Buying Foreclosed Homes - Deal or Mistake?

Certified Mortgage Advisor
NMLS 1701021
Published 
April 23, 2020

Should you buy a foreclosure and how does the process work?

Let's talk about, should you buy a foreclosure and how does the process work? So you're first going to learn the foreclosure stages that happen also things to consider when you're purchasing a foreclosure because it's different than if you're purchasing something sold by a traditional seller, and then the types of financing that you can use on a foreclosure because this is quite a bit different than purchasing a normal home.

Multiple Stages of Pre-Foreclosure and Foreclosure

So let's talk about the foreclosure seller internal. So who's selling this home. First, we have to understand there are actually multiple stages of a foreclosure process. So three stages here, you have pre-foreclosure, you have a foreclosure, and then you have post-foreclosure or real estate owned or bank-owned.

Pre-foreclosure stage

It's called different things at this stage in the pre-foreclosure stage. What's happening is the owner currently gets a notice that their home is going to be foreclosed upon if they don't meet certain criteria, which is normally paying back missed payments.

Foreclosure

In the foreclosure process, the home actually goes up for auction, and then a bitter canal bid on that home.

REO

So both of these stages right here, we're not going to talk about, we're only going to talk about the Real Estate Owned portion. So this is the portion in which it goes on the market in the pre-foreclosure process.

It's not on the market necessarily. You can purchase the home privately in the foreclosure section. Then the real estate owned is when it actually becomes on the market. So we're going to talk about owner-occupied, real estate-owned homes.

Check out Ryan Ingram's video

So if you're purchasing a home for yourself, this is what we're going to be talking about. If you're an investor, this is probably not good for you. I would recommend checking out Ryan Ingram's videos on this.

Purchased in "as-is" condition

But what you have to understand is that when you're purchasing a foreclosure, normally a bank owns that foreclosure. So they don't function in the same way that a normal seller would.

For instance, you're going to have to purchase the home in as-is condition, meaning there are no repairs. So normally what would happen with a seller is you'd be able to do an inspection and then request repairs if you needed them to purchase the home. But with the foreclosure, normally it's sold as-is.

You will be the one to do the fixing

So if there are issues. They either need to be fixed before or after you closed the home. And this can create problems because you need an appraisal. When you are purchasing a home with financing. And so if there's an issue, for instance, let's say an appraisal comes back and says, there's an issue with a specific item of the house.

Then what ends up happening is somebody is going to have to fix that. So either you're going to fix it before closing, which isn't always recommended. But normally the bank is not going to fix that for you.

No contingencies

Also, banks don't like contingencies. So normally they're not going to allow a contract. And if you have a contingency to sell your home first, before you purchase, normally they don't let those things fly.

The fewer contingencies you have in the contract, the more likely the bank is to approve your offer with foreclosure.

Appraisal for traditional financing

An appraisal needs to be done to get financing. If you see an auction with a foreclosure that's in this traditional foreclosure stage, you almost will never be able to get financing on an auction because an auction is not going to allow you to see the home and actually perform an appraisal on it. And they normally want you to close very quickly. So you have to have an appraisal done to be able to use secure traditional financing.

$100 down HUD REO program

So here's what you do. First FHA actually has a hundred dollars down the program. They call it the HUD Rio program. And again, this is through FHA, so it works just like a normal FHA loan, but it's instead of three and a half percent down, you can actually do a hundred dollars down minimum and you can pair this with a 203k.

Rehab loan if you want to. So this is a really cool program, but it only works on properties that are HUD REOs. That means that HUD currently owns the property. Okay. That's only one only time that you can use a program like this.

Don't mentally paint a picture that you can't create

So I know it can be tempting when you see homes, especially for closures, because they're normally sold at a discount. But normally these homes are not in the best condition and it can be really easy to think. I'll go into the home and we'll do all these repairs and fix it all up. And then eventually we can sell it for a bunch of money.

But if this is your first time purchasing a house and you don't have experience or rehabbing or doing remodeling, then he might be taking off a little bit more than you can actually come through with. So just be really careful there that maybe the idea that you have in mind isn't as grand as what you can actually execute because sometimes we see things on HGTV and we think, oh yeah, I can just come in and fix up this home.

But if you don't have experience or know how to do that in a cost-effective way, it can get you in a lot.

Carefully read contract, normally in favor of the bank

Also normally when you're purchasing something from a bank when the bank is the seller, they tend to have a different contract than what your local market might have. So you want to read this contract very carefully because this is normally going to be in favor of the bank. So keep this in mind.

Because normally a contract in your market, the average one used in your market tends to be pretty neutral, protect both the buyer and the seller, but when it's the bank that's providing the contract, normally most of the terms are going to be in favor of the bank.

