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At first glance foreclosure investing can look like a great deal. You pick up a property for a rock-bottom price, fix it up and then sell it for a huge profit. But Like many things in real estate investing a closer look reveals that things are not as simple as they appear. To succeed in foreclosure investing you’ll need a good understanding of the market, the risks involved and good business sense. It’s definitely not a market for beginners in real estate.
What is Foreclosure Investing
When a homeowner fails to meet their mortgage obligations the lender, usually a bank, will confiscate the property as a way to recuperate the losses. Banks generally want to get such a property off their hands as soon as possible. For an investor, this can present a prime opportunity to scoop up a property for well below the market value.
However, the process is rarely a smooth one. Most transactions like this are done with no warranty and if done at an auction present the buyer no opportunity to inspect the house first. Down payments of 10-20% are often required to secure a loan which also tends to come with a high interest.
If you’re willing to brave the risks there are three different options for acquiring foreclosures, each with their own pros and cons. The first step is to decide which stage of the process you’re interested in. Then decide on a strategy to successfully purchase at that stage.
This is where the whole process begins. If a homeowner is late on a mortgage payment they will begin receiving phone calls and letters from the lender. If after 120 days no payment has been received the lender can initiate foreclosure. You can find pre-foreclosure deals in the 30, 60 and 90 days’ lists on various listing resources.
Knowing the exact reasons for why the owner failed to make their payments is critical when dealing with foreclosure investing. if it’s a short-term problem the owner may hold out until they can arrange a loan modification with the lender. If it’s due to a wider problem with the market then it can affect your chance of reselling.
The main benefit to this is that you can inspect the property first before deciding to buy. A downside though is that the owner could be desperate to sell and ‘forget’ to mention any liens on the property, large utility bills or unpaid property taxes will become the buyer’s responsibility on the purchase.
If the loan is not reinstated by the end of the pre-foreclosure stage the property is put on public auction. Acquiring at auction is the riskiest choice as an investor cannot inspect the property firsthand. You have no warranty on the condition of the property, no assurance that there are no other liens or loans on the property and no idea as to the condition of the utilities. The upside though is that you can walk away with terrific bargains if you play your cards right.
Most auctions are all-cash sales and in some states, you may only have a week to a month to come up with the full purchase price. If you fail to raise the money in time you lose your deposit.
If you do get a good deal at auction the former owner may even file a lawsuit to overturn the sale so be prepared to hire an attorney if needed.
The safest option but the one with the least profit is acquiring an REO (real estate owned) property. In this case, the property failed to sell at auction and is now owned by the bank or mortgage company. Since they now own it they must deal with the removal of tax liens and eviction of occupants if necessary.
Be aware that some REO’s might be exempt from standard disclosure agreements, a document requiring sellers to disclose any defects they know of. Ensure that you have such an agreement before finalizing anything. Most REO’s are listed on the market and sold through a local agency. Because of this, there is more competition so the profits can be less than the other options.
Before buying any REO property research comparable prices in the same neighborhood and take into account any costs for repairs or remodeling needed before preparing for resale. Many mortgage companies have staff dedicated to REO properties and will usually advertise through a listing agent.
Foreclosure investing has to be approached with caution and an understanding of both the risks and state laws. If done right you can scoop up a property for a bargain and sell for a tidy profit. Make poor choices though and you could be stuck with a money sucking property that you can’t get rid of.