Buying a foreclosure (FCL) is often touted as a way for both owner-occupants and investors to get a great deal on a property. However, the potential financial rewards of buying a foreclosure don't come without their share of hard work and headaches. Read on to learn about the problems these properties commonly possess and the difficulties you may encounter in purchasing one. (To learn more, read Foreclosure Investing Not A Get-Rich-Quick Venture.)

Tutorial: Exploring Real Estate Investments

Problems With the Property
The most important thing to understand before jumping into the foreclosure market is that these properties were given up by owners who couldn't afford the payments anymore. In these cases, the house is often poorly maintained - after all, if the owner can't make the payments, he or she is likely falling behind on paying for regular upkeep as well. In addition, some people who are forced into foreclosure are embittered by their situations and take out their frustrations on their home before the bank repossesses. This often involves removing appliances and fixtures, and sometimes even outright vandalism. After the occupants leave, foreclosures sit abandoned, often inviting criminal activity. (If you are facing foreclosure on your home, read Saving Your Home From Foreclosure to learn what your options are.)

Maintenance and Cleanliness
Maintenance and cleanliness can be a problem in foreclosure properties because of the circumstances under which the previous owners moved out, and because of the time the house may have sat empty. Some of the main concerns include:

  • Lack of Cleanliness
    Bank-owned properties are sometimes disgustingly dirty because of time spent sitting empty, intentional neglect by the previous owners or occupancy by vagrants. When the place is locked up with no air circulating for months, built-up dirt can cause the entire home to smell.
  • Bad Renos
    The previous owners may have made changes to the home without getting the proper permits or hiring good labor in order to save money. A common example is converting the garage into living space so more people can live in the home and help pay the mortgage. These changes may be undesirable to future owners or create headaches for the new owners with city government officials due to the lack of proper permits.

    If the previous owners started to improve the home but then fell on hard times, there may be partially finished work in the house. The bathrooms may be redone while the kitchen has not been updated in 40 years, or there may be new floors in the living room while the bedrooms still sport ancient carpeting. Also, if any repairs were made, they may have been done by the owners themselves or by unlicensed professionals - in other words, people who may not necessarily have done the work correctly. (Learn how to find qualified contractors and other professionals in The Better Business Bureau's Tool Belt For Saving Cash.)

  • No Electricity
    With no one living in the home, the electricity may be off unless the bank has intentionally kept it on. With no electricity, it can be hard to see what you are buying in some rooms, particularly basements and windowless bathrooms.
  • Water Damage
    A small leak under the kitchen sink can lead to a mold problem, and a roof leak or burst pipe can lead to major water damage. With no one around to take care of small problems as they occur, small problems can turn into big ones, and big problems can turn into disasters. (Learn how you can minimize some major maintenance costs in 4 Overlooked Homeownership Costs.)
  • Lack of Basic Maintenance
    If the previous owners couldn't afford their mortgage payments, you can bet that they also could not afford to repair leaks, termite damage, a broken garbage disposal or anything else. (Read about how much work is necessary to maintain your home's value in Will You Break Even On Your Home?)
  • Dead or Overgrown Yard
    Depending on the climate where the home is located, the lawn and landscaping may be totally dead or extremely overgrown. Banks usually do not pay for gardeners to maintain the yard.
  • Personal Property Left Behind
    Sometimes foreclosed homeowners get locked out of the property before they can move their belongings, and in some cases they do not take everything with them. Many real estate owned (REO) properties contain furniture, trash, clothes and other items that you will be responsible for disposing of when you become the property's owner.

Vandalism and Neglect
Damage is not uncommon in foreclosure properties and it may be caused by vandals or the former owners.

  • Random Vandalism
    Sometimes when a property sits vacant, especially if it is in a moderate-to-high crime area, new owners will have to contend with graffiti, broken windows and other damage. (Vandalism may be a red flag on a potential property. Read Foreclosure Opens Windows For Investors to learn more.)
  • Owner Vandalism
    Broken windows can be common in REOs for several reasons. As mentioned previously, vandalism could be a cause. Also, when banks lock out owners while taking possession of the property, the former owners may break a window to get back in and retrieve their belongings. Previous owners may also purposely inflict damage at the bank's expense by putting holes in walls and/or tearing off the baseboards and crown molding.
  • Removal of Valuable Items
    To get revenge against the bank and to make an extra buck, the previous homeowners might remove items that had value, including appliances, fixtures, the kitchen sink, bedroom doors, closet doors, copper pipes and more. Anything the homeowners do not take might be taken by thieves. Either way, many bank-owned properties are missing things that generally come with seller-owned properties.

