Shopping for a foreclosure? How to pick the right one

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Shopping for a foreclosure? How to pick the right one

When Amanda McConnell and Ishan Dillon bought a foreclosed house in late 2011, it turned out to be a shrewd investment. It was a bank-owned four-bedroom on a half-acre of land on the north end of Vashon Island, a small commuter island near Seattle. Dillon’s family owns a construction company, and he has a real estate license, so he has a keen eye for fixer-uppers.

They learned of the house through a multiple listing service. Along with its perfect location close to the ferry terminal and the charming town center, Dillon was attracted to the house for its fixable flaws. In particular, the house had a large, ugly garage with a flat roof that was visibly rotting.

“It was pretty derelict, but the things that needed repair were doable,” he said. “Banks typically are able to easily find a buyer for a house if it’s in really good shape, but a house like this was an ideal opportunity for us.”

They paid $208,000 for it, which was about a 25% discount to the market price at that time, said Dillon, 36.

The cheap price could also be partly attributed to a rumoured curse. (Learn how a tolerance for the macabre can help your home search.)

“It had burned down twice, then rebuilt, and three couples who had lived there had gotten divorced. No one wanted that house,” said McConnell, 38, who is studying education in graduate school. The couple envisioned the beauty the house could become.

Over the next four years, the couple worked hard to reframe the garage, put on a new roof, install a new custom kitchen and bathroom, and redo the floors, to the tune of $35,000 to $40,000. They did much of the work themselves, saving labor costs.

In fall 2015, they put the house on the market when a dream opportunity arose to move to Ireland with their two young sons. With the renovation, it fetched a cool $440,000, more than double their original investment. Given the continued popularity of the area, it’s probably worth around $700,000 by now, Dillon notes ruefully.

Is the siren song of bargain-priced foreclosures calling your name? Maybe you’ve heard of friends buying bank-owned homes at fire-sale prices and want to find a cheap gem of a property too. But many foreclosure buyers of years past had the advantage of being in the right place, at the right time of the real estate market cycle. (Learn how you can avoid a foreclosure on your home.)

The foreclosure market looks very different today. During the real estate crash from 2006 to 2011, banks had so many repossessed homes on their books that buyers were able to scoop up properties at big discounts. There are far fewer foreclosures today, thanks to a stronger economy and more conservative mortgage underwriting.

Bargain hunters might still find good deals, but they aren’t as plentiful. Searching for a cheap foreclosure today is a bit like joining the California gold rush in 1850: “It was over by 1848, and you’re late to the party," jokes Keith Watts, a real estate agent and short sale expert in Orange County, California.

“There’s a fallacy that banks just want to liquidate these properties,” says Philip Boroda, director of real estate owned properties and foreclosures for Coldwell Banker in Los Angeles. “From around 2006 to 2012, yes, it was like that. Banks had so many foreclosed houses on their books that they would package them in bulk for 70 cents on the dollar and sell them to investor groups.”

But foreclosures have trended downward in recent years at the national level.

“The foreclosure market is slower than before, but it’s still very, very busy,” says Boroda. With higher average home equity and fewer dodgy mortgages, delinquencies and foreclosures are at some of the lowest levels in almost two decades. As of November 2018, the share of U.S. mortgages in some stage of foreclosure was just 4.1%, its lowest monthly level since January 2000, according to CoreLogic, a real estate data analytics company.

However, some local markets run counter to the trend. Foreclosures are increasing in cities including Chicago, Cleveland, Miami and Philadelphia, according to ATTOM Data Solutions, a residential and commercial real estate data provider.

The first rule of shopping for distressed properties is buyer beware. To help you be an informed shopper, here’s our guide to buying foreclosures.

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What is a foreclosure?

When the owner of defaults on the mortgage after failing to make payments, the lender takes over and the property becomes a foreclosure. The homeowner may have had a job loss, fallen ill or refinanced the home too many times, taking cash out and never getting out from under the debt. In any case, the lender takes possession then tries to sell the house at a foreclosure auction or on the market to recoup its losses.

Each state has its own laws governing foreclosure, and local markets have their own price dynamics.

Cheap foreclosures aren’t as common as they were during the mortgage crisis, but there is always a chance you’ll stumble on a house in need of rescue.

“If a foreclosure costs less, it’s going to be because it needs work,” says Watts. “My question to anyone who wants to buy a foreclosure is, are you handy? Do you have the imagination to see what other people don’t see? And do you have some resources to do renovation work? Most of the success stories are people who bought a home and fixed it up and then it went up in value.” (Find out how to kep your renovation on-budget.)

It’s necessary to understand the different stages of foreclosure and how to approach buying a property at each stage:

  1. Short sale or preforeclosure
  2. Foreclosure auction
  3. Bank-owned or real-estate-owned

Buying a house through a short sale

Short sales occur during the preforeclosure period, when the owner is in default but the bank hasn’t yet taken over the house. Rules vary by state, but the bank may file a notice of default with the county recorder, or may post a notice on the front door of the property to warn homeowners they are in danger of eviction. The notice marks the start of preforeclosure.

