Foreclosures and REO
There is money to be made in foreclosures for those who choose their property carefully.
Buying a foreclosure, or a property that the bank has taken away from the owner because he or she stopped paying the mortgage, 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. If you have questions along the way, feel free to contact us – we’ll be happy to discuss the foreclosure market in detail.
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. If they couldn’t afford to make the payments, it’s likely that they also haven’t maintained or fixed anything in months – at the minimum. Worse yet, some people, embittered by their situations and wanting to take out their frustrations, will deliberately trash the property before they’re forced out. After the occupants leave, foreclosures sit abandoned, often inviting criminal activity.
Here are some specific problems you may have to fix before making a foreclosure liveable:
Maintenance and Cleanliness
- Filth and stench. Bank-owned properties are sometimes disgustingly dirty because of time spent sitting empty, intentional neglect of cleanliness 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.
- Unpermitted changes. Being strapped for cash, the previous owners may have made changes to the home without getting the proper permits or hiring good labor. A common example is converting a garage into living space so more people can live in the home and help pay the mortgage. These changes may be undesirable or could create future headaches with city permitting officials.
- No electricity. With no one living in the home, the electricity is probably off. 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.
- Way behind on basic maintenance. If the previous owners couldn’t afford their mortgage payments, you can bet that they also couldn’t afford repairs, such as roof leaks, termite damage, a broken garbage disposal or anything else.
- Unfinished upgrades and poor repairs. 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 have filthy carpet. 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.
- Dead or overgrown yards. 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 don’t take everything with them. Many REO properties contain furniture, trash, clothes and other items that you’ll be responsible for disposing of when you become the property’s owner.
Vandalism and Neglect
- Vandalism. Sometimes when a property sits vacant, especially if it’s in a moderate-to-high crime area, vandals will tag the property, smash windows and do other things to cause damage.
- Broken windows. 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. Windows may also get broken for a normal reason, like an errant baseball, but with no one living in or actively monitoring the property, the window is unlikely to get fixed. At best, broken windows may get boarded up by the bank or by concerned neighbors.
- Damage to walls. Previous owners who took poor care of the property or wanted to inflict damage on it at the bank’s expense may have put holes in walls and/or torn off the baseboards and crown moulding.
- Removal of valuable items. To get revenge against the bank and to make an extra buck, the previous homeowners might have removed items that had value, including appliances, fixtures, the kitchen sink, bedroom doors, closet doors, copper pipes and more. Anything the homeowners didn’t take might have been taken by thieves. Either way, many REOs are missing things that generally come with seller-owned properties.
- Poor/subpar location. Where there is one foreclosure, there may be others in the same block or neighborhood. Lower-income neighborhoods are more likely to have foreclosures, because they are more likely to have homeowners who were given predatory loans or who don’t have the resources to endure economic hardship.
- However, as a result of the subprime mortgage meltdown, sometimes even nicer neighborhoods have a high number of foreclosures. You have to look at the usual indicators of value to determine if the high number of current foreclosures might be indicative of a longer-term problem or if it is only a temporary issue because of the current economic climate.
Problems With the Purchase
Despite all these potential problems, foreclosures can still be a good deal. If you’re willing to fix problems that most people don’t 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 ready to move in.
Issues With Lenders
- Financing. Lenders will not give you money for a home they consider uninhabitable or that appraises below the purchase price. Of course, if you’re an investor paying cash, this won’t be a problem.
- Significant time delays in dealing with the bank that owns the property. 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.
- No seller disclosures. Since no one from the bank has ever lived in the house, they’re unlikely to have any knowledge of existing problems with the property. You’ll have to uncover everything yourself – either during the home inspection, by asking neighbors or through experience after you become the homeowner.
- Competition between owner-occupants and investors to buy the property. Because foreclosures can be great deals, they’re 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.
Issues With the Property
- Feasibility of repairs. If you’re a potential owner-occupant, you may not have enough time, energy or cash to make the repairs. Before proceeding with the purchase, realistically assess your handyman skills, calculate how much cash you will have to fix up the property after your down payment, closing costs and moving expenses and get rough estimates for repair times and costs.
- Inspection reveals hidden defects or that visible issues are worse than they appear. This can happen with any property, but unlike traditional sellers, banks always sell properties as-is and will not make any significant repairs. As long as the purchase offer includes an inspection contingency, the buyer’s loss will be limited to the cost of the inspection and a little bit of time.
- Double housing costs. Foreclosures are not often move-in ready, and for potential owner-occupants, a foreclosure that needs significant repairs can mean double housing costs (rent on the old place plus a mortgage on the new place) until the property is ready. The other possibility is that the new owner-occupants will have to live in a construction zone or stay with friends/family for a while in order to avoid paying double for housing.
Still Interested in Foreclosures?
There is money to be made in foreclosures – you just need to know what you’re getting into ahead of time. This means you must choose your property carefully. What you don’t want to do is overlook the fundamentals that make a property desirable just because the purchase price is a bargain.
That’s where we come in. We can help you assess foreclosures for investment potential. We can even keep you informed of foreclosure properties as they hit the market. Just contact us or sign up for property alerts. We’ll be happy to help you hunt for that potential “deal” that a foreclosure or REO can offer.