How to Buy a Foreclosure

The price may be right, but be prepared for the hassles.

By Amy Bickers, Associate Editor

From Kiplinger's Personal Finance magazine, June 2008

Michael Lappano knows a home bargain when he sees one. Last year, the Bellevue, Wash., real estate agent purchased a condominium for only $255,000 (including an outstanding lien). That's $65,000 less than what comparable units were selling for, he says. To get the steep discount, he bid on the home at an auction for foreclosures. "The location was perfect, just two traffic lights from my office," says Lappano. He now lives in the sunny two-bedroom, two-bathroom condo with his new wife, Stephanie. And the property is still worth about $315,000, even in the face of a nationwide slump in home prices.

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Just over a year after Lappano purchased his home, buyers looking for bargains are eyeing an unprecedented selection of foreclosed luxury houses and condos, in addition to more modest homes. Foreclosures were up 60% in February from a year earlier, according to RealtyTrac, an online listing service. Arizona, California, Florida and Nevada have been hit hardest, but foreclosures are on the increase just about everywhere.

Rick Sharga, marketing director for RealtyTrac, says he hears from brokers that many buyers now begin their home search with a request to look at foreclosures and bank-owned properties. But there's no guarantee that buying a foreclosure will save money compared with buying the traditional way. Discounts vary tremendously depending on where you live. In fact, many foreclosed homes are priced higher than their true value because sellers are trying to pay off the mortgage and cover taxes and transaction costs.

Plus, buying a foreclosure involves homework, patience and often a good measure of luck. If you're buying at auction, you usually need to pay cash. You may face long waiting periods to take possession of the property and move in, and the property could require extensive repairs. Sometimes the former occupants strip the house of all appliances and vandalize the property.

You may also have problems getting accurate information before you buy, says Seattle real estate attorney Richard Llewelyn Jones. "There could be judgments and liens attached to the property or more than one note or deed of trust being foreclosed." In the end, most buyers are turned off by the risks. "If you don't know what you're doing, you could lose your shirt," says Jones.

Getting a discount. If you're game, find an agent who deals with foreclosures. Your agent can locate properties and establish their market value -- which could be very different from the asking price. You will have to pay for any repairs, so build in a generous estimate of what they could cost. Also, you may need a lot of cash because traditional financing may not be an option.

Each state has its own rules governing foreclosures: whether the transaction goes through the court system, what taxes you pay and how much cash you need upfront. To get a summary of your state's law, visit the resource center at online listing service ForeclosurePoint.com.

Also, you generally cannot get title insurance until you take ownership, nor can you expect the title warranties that usually kick in during a traditional home purchase. You need to inspect the title thoroughly, which means paying several hundred dollars for a title search and combing through it to ferret out all outstanding debts. Even so, says Jones, there may be title problems that aren't of record or that appear on the record between the time of your title search and the public sale. Be prepared to pay off old tax liens attached to the home -- and to buy title insurance as soon as you take ownership.

Three ways to buy. Wherever you live, there are three ways to buy a foreclosure: in a presale (before the lender forecloses), at auction or directly from the bank. In a presale, you negotiate with homeowners directly, before their home goes into foreclosure. Although the discount can be as much as 20% to 40% off the property's value, a presale is the riskiest way to buy because deals frequently fall through and title problems are rife. And pre-foreclosure buyers have to add in the cost of an inspection and fork over real estate excise tax, as do those who buy bank-owned property. (Buyers at auction may avoid these costs in some states.)

Buying at a public auction is the most common type of foreclosure purchase. Buyers can expect a discount of 10% to 25% compared with buying a home through traditional channels, says Dean Street, an agent and 30-year veteran of foreclosure buying in the western U.S. But the road to auction can be bumpy, too. For starters, you often cannot inspect the interior of the home. Street says it's vital to see the property even if you can't gain entry. "If there is 300 pounds of garbage in the front yard, there is probably 600 pounds inside," he says. One way to research the interior is to check the local building department's permit records, or have your agent see if a recent listing has information on appearance, layout and previous remodelings.

Another hassle: Most foreclosures that go to auction get postponed, usually due to bankruptcy or loss mitigation (when the bank tries to compromise with the borrower), says Chris Matty, marketing director of ForeclosurePoint.com. He notes that opening bids also change frequently, especially as home values are marked down further.

The winning bidder will pay for the property and take ownership within a set period of time, which varies according to state law. But you're not out of the woods yet. Some states, such as North Carolina, give former homeowners a chance to buy the property back. Sometimes foreclosure buyers have to start eviction proceedings; once the house is vacant, you usually have to schedule repairs.

Work with the lender? If no one buys a property at the auction, it usually ends up back with the bank. Banks have a lot of these real estate owned, or REO, properties in their portfolios and are actively trying to sell them through agents. And unlike buying at auction, you can usually get a traditional mortgage for an REO. Unfortunately, lenders often list the property at or near market value to recover the outstanding loan amount along with legal fees, property taxes and maintenance costs.

But an experienced foreclosure broker can negotiate aggressively with a bank, especially when the property has been listed for a year or more. Plus, banks trying to sell foreclosures sometimes offer highly competitive financing packages to buyers, including low down payments and attractive rates. As home values decline, some lenders are willing to negotiate a "short sale," in which the property is sold for less than the debt owed on the house. That's one way foreclosure buyers can profit. In some markets, the discount is as much as 25%; but where there's less inventory, the discount can be smaller.

You can find REOs through real estate agents. Or approach local banks or mortgage brokers directly and let them know you are prepared to buy a property "as is" with cash and request a discount from the asking price. Banks sometimes pay to remodel properties to improve their value. But with so much inventory on their books right now, most lenders want to unload foreclosed homes quickly, without having to refurbish them.

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