Why Buy a Foreclosure?
In recent years, foreclosure sales have been trending downward, according to national property data curating company Attom Data Solutions. That is largely because a strengthening U.S. economy has reduced the number of borrowers who lose their homes as a result of failing to pay the mortgage. In 2017, distressed home sales – including foreclosures and short sales – made up 14 percent of all U.S. single family home and condo sales, according to Attom Data Solutions. That number was down from 15.5 percent in 2016 and a recent high of 38.6 percent in 2011.
Still, some buyers look to foreclosures to get the best possible deal. Homes may be for sale in various states of foreclosure. For example, pre-foreclosure is a period when the owner has fallen behind on payments, but the lender has not actually taken the home from the owner. Homes sold at this point often go through the short sale process, where the lender agrees to accept an amount of money from the buyer that is less than what the current owner owes on the mortgage.
Properties that are already in foreclosure are sold at an online or offline auction, or by a real estate agent. The biggest lure of buying a foreclosure is the potential savings you get compared with buying a similar nondistressed property.
“It can be like a 15 percent discount on your neighboring houses,” Reiss says. “So, it can be significant.”
But Mendenhall says how much you will save depends on the local real estate market and the stage of foreclosure of the property.
The Risks of Buying a Foreclosure
Purchasing a foreclosure involves several substantial risks, so buyers must enter the process with their eyes wide open. In many cases, if you buy a foreclosure at auction, you must purchase the property sight unseen. Reiss says this is the biggest potential danger of buying a foreclosure.
“The big, scary thing is that with a number of foreclosures, you can’t actually inspect the property before you actually bid,” he says. “That’s in part why the prices are below the market.”
Even if you can get a professional inspection on a foreclosure, you typically have to buy the house “as is.” Once you purchase the home, any problems that pop up are yours – as is the responsibility for finding and paying for a remedy. Such problems are more likely in a foreclosure than in a nondistressed property. For example, in some cases, a frustrated family might strip the home of valuable elements before vacating the house.
“Or they kind of just beat it up because they were angry about having to go through the foreclosure,” Reiss says.
The mere fact that the home is vacant also can lead to problems. Reiss says a home is like a plant – if you don’t tend to it regularly, it can wither and die. “If you happen to leave it alone on its own for too long, water leaks in, pipes can burst, rodents can get in, just the elements can do damage,” he says.
Mendenhall adds that people who lose their homes to foreclosure typically have major financial troubles. That can trigger other troubles for the new owner. “If the previous owner was in financial distress, there’s a chance that there’s more maintenance and work maybe that they haven’t completed,” she says.
Reducing the Dangers of Buying a Foreclosure
There are a few things you can do to mitigate the risks associated with buying a foreclosure. For starters, see if you can get a professional inspection of the property. Although buyers often cannot inspect a foreclosure property, that is not always the case. So, be sure to ask a real estate agent or the seller about hiring a home inspector.
“Even though it may extend the process, if you can have a qualified inspector come in, you can know a little bit more about what you’re getting into,” Mendenhall says.
If you can’t inspect the property, Reiss recommends researching its history. Look at publicly available records to find out when the property was last sold and how long the current owner had possession. Also, check whether building permits were drawn and what type of work was done. “Maybe you’ll see some good news, like a boiler was replaced two years ago,” Reiss says. “Or maybe you’ll see some scary news, like there’s all these permits and you don’t know if the work was completed.”
Also, visit the house and perform a “curbside inspection” of your own, Reiss says. “Even if you can’t go inside the house, you want to look at the property,” he says. “If you can peek in the windows, you probably want to peek in the windows.”
Knock on the doors of nearby neighbors. Tell them you want to bid on the property but need to learn all that you can about the previous owners, including how long they lived in the home and whether they took care of it. And ask if there have been any signs of squatters or recent break-ins.
“Try to get all that information,” Reiss says. “Neighbors are probably going to have a good sense of a lot of that, and I think that kind of informal due diligence can be helpful.”
Working with a real estate agent experienced in selling distressed property may help you avoid some of the potential pitfalls of buying foreclosures, Mendenhall says. Some agents have earned the National Association of Realtors’ Short Sales and Foreclosure Resource Certification, or SFR. Such Realtors can help guide you through processes unique to purchasing distressed properties, Mendenhall says.
How to Find a Foreclosure
You can find foreclosures by searching the listings at bank websites, including those of giants such as Wells Fargo and Bank of America. The government-sponsored companies Fannie Mae and Freddie Mac also have listings on their websites.
The federal government’s Department of Housing and Urban Development owns and sells foreclosed homes. You can find listings on the website.
