A “foreclosure” is the process in which a lending institution tries to recover a portion of the outstanding mortgage balance from a homeowner who has defaulted on their loan. Typically, they do this by selling the property at a foreclosure auction.
Buying a foreclosed home offers real estate investors an excellent opportunity to buy low. Some real estate investors with a social media presence film the entire process, and they can get YouTube views from people interested in doing the same.
Here are the five steps needed when buying a foreclosure.
1. Understand the Foreclosure Process
Foreclosed homes are generally one- to four-unit residential properties that have been repossessed by a lender because of nonpayment by the previous owner. The lending institution forecloses on the home and then tries to sell the property in an attempt to recoup as much as it can. It’s typical for lenders to sell foreclosures at a discount.
A foreclosure goes through a process before the property is sold. First, the lender must file a public notice with the county recorder’s office, most often referred to as a notice of default (NOD). In many cases, the lender is required to post a foreclosure notice on the front door of the property.
Once the NOD is issued, a grace period―also known as pre-foreclosure―goes into effect for one month or more. During this time, owners have an opportunity to settle the debt, either by paying it off or by selling the property through a short sale. A short sale is when the lienholder agrees to sell the property for less than the balance of the outstanding mortgage. Keep in mind that buying a short sale is a longer process than buying a non short sale and can take 90 to 120 or more days to close.
If the owner can’t settle or sell the property, it will be offered at a foreclosure auction. The pending sale is recorded with the county and often reported in the legal notices section of the local newspaper. Real estate auctions typically are held either on the courthouse steps, at the subject property, or at an auction house. Then, the property is sold to the highest bidder.
If the foreclosed home doesn’t sell at auction, the lender takes possession of the property, at which time it becomes real estate owned (REO). The lender will attempt to sell REO properties by listing them for sale with a local real estate agent or at a liquidation auction.
When It’s a Good Idea to Buy a Foreclosed Home
It’s a good idea to buy a foreclosure if you want to purchase a property at a discount. This could be beneficial to you if you’re a fix-and-flip investor as well as if you’re a long-term investor. Beware, however, that while not all foreclosures are in a distressed condition, many of them are since the owner often can’t afford to keep up with the repairs.
2. Choose an Area and Research it
It’s possible to find foreclosures in almost any neighborhood and at almost any price point since one out of every 2,043 properties in the country is a foreclosure. Even homes in affluent neighborhoods are susceptible to foreclosure. What this means for you is that you can find foreclosure opportunities in growing neighborhoods that offer a great investment.
Don’t think that just because you’re looking for a foreclosure that it has to be a beat-up house in a rundown neighborhood. Make sure that the foreclosures you’re looking at are located in a neighborhood that attracts tenants and home buyers. Zillow and Trulia can help you understand better how vibrant a neighborhood is in terms of population growth, public goods, and price appreciation.
When choosing a neighborhood to purchase in, look at the school district rating, take note of abandoned or vacant properties, and don’t buy on a street that has multiple abandoned properties since this brings home values down. Look at the walkability score of the neighborhood online and see how far away shopping and public transportation are. Remember that a tenant or buyer is going to live in the neighborhood, so you don’t want all the businesses to be closed, streets littered, or no access to public transportation.
“Once you’ve chosen a neighborhood you want to purchase in, you need to research it. You need to know city and suburban distinctions and how to do great comps so that you have a realistic after repair value (ARV) that your renovated property can sell for. For example, houses even a half mile away may not be a true comparable sale based on age, size, neighborhood, or school boundaries.”
―Debra Nemeth, Senior Managing Partner, Urban Prairie Invest
3. Find Foreclosures for Sale in Your Area
Real estate investors can find foreclosed homes in several ways. Banks and mortgage lenders typically make their foreclosure auctions and REO listings public. Online sources and newspapers are other ways to find foreclosures. We recommend looking online and working with a real estate agent at the same time.
4. Choose a Property Below Market Value
It’s sometimes possible to find foreclosures that sell for as little as half of their fair market value at auction. When you’re assessing potential foreclosure purchases, the most important thing to check is its sale price―or starting bid price―vs the value given by real estate websites like Zillow or Trulia.
If the REO price or the auction price rises above the fair market value, it’s probably not a good investment. If the sale price is below market value, however, it could be a great opportunity and should be explored further. While there’s no hard rule, you should aim to buy foreclosed homes at least 30% less than the market price.
What you look for in foreclosures depends on your exit strategy. You may want a turnkey property that is more expensive but doesn’t need any repairs if you’re going to buy and hold the property and don’t have time to renovate it. If you have the time or expertise to renovate the property, then don’t be afraid to buy a property that needs to be fixed up.
Usually, it’s a tradeoff, the more expensive the property, the better condition it’s in. Most fix-and-flippers want a less expensive property that requires more repairs so that there’s enough equity once the property is rehabbed. Regardless of if you’re a long-term investor or a fix-and-flipper, the property should fit in with your budget and exit strategy.
5. Finance Your Foreclosure Purchase
Cash is the preferred way to purchase foreclosed properties since it enables a quick sale. This is because cash deals aren’t subject to lender requirements, which are strict when it comes to the purchase of foreclosed properties. Below is a table summarizing who each type of loan is right for.
Common Foreclosure Loans at a Glance
|Type of Loan||Best for|
|Hard money loan||A fix and flipper who wants short term financing to compete with cash buyers|
|Permanent mortgage||A buy and hold investor who wants permanent financing and lower interest rates|
Hard Money Loans
Hard money loans are offered by a variety of lenders and are available to investors who fix and flip houses or long term investors looking for bridge financing. Bridge loans allow borrowers to buy a foreclosure and complete major repairs, then refinance when the house is more likely to qualify for permanent financing.
Hard money loan rates, terms, and qualifications include:
- Down payment: 10% to 20%
- Credit score: 550-plus (Check yours free here)
- Loan term: 12 months
- Rates: 7 to 13%
- Origination fees: 1.5% to 3%
- PMI: N/A
- Funding time: 10 to 15 days
Permanent Mortgage Financing
Permanent mortgages for investment properties can be either long-term conforming or nonconforming loans. They’re available through nearly all major banks, mortgage providers, and mortgage brokers. Requirements vary for each of the three loan types. For example, while permanent mortgages are available for investors, FHA and VA loans are for owner-occupied properties only.
More significantly, all permanent mortgages for foreclosed properties are “end loans.” That means the subject property must be in move-in condition, there can’t be major deficiencies or safety violations. Unlike rehab loans, conventional mortgages aren’t available for renovations if the property needs major repairs, which is common with foreclosures.
Permanent mortgage for investment properties rates, terms, and qualifications:
- Down payment: Single family – 15%, Multifamily – 25%
- Credit score: 640-plus (check yours free here)
- Term: 10 to 30 years
- Rates: 4% to- 6%
- Origination fees: 0% to 1%
- PMI: Required with less than 20% down
- Funding time: 30 to 45 days
Buying a foreclosed home can be profitable for investors whether they plan to rent the houses or fix-and-flip the properties. Similarly, foreclosed houses can have unexpected expenses, be purchased at inflated auction prices, and be much harder to find. Follow our steps and work with professionals to make the projects as profitable as possible.
When you’re ready to move forward with buying a foreclosure, make sure you have the financing you need to close on a great opportunity when it arises. Getting prequalified online with Visio Lending takes a couple of minutes, and they offer competitive rates for prime borrowers.
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