How to Buy a Foreclosure

how do foreclosures work?Getting a great deal on houses is key to my real estate investment strategy. Buying a house from a foreclosure auction is one way to get a great deal, but it comes with risk. You can also buy foreclosures from the MLS (multiple listing service), which are often called REOs. It is even possible to buy foreclosures directly from banks, but that is a very rare and tough strategy to implement. I have bought many foreclosures in my career as an investor, and I have sold many REOs as a real estate agent. I have sold many HUD homes as well, which are government foreclosures. In this article, I discuss many ways to buy foreclosures and the pros and cons of each. I also show videos of foreclosures I have bought from these sources.

Should you focus on buying foreclosures?

A lot of investors only want to buy foreclosures, but that is not the only way to get a great deal on real estate. I flip from 20 to 30 houses a year, and I also buy multiple rental properties each year. I rarely buy foreclosures because there are not that many in my market, and they are not always a great deal. You can get a great deal on a foreclosure, but do not rely on them as your only source for deals. We also get deals from:

  • Wholesalers: Wholesalers will find deals (usually off-market properties) and sell them to investors. I have bought many houses from wholesalers.
  • MLS: The MLS is the multiple listing service and is where most houses are listed for sale by real estate agents. I am a real estate agent, which gives me a huge advantage, but there are deals on the MLS. We buy quite a few rentals and flips every year.
  • Off market: There are many ways to buy properties that are not listed for sale. You can use bandit signs, direct mail, drive for dollars, door knocking, or even websites to find property owners who want to sell but have not listed their house for sale yet.
  • FSBO: For sale by owner houses are another great way to get deals. Sellers may not want to use a real estate agent for many reasons, so they list the house for sale on their own. Often, they underprice the home, which leaves an opportunity for investors to pick up the property.

Part 1: How to buy a house from a foreclosure auction

There are many different types of real estate auctions that come with varying amounts of risk. The riskiest auctions are the local foreclosure sales because they require the quickest payment with the least amount of due diligence available. Every state has different laws regarding foreclosure auctions, which will make it very tough for inexperienced buyers. Make sure you know your local laws before bidding!

A foreclosure auction gives the general public a chance to buy homes that are being foreclosed on by the lien holder. Before the lien holder can take possession of the house through a foreclosure, they have to offer it up for auction. The bank or lien holder will make a starting bid, which may be what is owed on the loan including late fees and interest. The bank can also start the bidding at less than what is owed.

If no one bids on the home at the foreclosure sale, the house will go back to the bank. At that point, the house becomes an REO and will most likely be listed for sale on the MLS (more on that later). Investors or even owner-occupied bidders are allowed to buy houses at the foreclosure sale if they bid more than the bank’s bid (assuming the bank isn’t bidding as well, which is possible). I used to buy most of my fix and flips at the foreclosure sale in Colorado, and I even bought a personal residence at the foreclosure sale. We very rarely buy from the foreclosure sale now because there are so few foreclosures in our area and other investors are willing to pay more than us 95% of the time.

Below is a video of a property I bought from the foreclosure auction:

How does the foreclosure sale work in Colorado?

Here is how the foreclosure sale works in Colorado:

  • The pre-sale list is published every Monday afternoon, which lists the properties going to sale and the starting bid.
  • The foreclosure sale is on Wednesday morning at 10 a.m. You can call the public trustee’s office on Wednesday before the sale to see if any properties you are interested in are still going to auction.
  • The auction is conducted and all bidders must register before the auction in person at the public trustee office. The auction is live and goes very quickly.
  • The winning bidders must sign a form, and they have until noon on Wednesday to come back to the office with a cashier’s check for the full amount of the bid. If the winning bidder does not show up, the second-highest bidder is notified and given a chance to buy the property at their highest bid.
  • There is a short redemption period for junior lien holders in Colorado that lasts at least 10 days. A junior lienholder can redeem the property by paying off the first bid amount plus interest in full. Junior lienholders may be second loans, people who have judgments against the previous owner, or even an HOA.

In Colorado, there is no guarantee you are bidding on a first loan or will get a clear title. On the day before the sale (Tuesday), we would get an O and E (ownership and encumbrance report) from the title company, check out the house as much as we could, and then decide if it was worth bidding on the home. There is also no way to get inside the house to see it, at least legally, and there may even be people living in the home.

What are the foreclosure laws in other states?