Private companies such as RealtyTrac offer foreclosure listings online, typically for a fee. Finally, you can contact a real estate agent who will find foreclosures for you. These agents may help you find foreclosures before others snatch them up.
Is a Foreclosure Right for You?
Before you pursue a foreclosure, Reiss encourages you to ask yourself whether you are in a good position to take on the risk – and, hopefully, to reap the reward – of buying a foreclosure. It is possible to use conventional financing, or even a loan from the Federal Housing Administration or Department of Veterans Affairs, to buy a foreclosure. However, people with deeper pockets are often better candidates for buying a foreclosure.
Because the process can be highly competitive, buyers with access to large amounts of cash can swoop in and land the best deals. “You can get financing, but you need to get it quickly,” Reiss says. “I think a lot of people who go into purchasing foreclosure(s) want to have the cash to just kind of act.”
Sellers of distressed properties love cash-only buyers, because the home can be sold without a lender requiring either a home appraisal or a home inspection. “So, the more cash you have on hand, the more likely you’re playing in those sandboxes,” Reiss says.
In addition, buyers of foreclosures often need to spend money to bring a property up to code or to make it competitive with other homes in the neighborhood. “Have a big cushion in case the building is in much worse condition than you expected,” Reiss says.
He cites the example of someone who buys a foreclosure, only to discover that the piping has been stripped out of the basement and will cost $10,000 to repair and replace. “You need to know that you can handle that one way or the other,” Reiss says.
People with solid home maintenance and repair skills also are good candidates for buying a foreclosure. “I think if you’re a handy person, you might be able to address a lot of the issues yourself,” Reiss says. He describes such buyers as anyone who has “a can-do attitude and is looking to trade sweat equity for home equity.”
Reiss and Mendenhall agree that flexibility is crucial to successfully shopping for and purchasing a foreclosure. Mendenhall notes that a foreclosure sale can take a long time to complete. “It can be a long process, or a frustrating one,” she says. “It can depend upon where they are in the foreclosure process. It can take a much longer time to go from contract to close.”
For that reason, a foreclosure might not make sense for buyers who need to move into a property quickly, she says. Also, think hard about how you really feel about buying a house that needs extensive renovation work that might take a long time to complete.
“It can be hard for some people to live in a property and do repairs at the same time,” Mendenhall says.
September 4, 2018
Housing Finance Transitions
By David Reiss
The Congressional Budget Office released a report, Transitioning to Alternative Structures for Housing Finance: An Update. The report updates a 2014 analysis
to inform policymakers about how different approaches to restructuring the housing finance system would affect federal costs, risks to taxpayers, and mortgage interest rates. The study focuses on the secondary mortgage market, in which financial institutions buy residential mortgages, pool them into mortgage-backed securities (MBSs), and sell the securities to investors with a guarantee against defaults on the underlying loans. That market is dominated by Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs) that have been under the control of the federal government since the financial crisis of 2008.
• Federal Costs. CBO projects that under current policy, the GSEs will guarantee almost $12 trillion in new MBSs over the next 10 years and that those guarantees will cost the government about $19 billion on a fair-value basis. That cost represents the estimated amount that the government would have to pay private guarantors to bear the credit risks of the new guarantees. New structures for the secondary mortgage market that emphasized private capital would greatly reduce federal costs, compared with current policy, and would decrease taxpayers’ exposure to credit risk, but mortgage borrowers would face slightly higher costs.
• Risks to the Government. Three of the four approaches to restructuring the secondary market that CBO analyzed would keep some type of explicit federal guarantee of MBSs to provide stability to the market during a financial crisis. Under those approaches, the government would continue to bear most of the risks on new guarantees during a financial crisis, but the approaches differ in the extent to which private guarantors and investors would share risks under normal market conditions. Alternatively, if the secondary market were largely privatized, there would be no explicit federal guarantees on most residential mortgages. But some type of government intervention might be necessary to stabilize mortgage markets during a financial crisis.
• Availability of Mortgages and Changes in Interest Rates. New structures for the secondary market that emphasized private capital would lead to slightly higher interest rates and slightly lower home prices under normal conditions (because the fees that the GSEs currently charge for their guarantees are close to the prices that CBO judges private firms would charge). If the market were controlled by a single, fully federal agency, interest rates could fall slightly. During a financial crisis, however, borrowers could face significant constraints on the availability of mortgages and higher interest rates under a largely private secondary market, though not under the other structures, unless the government chose to intervene.
This report is particularly valuable because it focuses on the transition from the limbo state of conservatorship that we find ourselves in to a more stable one that is built to last. The report considers four possible pathways:
Things still are very much up in the air as to which way things will go when Congress finally turns its attention to this issue, but this report helps to plan for the transition no matter which path is followed.
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