Again, it's difficult to negotiate what's in that contract, but you just want to be careful and understand, what's happening because sometimes this contract can say, if you need an extension, it's going to cost X amount of dollars. And there are all sorts of different contingencies and things in there that you need to be mindful of.

Get CMA from your real estate agent

Also, keep in mind that the bank that actually holds their property most likely isn't super familiar with the market. Sometimes they have local property managers that do, but a lot of times they're just unfamiliar with the local market. So the pricing might be off. So what is offered by the bank to purchase that foreclosure might not be the best price for you to purchase.

What can CMA do for you?

So talk with your real estate and get a CMA and that's Comparative Market Analysis. Basically, a real estate agent is going to help compare this property that you're looking to purchase versus other ones in the area to see what's the value that they think you should purchase the home for that we make sure you don't overspend just because the bank price it at an arbitrary price based on what they thought.

You get priority over investors in the beginning

Then another cool thing is that you get priority over investors in the very beginning. So normally when a foreclosure is listed on the market, you tend to have two weeks where people who are purchasing it as a primary residence, that they live in, have priority over investors. And this is really beneficial because otherwise, investors could just go scoop up a ton of properties that get listed on the market.

But this gives people who are actually looking to purchase a primary residence a little bit more time. That way they don't have to compete against investors. So you want to make sure that if you are looking at foreclosures, ask your real estate agent to set you up on alerts. So you can see these homes first before you have to compete with investors who most likely are using cash to purchase, which is going to be a more favorable offer than you if you're using financing.

#CalmMoment

So let's have a #CalmMoment really quickly. If you're looking at a foreclosure, you might be at the stage where you're getting really frustrated with how little inventory there is right now. And I completely understand that because we're in a seller's market, it's incredibly frustrating. All the homes that are in great condition, most likely are going for above the asking price.

And there, maybe they're not requiring, or they're not asking for any closing costs and. All this stuff is stacked against you. Can you put in an offer and you might be competing against 10 other people in the offer as well, it can be frustrating. So if you are looking at a foreclosure. I want to make sure that you have the mindset, that this is not just a last-ditch effort, and we're just going to go try to find a house because we're in it.

Don't pressure yourself

You can take a moment to slow down and you can actually pull yourself out of the home shopping process. If you have the flexibility to do so. Don't feel like you have to purchase something like a foreclosure that might require a lot of work, just because you're not finding any other option available for you.

Sometimes it can feel like you get into real estate and then we have. No, we have to go purchase something, but you do not have to purchase anything. Don't feel pressured into purchasing something just because you're, pre-approved just because you're talking with the realtor, you could always take a moment to slow down, back away for a little bit, take some time to breathe, and see what changes with the market.

Financing: Cash

So let's talk about financing the best way. To purchase a foreclosure is with cash. And the reason why is you're not running into any appraisal requirements at all. Praise. Okay. No appraisal requirements with cash, so you can get an appraisal if you want, but it's not required.

Hard money

The next would be hard money. Now, hard money is a little bit more difficult to get, especially if you're purchasing as a primary residence. Instead of them looking at your financials, they tend to just look at the property's value. So your interest rates are crazy high on hard money. And then, you're probably not going to get the most favorable terms. They might have balloon terms to them. They're not going to be a good long-term loan.

There they'll allow you to purchase a property that is in not so great condition and possibly give you money for repairs.

Traditional financing

And then we also have traditional financing. So conventional is your best option. Conventional has the most lenient appraisal requirements of all the other loan types.

Rehab Loan

Now you can also look at a possible rehab loan. So something like an FHA 203k, Fannie Mae Homestyle. What these will do is they'll help you purchase a home and repair it. If the home is in a condition where it's not going to pass an appraisal. So for instance, let's say you look at foreclosure and this home is just trashed. There are tons of safety issues. There are electrical problems, maybe there are plumbing issues. You have an outdated kitchen, you have a destroyed bathroom. You're not going to be able to purchase that home even with a conventional loan.

But what you could do is you could look at something like a fan or FHA 203k, so you could do three and a half percent. And what the FHA 203k will lie to purchase is the home plus repair costs. And you'll be able to finance all of that with a 3.5% down payment. So this is a really great option. And then what you can do is you can refinance out of the two or three K into a conventional loan if you would like to. So that's a great way to purchase some of these homes that are in disrepair.

Government loans are more difficult to get appraised

Then also government loans are more difficult to get appraised than something conventional. So any government, USDA, VA FHA, these are going to be more difficult to get approved.

And then a conventional loan. If you're looking at government, you might have to go with a rehab loan that we can get met up to the appraisal requirements because government loans have more strict appraisal requirements than conventional does.

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