The process I outlined is only for Colorado. Other states have much different laws and each state handles their auctions differently. Here are a few differences:

  • Some states require proof of funds before the auction. This requires bringing cashiers checks for the full amount you want to bid.
  • Some states give much less notice of what houses will go to the sale and what the bids will be. I have heard some areas only have hours to research properties before they are sold.
  • Some states have owner redemption periods, which means the owner of the home has a period of time to pay off whoever bid at the sale and get the house back. Some states have redemption periods as long as 6 months!
  • Some states allow the buyer to get title insurance and have weeks to complete the sale.

Make sure you know exactly how the foreclosure auctions work in your state before you bid. When I used to attend our foreclosure auctions, I saw many new investors check out the auctions for weeks to see how they worked. I have also seen new investors bid on a second loan assuming it was the first and lose a lot of money!

What is the risk/reward of foreclosure sales?

The fewer people you have to compete with when buying a house, the better chance you have of getting a great deal. Very few people buy from the foreclosure sales because they can be very risky and take a lot of upfront money.

  • Cash purchases: many auctions require the buyer to pay cash for houses they bid on. Foreclosure auctions may require the buyer to have cash the same day they bid or before they bid on a property.
  • No inspections: many auctions do not let buyers inspect a house before or after they bid on it. In some cases, a house may be occupied, and the buyer cannot inspect the interior until an eviction is completed. We bought many occupied, and we could not view the interior. If the house is occupied, you can’t just kick out the occupant. You have to evict them or possibly honor their lease if they have one.

All of these factors make it tough for most buyers to purchase homes from auctions. The majority of house buyers are owner-occupants who need to get a loan. Most investors also need a loan to buy a house, and auctions that require cash to eliminate those buyers as well. Many buyers are scared of auctions because of the possibility of losing earnest money, the lack of inspections, and other issues. That usually leaves the experienced investors to battle over houses. The experienced investors know how much they can pay for houses that come with all this risk and still make money. Some online auctions are less risky than foreclosure auctions, which can provide opportunities for less experienced buyers.

How did I lose money on houses I bought at the foreclosure sale?

I have made a lot of money from houses we bought at the foreclosure sale, but I have also lost money because of the nature of the auction.

On one deal, we had the winning bid on a house at the foreclosure auction. We had an O and E that showed we were bidding on a first-position note, and we viewed the home before the sale. We looked through the windows, and the house appeared to be completely vacant. After winning the bid, we found out the previous owners filed a lawsuit against the bank claiming the bank wrongly foreclosed on the home. The lawsuit had not been recorded yet, and we had no way of knowing about it. In the end, the lawsuit was thrown out, but it took the judge one year to look at the case, and we had to hold the property that entire time. After interest and carrying costs, we ended up losing money.

How to buy houses sight unseen

In many instances, I had to buy a house without seeing the interior. There are no open houses or showings when you buy a house at the foreclosure sale. Some investors will try to get into homes before the sale, but if you’re caught, it is trespassing and could be considered breaking and entering as well.

When buying a house you can’t view you have to consider how much the repairs could be. I almost always bought the houses from the auction for flips, so I knew how much my repair budget could be to make money. I would always assume a house would need new flooring, paint, appliances, fixtures, and at least $15,000 in other repairs depending on the age of the home. Sometimes, we got lucky and the house needed less work, and sometimes it needed more.

I also tried to talk to the occupants before the sale to get as much information as I could. This is not a fun situation, especially if you’re talking to someone about buying a house they are losing to foreclosure. Most people are actually friendly and will at least tell you if they are renting or if they own. Often, they have no idea how the process works, and you can build rapport by telling them how it works and what the timelines are.

How do online foreclosure auctions work?

There are many types of auctions, and some banks use online or in-person auctions to sell the house once they have completed the foreclosure. HUBZU, Homesearch, Auction.com Williams and Williams, Hudson and Marshall, HUD, and many more sites hold auctions for REO properties that the bank already owns. These auctions have much different terms than the foreclosure sales and are much easier to buy from.

REO stands for Real Estate Owned and is often how banks refer to the foreclosures they own and are trying to sell. You may also hear the term OREO, which stands for Other Real Estate Owned.

The auctions for properties that are already owned by banks have very different processes depending on the bank or asset manager selling the property.

  • Some properties are sold sight unseen as well, and some are occupied.
  • Some properties will require cash to purchase the home, but they usually give the buyer at least two weeks to buy the house and get the money together.
  • Almost all the auctions will require some form of earnest money or a deposit. Most of the time, this money is nonrefundable.
  • Some auctions will offer title insurance, and some will not.
  • Some auctions will offer time for the buyer to get a loan.
  • Very few, if any, auctions will allow an inspection period.

