What To Know Before Buying A Foreclosure

By Investopedia | December 30, 2013 AAA

By Shirley Pulawski

While the rate of home foreclosure has been slowing down, foreclosed homes can be an inexpensive way to buy into the housing market at a lower rate, while possibly helping to improve a neighborhood by bringing one property back up on the rise, rather than into decline. While foreclosures can be terrific investments, buying a foreclosure can also be a very risky expenditure, one into which no one should enter without a lot of research and intestinal fortitude.

One of the first things to understand about buying a house on foreclosure is that payment in full, in cash, is required. Financing is not part of the deal -- the bank which owns the house wants to unload it as quickly as possible, with as few strings as possible. They have likely already lost money on the property and want it off of their books so that they can claim losses on their taxes and show investors they can reduce financial risks quickly.

This doesn't necessarily mean the home must be purchased with cash, but if not, a pre-approval letter from a bank will be necessary.

Depending upon the market, foreclosures can sell very, very quickly, even in as little as hours or days. While it might seem tempting to make a low-ball offer initially with the hopes of haggling, the bank is likely to have several other interested buyers. Unless the bank is sitting on a large number of foreclosed properties, in a hot market, it probably isn't a good idea to make an offer for less than the asking price, unless the buyer has a lot of reservations about the property.

The quick turnover can make it difficult to perform due diligence on the buyer's part, so buying a foreclosure can be a risky business and isn't for the faint of heart. In a slower market, the buy may have more power to negotiate.

Because the loan is sought before the home is agreed upon and the house is typically unoccupied, closing times are generally quicker than regular home sales, but it also means the buyer has to have a lot in place before making an offer, and must be positioned to move quickly from the outset. This means the risks are higher, and a lot of hidden issues can be lurking in a foreclosure.

The bank which owns the property may have completed title work, but it is still possible the house may have additional liens on it. Liens can come from municipalities in the form of fees for grass cutting or other issues related to vacancy or disrepair of the home, but the bank may not be the only entity to which the former owners owe money. Paying for a title search can be well worth the investment to avoid a disaster, but the added time may mean another buyer could land the sale faster.

While the house may close more quickly because it is vacant can make viewing it and moving through the paperwork easier, homes which have been vacant for a long period of time can have problems of their own. Neglected properties may not have been properly winterized and can have leaky water pipes after being subjected to freezing temperatures, problems with furnaces and water heaters from neglect, and other maintenance issues.

In many cases, the former property owner may have overlooked important (and expensive) repairs and maintenance such as replacing roofing, properly addressing water or mold issues, and a host of other potential problems. Potentially worse, repairs may have been made poorly or by unqualified workers, and existing damage may simply be hidden by newer looking materials.

Look around the property for any signs of termites, cracks in the foundation, An in-ground pool that may seem very enticing could also be a money pit, with leaking pipes underground or other problems. Because the water, electric, and other utilities are usually shut off on foreclosed properties, it can be difficult to detect some of these issues until after the sale has been made, and foreclosures are sold in "as is" condition. Paying a few hundred dollars for a home inspection may be a good investment if time permits.

In the early 2000s, I bought a two-family house on foreclosure in Buffalo, NY and the house had been vacant for over a year. As soon as the water turned was on, a rush of water began spraying throughout the basement because pipes had frozen while the place was unoccupied.

Fortunately, the damage was limited to a small set of pipes, and I had a friend who was a professional plumber, so the unforeseen expense was small. It's safe to imagine that if the previous owners didn't have the money to keep up with mortgage payments, they probably didn't have money to invest in repairs, regular maintenance, and other safeguards. In short: expect the worst in repairs, on top of any obvious cosmetic or other issues the house may need and plan accordingly.

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