip uneconomical. You have options available for your situation.
3. ROI can take an unexpected hit
Many newbies are not familiar with the potential costs and additional costs associated with purchasing a foreclosure.
In most cases, you’ll be prepared to pay the property price and standard tenure fees, but there can be unexpected expenses as well. Real estate may be subject to transfer taxes, mortgages, and you may also be required to pay fees associated with the original foreclosure.
4. Your rental plan may be delayed
Buying a foreclosed home risks delays introduced by the process of buying a foreclosure.
Foreclosure sales are known to experience more delays than traditional sales, especially during the escrow stage of closing. One way to minimize these delays is to make sure you are working with an experienced broker or real estate agent.
Your agent should be familiar not only with the sale of foreclosures, but with the financial institutions involved in the transaction.
5. Selling as-is can be vague
A big risk when buying a foreclosed home is that the seller has no legal obligation to disclose material defects.
Homes are generally sold as-is. This means that due diligence is the sole responsibility of the purchaser and the purchaser must arrange for a licensed inspector.
It’s always a good idea to have funds on hand in case your property needs significant repairs or major expenses such as roofing or foundation work.
Benefits of buying a foreclosed home
The main advantage of buying a foreclosed home is that you can often pay well below market value if the right circumstances exist.
They don’t necessarily have lower listing prices than homes in other areas, but they are priced by lenders who want to sell the home off their books.
Can I get a mortgage to buy a foreclosed home?
It is not uncommon for a buyer to be able to obtain a mortgage to purchase a foreclosed home. Many lenders specialize in financing foreclosed properties or properties in need of rehabilitation.
Loan terms vary by lender and may or may not require the home to be in livable condition.
We recommend that you apply for a mortgage and get pre-approved before you start looking for a property. This greatly increases the likelihood that the seller will accept your offer.
Mortgage options to buy a foreclosed home
In many cases, even if your property is foreclosed, you can still take advantage of a variety of traditional mortgage options.
Rather than buying from a cash-only auction, you may be able to take out a traditional mortgage as long as the house is in livable condition.
Other options include government-backed loan programs from the Veterans Administration, the Federal Housing Administration, and even the USDA.
Government-backed loans have the big advantage of making housing more affordable, but there are some stipulations depending on the property.
For example, if the property you are looking for does not qualify for a loan because it is not in “liveable condition,” additional work may need to be performed before meeting the minimum standards.
On the other hand, government-backed loans don’t require mortgage insurance, so you can use the money you save there for your next job.
Conclusion
After all, buying a foreclosed property may not be a bad investment, but there are risks and benefits that are unique to foreclosure.
However, knowing what you are facing regarding these risks will help you prepare better.
One of the best ways to participate in a foreclosure sale is to visit your lender today and start the pre-approval process. Then you can start seriously looking for your next investment.
Carter Wesman
Carter Wesman hails from the charming town of Norfolk, Massachusetts. When he’s not writing mortgage-related articles, he plays ping-pong, bass, and he plays guitar.