Below is a video of a house I bought from Auction.com

Part 2: How to buy an REO property that is listed on the MLS

I was an REO listing agent, and I listed foreclosures for over 35 banks, HUD, asset management companies, and hedge funds. REO transactions are much different from auctions. Homes that are listed on the MLS give the buyers more protection, and I will show exactly what a buyer should expect through the entire purchase process. One thing to keep in mind is every bank and asset manager has different policies, and transactions are not handled exactly the same. Not only am I a listing agent for REOs and foreclosures, but as an investor, I buy them as well.

What is an REO property?

REO stands for Real Estate Owned and is the term banks use to describe their foreclosures. The previous homeowners fell behind on their payments, the bank started the foreclosure process, the property sold at the foreclosure sale, and the bank took title to the property. REOs are homes that are owned by the bank, are almost always vacant, and can be purchased fairly easily. However, just because a bank is selling a home does not mean it will be an awesome deal. Banks also have many restrictions on who and how their properties can be bought. They are not looking to unload properties for pennies on the dollar.

Who can buy an REO property?

There is a huge push in the REO industry to sell foreclosures to owner-occupied buyers. HUD, Fannie Mae, Freddie Mac, Wells Fargo, and other banks, have owner-occupied-only bid periods. This makes it very tough for investors to buy REOs from these companies, but there are still opportunities for investors. The key for investors is to submit an offer as soon as the owner-occupant period expires (if that property has an owner-occupant-only bid period). I also watch for any properties that come back on the market which are eligible for investor purchases. Many of the properties I buy were under contract at one time, came back on the market, and I made an offer that same day.

Many may think I have an advantage when buying REO properties because I used to list REO properties. However, when I was an REO listing agent, I was prohibited from buying my own listings, and when I listed HUD homes, I was prohibited from buying any HUD homes.

Below is an REO property we recently bought:

Can you get a good deal on an REO?

Buying an REO property can be more difficult than purchasing a regular listing. The reasons for buying foreclosures are simple: they can be priced lower than similar fair-market properties. In reality, I don’t care if a property I buy is an REO, a short sale, a fair market sale, or not listed at all. I care what the price is and whether I am getting a great deal. The main reason REOs are cheaper than other homes is they may need work and may even need so much work that they can’t qualify for financing. If a home can’t qualify for financing, that eliminates 75 percent of buyers in my area. The fewer buyers there are, the lower the price, and the better deal I can get.

Right after the housing crisis, it was easy to get a great deal on a foreclosure. There were tons of distressed properties, and banks did want to let them go as soon as they could. As the housing crisis progressed, banks created stricter guidelines and focused on getting as much money as they could. There are deals on foreclosures, but banks want to make as much money as they can on these properties—just like any other buyer. Some banks even make buyers wait days before the bank will look at offers to make sure everyone gets a fair chance.

How to make an offer

Once you find a foreclosure to buy, making an offer on it is similar to making an offer on a regular listing with some additional paperwork. Banks all tend to use their own addendum to go along with state contracts unless the home is a HUD or VA property, in which case the HUD or VA contract is used. You will need a licensed real estate agent to make an offer on HUD homes or REOs.  Besides negotiating the price, there are a few things to remember.

  • The bank will require a pre-qualification letter or proof of funds letter before they will even consider your offer. A pre-qualification letter is a letter from your lender saying you have the ability to get a loan.
  • The bank will require a copy of the earnest-money check when you submit your offers and may require the check to be certified funds.
  • The bank can take a long time to sign docs or respond. Some banks act quickly (1 or 2 days), while others can take 10 days or longer to respond!
  • The bank has the right to cancel the contract at any time for any reason. They very rarely cancel contracts without a reason, but they have the right to do it.
  • Nothing is under contract until all documents are signed by all parties! Banks are very clear that their verbal offers or counters are not binding. If you have something agreed upon with the seller, get the docs signed, and go to the bank ASAP.
  • Make sure you read the addendum, especially in regard to the inspection, appraisal, and closing process. If there is a difference in the state contract and the bank addendum, the bank addendum will win every time.

How much below list price can you offer?

When I was listing REOs, I saw many offers come in from buyers, and I saw the bank’s response to those offers. There is a misconception among many buyers that banks simply want to liquidate their properties and don’t care how much money they get for them. The banks want to get as much money for their properties as they can, just like any seller. The amount they will accept below list price varies depending on the bank and the property. The longer a home has been on the market, the less the bank will accept. In my experience, banks might negotiate up to ten percent off the list price when a home is first listed. They may accept less, but it is rare.

Once the house has been on the market for 60 days or longer, the bank will negotiate more. If you find aged REO listings, there is much more opportunity to negotiate. Do not expect a bank to accept offers 50 percent below list price simply because they want to get rid of them.

