A foreclosed property is a piece of real estate sold by a mortgage lender or bank in order to pay off a defaulted or unpaid mortgage loan. Foreclosures end with a public auction in which mortgage lender or bank sells the property, which can be bought by a private citizen as well as the bank itself.
Foreclosure, the legal process that takes place when a homeowner defaults on a mortgage loan, is intended to satisfy the outstanding balance on the mortgage loan. For example, if a homeowner applies for a loan from the bank to purchase a home, the bank will require a mortgage or trust deed to be signed, which allows the bank to foreclose on the property if the payments aren’t met.
Types of Foreclosure Sales
Once a state court approves a foreclosure sale, an order will be issued that entitles the sheriff’s department to sell the mortgaged property. This is a sheriff’s sale because local law enforcement manages the auction.
Under a trust deed, in which the bank remains the owner of the property, a foreclosure sale is called a trustee’s sale. A trust deed is similar to a mortgage except that it allows the bank to foreclose without filing a lawsuit or enlisting the sheriff’s office to execute the sale. Rather, a trustee designated by the bank will advertise public notice of the foreclosure sale and the trustee will manage the auction. The trustee will sell the property to the highest bidder at the auction.
In order to purchase a foreclosed property, investors can proceed in two different ways. Firstly, they can bid at a sheriff’s sale or trustee’s sale and if they tender the highest bid, they will own the property. Secondly, if the bank purchases the foreclosed property, investors can purchase the property directly from the bank. These foreclosed properties are commonly referred to as banked-owned properties or REOs (real estate owned).
Applying for a Mortgage
Investors should get pre-approved for a mortgage before considering purchasing a foreclosed property. In order to compete effectively, an investor will need financing in place before bidding – unless they can pay cash. There is also the option of paying cash initially and then refinancing.
Investors should get a pre-approval letter from one or more mortgage lenders, not simply a pre-qualification letter. Pre-approval means applying for a mortgage and submitting the documents underwriters need to approve a mortgage. Pre-qualification may not a credit score check, but simply an estimate of income.
A pre-approval letter confirms that the investors can borrow the amount needed based on an evaluation of the investor’s credit score, assets and income. With pre-qualification, the mortgage lender will estimate how much the investor can borrow, though it will not directly commit to a loan.
According to Keith Gumbinger, an expert on the mortgage and consumer debt industries, when investing, “Your credentials need to be much stronger. Expect to put down 25 or 30 percent on the property and expect to pay higher fees to get your mortgage.”
Valuation is also essential. If the list price of a property is higher than its appraised value — for example, if the purchase price of a property is $200,000, but it only appraises at $180,000, many mortgage lenders won’t supply the difference, and investors may have to come up with a larger down payment.
“Valuation really does matter,” Gumbinger says. “If you think the property is worth ‘n’ and the seller is selling the property for ‘n’ and you think you can rent it out for ‘n,’ you may have to demonstrate both of those things. The burden of proof may end up being upon [the buyer].”
Negotiating a Price
Before making an offer, an investor should assess the local housing market and take into consideration the condition of the home, the location and the market value of similar properties that have been sold recently. Also, an investor may want to consider the absorption rate, which is the rate at which comparable properties are selling in order to present an attractive offer.
The risk of investing in foreclosed properties that the original homeowner may have the redeem the mortgage for up to one year after the foreclosure auction, meaning they can pay off the full mortgage balance as well as the costs associated with the foreclosure process and regain ownership of the property sold at auction.
Oftentimes, there are courses offered on how to buy foreclosed properties. These usually cover the following:
- Understanding the different types of foreclosure properties.
- Financing options available for buying foreclosed properties.
- Legal risks when purchasing foreclosed homes.
- What to offer to be considered a serious buyer.
- Title insurance and its importance when buying foreclosures.
- Inspections, most concerning issues.
According to Jeannette Burke, partner of The Real Deal Team, “First-time homebuyers, flippers, new investors, renters, or anyone simply looking for a good real estate deal should attend. Last year’s session was very well attended and everyone left happy and a little more knowledgeable.”
Though many online sites advertise foreclosure sales, one of the most reliable sources is the Department of Housing and Urban Development website, which lists foreclosure homes owned by HUD (FHA loans), the VA, the IRS, USDA and other agencies. HUDHomeStore.com, for example, allows investors to search within their state for foreclosure properties.