During this time the owner can try to sell the house, even if it’s for less than the amount owed on the mortgage. The bank or lender must approve the transaction, since it will take a loss from the short sale.

Short sales can offer considerable price discounts. The bank is motivated to limit its losses and the homeowner is trying to stave off a foreclosure. However, potential complications can cause a deal to fall apart, right up until the last minute. Homeowners may try frantically to raise the outstanding money or reach some kind of deal with the bank to avoid eviction. The timing can be unpredictable, and the risk to the potential buyer is that the deal may be halted mid-stream or at the last minute if the homeowner scrapes up the funds owed.

“A short sale is going to be less expensive, and you might be first in line for the house. But it can be too much hassle,” says Dillon, who now lives with his family near Cleveland, Ohio, and looks for foreclosures to fix and flip. “You could be working on a deal for months and then the homeowner somehow gets his Uncle Bill to provide money to get the loan back in good standing.”

The owner that is at risk of losing the home could try to undermine the short sale to stay in the home longer.

“Some sellers draw it out. It’s really common for people to squat in a short sale, and then tell the bank that the buyer walked because the bank approval took too long,” said Watts.

That’s why experienced buyers of distressed properties often prefer to wait for a property to come up for auction or become bank-owned.

“Even if you end up paying a bit more, there’s so much less risk,” said Dillon.

Finding short sale houses can tricky. Even if a house is in a preforeclosure sale, the owners may not want to sell. Read the legal section of local newspapers to find notices of default, with any details, like the bank name or an upcoming auction date. Let real estate agents know of your interest in potential short sales since they might hear news of houses that might become available. If you spot promising houses that appear abandoned, try looking up the address on the county website.

Buying a house at a foreclosure auction

Homes are offered at auction after the owner’s grace period — which could range from a few weeks to a year after the notice of default, depending on the state — expires, and the bank or lender takes it over. These auctions are also called sheriff’s sales, and the houses are generally sold “as is.” There is usually no opportunity for a house inspection.

“With a sheriff’s sale, you can’t get in it and you’re only walking around the exterior. You’re blind-buying,” said Dillon.

To limit your risk, you must do your homework before bidding at an auction. Visit the properties you’ve identified, but be careful not to trespass. Try to speak with neighbors to find out about the condition of the house. Peek in the windows, if possible.

Dillon recently did that with a foreclosure in Elyria, Ohio, that he was interested in, and he was glad he did. While the house appeared attractive on paper, walking around it, he was surprised to spot an indoor pool on the ground floor.

“It was covered with a sheet of ice. I immediately crossed it off my list,” he said. “If there were issues with the pool, there could have been $40,000 of work to be done.”

To find foreclosure auctions, you can check local newspaper listings or the county clerk’s website. Search real estate websites by filtering for bank-owned properties in the neighborhoods you are interested in.

Before bidding on a particular house, consider paying for a title search to check for any surprise liens that could come with the deed. Look up comparable properties in the neighborhood to get a sense of the market price. Make a rough list of anticipated repairs and estimate the costs.

Based on your research, figure out your top bid ahead of time and stick with it in the heat of the moment.

“When you’re going after a foreclosure, the more emotional it is, the higher the offer you’ll end up making,” said Jordan Moorhead, a real estate agent with Keller Williams Realty in the Minneapolis-St. Paul area.

Before the auction, call ahead to find out what you need to bring (you may need ID or other documents), and what forms of payment are acceptable. You may need cash, a money order or cashier’s check.

Buying a bank-owned property

Bank-owned or real-estate-owned houses have been repossessed by the lender and couldn’t be sold at auction.

“If no one bids on [a house at auction] then it becomes bank owned,” said Boroda.

Compared to a short sale or a foreclosure auction, buying a bank-owned property is more similar to a conventional home purchase. Such houses may be priced much lower than their last sale price, but they are generally listed at market value. The bank hires brokers to set a fair price based on comparable homes nearby and the estimated cost of fixing it up, said Watts.

“If the market price is $100,000, the bank is not going to price it at $70,000,” said Boroda. “It might be priced a little below market, like $95,000. It’s the same as buying from a regular seller, but it’s a bank and they’re not as emotional.”

There are many ways to identify real-estate-owned properties. You can work with a real estate agent or search on websites like Realtor.com, Trulia and Zillow. Large banks, like Bank of America and Wells Fargo, list REOs for sale on their websites, along with the agent name to contact. Fannie Mae’s HomePath and Freddie Mac’s HomeSteps are two online databases of foreclosed homes around the country.

You can also search for homes owned by public agencies at the U.S. Department of Housing and Urban Development website.

Wherever you find the perfect foreclosure, do your research and be careful not to overpay.

Next week, we’ll look at the various ways to pay for a foreclosure. Spoiler alert: You don’t need a wheelbarrow full of cash.

Image: Breno Assis