How does the inspection process work?

Once you get an REO under contract, you usually have the right to do an inspection (sometimes an investor will remove his inspection contingency to make their offer stronger). Usually, the bank gives a buyer 10 days or less to complete the inspection on a foreclosure.

Winterization

The bank may or may not de-winterize a house for you. In states where it gets cold enough to freeze, banks will winterize their properties during the winter months. Winterizing means the bank hires a plumber to shut off the water, blow out the pipes, and put antifreeze in toilets and p-traps. This process hopefully prevents the pipes from freezing if the heat is off or if the heating system fails. In order for the buyer to complete their full inspection, REOs need to be de-winterized: the water is turned on, any leaks are fixed, and the system is pressurized. Some banks will de-winterize a home for the buyer at no cost; some banks will de-winterize and charge the buyers for it; and some banks (HUD) leave it up to the buyer to de-winterize.

Will banks repair houses?

If, during the inspection, the buyer finds problems with the home, the bank may or may not fix the issues. Each bank is different regarding how they handle inspection requests. Sometimes, banks will make minor repairs on items that might delay financing, like a plumbing leak. Other banks won’t do any repairs, and others may make other repairs that are only required for financing. There really is no way to know what the bank will do because each situation is looked at on a case-by-case basis. The rule of thumb is not to count on any repairs being made, although you may get lucky with some sellers.

Will banks decrease the price based on inspection?

If the buyers want a lower price based on the inspection, they are most likely out of luck. It is very rare that a bank will lower the price unless there is a massive problem that was not known at the time the buyer made an offer on the home. In fact, most banks will flat-out reject any inspection requests if it was likely the buyer already knew about the item before writing the contract.

How does the appraisal process work?

If you are getting a loan on a foreclosure, you most likely will need an appraisal to be done on the home. An appraisal is a report done by a licensed appraiser that gives a value on the property. If the appraisal comes in low, your loan can only be based on the appraised amount. With a low appraisal, the bank may or may not lower the price for the buyer. Low appraisals are a huge issue for us right now, although low appraisals are rare on bank-owned homes since they are usually priced well.

The appraiser may also say the house won’t qualify for a certain loan if it is not in good condition. For a home to qualify for FHA appraisal guidelines, it has to be in decent condition. The plumbing, electrical, heating, and other systems all have to be in working order. If the appraiser determines these systems are not in working order or the home needs other repairs, the home can’t go to FHA. The only option is to have the seller make the repairs before closing or add an escrow account for repairs to be made after closing. Some banks will make repairs, but many will not, even if the deal dies because of the needed work. Many conventional loans have the same guidelines as FHA. VA, USDA, and other loans have basic requirements all homes must meet to qualify for financing.

An FHA 203k loan is one way to finance a home that needs a lot of work!

What does “as-is” mean?

Most REO properties are listed as being sold in as-is condition. That means the way the home sits as it is now is how the bank will sell the home. As you can see from what we have discussed in this article, some banks will make repairs and some will not. Just because the home is listed in as-is condition does not mean repairs won’t be made, but it might. There really is no way to know what the bank will do until you formally ask the bank to make repairs after an inspection or appraisal. With HUD, the house is sold strictly as is, and they will not make repairs.

What does “no inclusions” mean?

Many bank contracts state there are no inclusions with the home. Inclusions are items that are not attached to the home but may be sold with it like a dishwasher or stove. This can be confusing because there may be a stove, refrigerator, or other items in an REO. The bank’s policy is to always list nothing included, even if there are items in the home. The bank will not take these items out before closing, and the homes are sold just as they are when they are listed.

Should you ask for the seller to pay closing costs?

When you get a loan on a property, closing costs can amount to up to 3 percent of your loan amount. This money must be cash brought to closing by the buyer unless the buyer asks the seller to pay for part of the costs. Most banks and HUD will pay closing costs for the buyers, but it must be stated in writing in the contract. Remember, those closing costs will make your offer look lower than a similar offer without closing costs. The seller may also ask you to raise your purchase price to make up for any closing costs that are paid by the seller.

Can the buyer choose the title company?

Many banks and REO sellers have title companies they like to use on their transactions. Many states, like Colorado, have laws that state the buyer may choose their own title company. However, that does not mean the seller has to pay for the buyer’s title work. It is typical for the seller to pay for the buyer’s title policy (although HUD and VA do not), but many banks will not pay for the buyer’s title policy if the buyer chooses their own title company. Title policies vary in cost, but a typical policy can cost $1,000. Title policies are very important and guarantee a clear title to the property.

