Why buy foreclosed homes?
Contrary to what many want to believe, buying foreclosed homes isn’t always as easy as it might seem.
This guide is mean to help you, a real estate investor, better understand the foreclosure space so that you can make better investment decisions.
Let’s dig in.
What is a foreclosure?
Here is how Wikipedia defines foreclosure:
Foreclosure is a legal process in which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender by forcing the sale of the asset used as the collateral for the loan.
In other words, someone borrowed some money to purchase a home and has now, for whatever reason, stopped paying that money back. In an attempt to recoup that money, the lender is now attempting to force the sell of the home.
This is foreclosure.
What is The Foreclosure Process?
To properly have this discussion, it’s important to understand that there are different stages of the foreclosure process.
For the purpose of this article, we’re going to bypass the idea of buying foreclosed homes at auction and focus on the following two generic stages:
As you might suspect, a property is in pre-foreclosure when the home owner is no longer making proper payments to the lender but the lender has not yet taken back ownership of the home.
Post-foreclosure (REO Foreclosures)
Similarly, foreclosure is when the lender has formally taken back ownership of the property. This is known as a “REO” or “real estate owned”.
This stage is reached after an unsuccessful attempt to sell the property at a foreclosure auction.
Buying foreclosed Homes Pros and Cons
Everyone gets really excited about buying foreclosed homes.
However, as you can imagine, there are two sides to every coin.
Let’s take a moment to quickly look at both the pros and cons of buying foreclosed homes; specifically homes that have already been taken back by the bank.
Benefits of Buying Foreclosed Homes:
- Motivated Sellers – When a property is in foreclosure, the lender is trying to get their money back. In some scenarios, this naturally puts the buyer in a position of leverage.
- Deferred Maintenance – When a home has been foreclosed upon, it means the previous Owner couldn’t or wouldn’t make the payments. If they couldn’t make the payments, it’s also reasonable to think that they would stop investing in the on-going maintenance of that property as well. Most people will see this as a negative to buying foreclosed homes. However, as an Investor, you should realize that it will scare of away some potential buyers and leave you with less competition.
- Less Emotional – Dealing with Banks and not homeowners.
- Fewer Liens – In most cases, by the time a property is taken back by the bank, it will have had any liens placed against it settled. This makes your life as an investor easier.
Risks of Buying Foreclosed Homes:
- Competition From Investors – Believe it or not, buyers don’t always have the upper hand when buying foreclosed properties simply due to the amount of competition from Investors these days. As with anything, to win as an Investor in the foreclosure space, you need to be able to do this better than your competition.
How to find foreclosed homes
Alright. So now that we have a general idea of the foreclosure process, let’s dig in to how to find foreclosed homes.
Again, you can really break this down into pre-foreclosures and REO foreclosures.
What you’ll notice is that the way you go about finding foreclosed properties doesn’t really differ much to how you’d go about finding any investment property.
- Buy a list – One option for finding pre-foreclosure opportunities is to purchase a list from businesses who track this sort of thing.
- Driving for dollars – A somewhat passive option is to do what’s called “driving for dollars”. This is where you simply note troubled looking houses as you drive around your city. If you see a dumpy property, chances are it’s in trouble. Make a note of the address and do a little digging.
- Online sites – Lastly, sites like Zillow and Trulia are able to track properties that are likely to be in pre-foreclosure. While you should always take these sites with a grain of salt, they do provide some level of insight into properties that MAY BE in trouble.
For a deeper dive, check out this REO properties resource compiled by the folks over at BiggerPockets.
- MLS – Probably the best way to find a REO foreclosure is to simply have a great Real Estate Agent working on your behalf. This person will have access to the MLS where the REO foreclosures are listed. The good news here is that the seller (the bank) will typically cover the costs of the agent.
- Online sites (not perfect) – As I mentioned earlier, you can use online sites like Zillow or Trulia. Please just make sure you understand that their data is not perfect. You should consider it just insight and do your own investigation from there.
How to Buy Foreclosed Homes
As an Investor, the overarching available strategies you have when buying foreclosed homes really doesn’t vary much from how you would approach any other home investment.
The same investment strategies are available. Below are a few of our favorite:
- Buy and rent (BRRRR) – Buy, renovate, rent, refinance and repeat…just with a foreclosed property.
- Buy and sell (flip) – Buy, renovate and flip it.
- Live in flip – Buy it, move in to it and renovate it over a period of two years. After two years, flip it.
Regardless of which approach you take, make sure you take your time to plan out and professionally manage your project.
Similarly, if you plan to hold the property as an investment, make sure you take into consideration any holding costs you will have; such as property management fees.
Financing a Foreclosed Home
Buying foreclosed homes, particularly those not in great condition, can be tricky.
Here are your typical options:
- Standard bank financing – if the home is in decent shape, chances are, you can pursue the traditional bank financing options. FHA, VA or conventional.
- All cash – if you’re an Investor, it can really give you a leg up on your competition if you have enough cash to purchase and renovate the property.
- Private money – If you don’t have the cash yourself to fund the purchase and renovation, you can go to private individuals and try to convince them to fund your investment.
- Hard money – Similarly, hard money lenders are another option for those who do not have the needed cash available to fund the investment by themselves.
So to wrap this up – buying foreclosed homes can be a great path to take in some scenarios. However, as with most things, you can’t expect this to be a silver bullet that will make you rich over night.
Instead, take your time to really understand the foreclosure process and invest your time and money incrementally to get more experience in the space.