Problems With the Purchase
Despite all these potential problems, foreclosures can still be a good deal. If you are willing to fix problems that most people do not want to deal with, you can buy a home at a significant discount. However, you may encounter additional issues when it comes to actually purchasing the property and getting it in move-in condition.

Issues With Lenders
Buying a home from a lender has its issues as a result of the increased level of bureaucracy and the limited transparency afforded to those who buy foreclosures.

  • Financing
    Lenders will not give you money for a home they consider uninhabitable or that appraises below the purchase price. If you are an investor paying cash, of course, this will not be a problem.
  • Time Delays With the Owner Bank
    Common sense says that banks should want to unload REOs as quickly as possible, but in reality banks sometimes drag their heels in considering offers and throughout the escrow process. (Learn more about the steps leading up to closing in Understanding The Escrow Process.)
  • No Seller Disclosures
    Since no one from the bank has ever lived in the house, they are unlikely to have any knowledge of existing problems with the property. You will have to uncover everything yourself, either during the home inspection, by asking neighbors or through experience after you become the homeowner. (Read more about the value of hiring a professional in Do You Need A Home Inspection?)
  • Competition
    Because foreclosures can be great deals, they are attractive to investors looking to flip properties or use them as rentals. Since investors can make all-cash offers with fewer or no contingencies and fast closings, their offers may be more attractive to the bank than those from would-be owner-occupants. (Read more in Investing In Real Estate.)

The Bottom Line
There is money to be made in foreclosures, but you should know what you are getting into ahead of time and choose your property carefully. Don't overlook the fundamentals that make a property desirable just because the purchase price is a bargain.

For further reading on avoiding the pitfalls of foreclosures, see Avoiding Foreclosure Scams.

Related Articles
  1. Investing

    Why We’re Bearish On U.S. Housing

    Hedgeye analyst Josh Steiner discusses the reasons behind our decision to go from bullish to bearish on the U.S. housing market.
  2. Investing Basics

    How to Get More Yield From Your Investments

    Yield seeking investors can boost the amount of income their investments generate through tweaking their portfolio of stocks and bonds.
  3. Retirement

    Dollar Shave Club Review: Is It Worth It?

    Learn about the business model of the Dollar Shave Club, and find out whether the razor subscription company is a worthwhile investment.
  4. Term

    The Implications of Nonfarm Payroll

    The nonfarm payroll is a key economic indicator that’s closely monitored by analysts and investors around the world.
  5. Chart Advisor

    3 Charts That Suggest Now Is The Time To Invest In Real Estate (VNQ, SPG,PSA)

    Real estate assets have some of the strongest uptrends around. We'll take a look at three candidates poised for a move higher.
  6. Real Estate

    4 Real Estate Plays for Income Seekers in 2016 (CCI, HCN)

    Discover four real estate investment trusts that have favorable business developments and provide attractive dividend yields for income-seeking investors.
  7. Home & Auto

    Understanding Pre-Qualification Vs. Pre-Approval

    Contrary to popular belief, being pre-qualified for a mortgage doesn’t mean you’re pre-approved for a home loan.
  8. Investing Basics

    Understanding Real Estate

    Real estate is an encompassing term that refers to land, the buildings on that land, and its natural resources, such as crops and minerals.
  9. Investing Basics

    How To Value A Real Estate Investment Property

    Two common methods for real estate valuation are the discounted net operating income and gross income multiplier approaches.
  10. Investing Basics

    How to Calculate ROI For Real Estate Investments

    When it comes to real estate investments, there are two important ROI calculations to know.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Full Answer >>
  3. Do FHA loans require escrow accounts?

    Federal Housing Administration (FHA) loans require escrow accounts for property taxes, homeowners insurance and mortgage ... Read Full Answer >>
  4. Do FHA loans have prepayment penalties?

    Unlike subprime mortgages issued by some conventional commercial lenders, Federal Housing Administration (FHA) loans do not ... Read Full Answer >>
  5. Can FHA loans be refinanced?

    Federal Housing Administration (FHA) loans can be refinanced in several ways. According to the U.S. Department of Housing ... Read Full Answer >>
  6. Can FHA loans be used for investment property?

    Federal Housing Administration (FHA) loans were created to promote homeownership. These loans have lower down payment requirements ... Read Full Answer >>
Trading Center