For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook, and is an Amazon bestseller.

Can you buy an REO before it is listed?

 “How can I buy a foreclosure that is not for sale yet?” Typically, investors are asking how to buy a house that has been foreclosed on and is currently owned by the bank. The home has not been listed by a real estate agent yet, but it is vacant and may have been vacant for a long period. In most parts of the country, it is getting harder and harder to find awesome deals since the REO inventory has decreased. These vacant properties appear to be great opportunities to buy cheap houses if you can buy them before they hit the market.

If you are looking to buy a foreclosure that is not listed, you have to first figure out what stage the home is in. If the house is still in the foreclosure process, the borrower owns the home—the bank does not. The banks cannot sell a house if the foreclosure process has not been completed. The owner may sell the house if they can pay off the bank and all other lien holders, or they may try to complete a short sale. If you are an investor looking to buy a short sale, be careful how you do it to avoid short-sale fraud.

If the house had gone through the foreclosure sale, you need to make sure the bank is the current owner of the house and the house was not bought by another investor. Public records will show who the owner of the property is.

Buying a house from the bank before it is listed is going to be very difficult, and depending on the bank, it might be impossible. I have tried to buy houses from banks before they were listed, and I know many investors who have tried as well. Here is a basic outline of how the process usually works when you try to buy a foreclosure from the bank before it is listed:

  • The investor spends hours trying to figure out who the actual owner of the property is. The title of the property can be under some crazy names like electronic mortgage registration C3121. If you do a little more digging and look at who the bank was that loaned on the house before it went to foreclosure, you can usually find out who the bank is.
  • The investor finds out who the bank is and spends hours on the phone trying to talk to someone who has a clue about how to buy houses from the bank. Usually, the investor calls about 20 departments and might talk to someone in the REO or defaulted-loans department (the banks all have different names for their foreclosure department).
  • Once the investor talks to someone who has some idea what the investor is talking about, the bank will tell the investor another company handles their REOs, and you will need to talk to them. Or, the bank will tell the investor they don’t sell their houses before they are listed.
  • If the investor was told another company will sell the property, they might try to call that company. The investor will go through the same circus and then be told that company doesn’t sell their houses before they are listed.

It is a rather frustrating process and a huge waste of time when you try to buy foreclosures from the bank before they are listed. The only time a bank might agree is if the bank is very small and local.

Why don’t banks sell their foreclosures before they are listed?

Most investors want to buy foreclosures because they are cheap and they can get a great deal. That is why I like to buy foreclosures. When a home is listed on the MLS, there is usually a lot of competition for houses that are priced very well. Often there are multiple offers, and the house is not as good of a deal as it first seemed. Investors think if they can buy a house before it is listed, they might be able to get a better deal.

This is exactly why banks do not sell their houses before they are listed on the MLS. The banks also know the more people that know their houses are for sale, the more the houses will sell for. Contrary to some opinions, the banks are not looking to get rid of houses as fast as possible with no regard for how much they sell for. The banks are just like you and me: they want to make as much money as they can. Even after a house is listed on the MLS, the banks will sometimes not look at offers for weeks. They want everyone to get a chance to make an offer who wants the home.

When a bank lists a house, they will get multiple values from real estate agents. They will usually order an appraisal, and they will want the home marketed just like a traditional listing. The banks spend a lot of money on making sure they value a home correctly, on the real estate agents who sell the house, and on the lawyers who complete the foreclosure. They want to recoup as much of that money as possible, and selling a house on the MLS is the way to do that.

Big banks will sell thousands of foreclosures a year, and they have set up their systems to work with real estate agents or auction companies to sell those houses. For the banks to sell one house before it is listed to one investor, they have to change their system, change the valuation process, and it takes more work to make those changes. Plus, it may prolong the time it takes them to list a house if they are dealing with an investor who may not even end up buying the home.

Conclusion

There is a lot that goes into buying foreclosures! It can be very complicated, and the tricky part is each state has its own rules and laws on foreclosures. Each bank has its own policies for selling foreclosures, and every foreclosure is not a great deal. I am not saying you should avoid foreclosures when looking for a great deal, but do not expect it to be an easy process, and do not expect every foreclosure to be sold for pennies on the dollar. Do not limit yourself to only buying foreclosures as other types of deals can be safer and net you more profit.

Mark Ferguson Best Selling Books on Amazon

Get the bestselling books from InvestFourMore on Amazon and Audible!

Categories Buying
shares
[ Inside Real Estate Investing ]
[ Inside Real Estate Investing ]