Despite the media continuing to tout great buys available on Ã‚Â“distress salesÃ‚Â” -- foreclosed homes and Ã‚Â“short salesÃ‚Â” -- those reports tend to minimize the downside of buying distressed properties.
Despite the media continuing to tout great buys available on “distress sales” -- foreclosed homes and “short sales” -- those reports tend to minimize the downside of buying distressed properties. Here are several things to consider if you are thinking about buying a foreclosure or short-sale property:
1. If you are expecting deep discounts off listed prices, think again!
Many prospective buyers of foreclosure and short-sale properties believe they will be able to buy distressed real estate at 20 or 30% "off list." While there are occasional exceptions, in most cases such deep-discount offers will be a waste of a buyer's time and effort. They will quickly discover they are very often competing with multiple offers from cash buyers and 20% to 50% down conventional mortgage buyers. Why? Because the deep discounts are usually already built into the listed price.
2. Foreclosure listing prices encourage fast, uncomplicated sales.
Most banks hire two or three very experienced real estate brokers or appraisers to give them more than one opinion of value on a distressed property. While there are some cases where banks have accepted offers 10% less than the listed price, in most cases, the listed price takes the property's condition and marketability into consideration. The property is priced to sell quickly and with as few complications to the lender & asset manager as possible.
Why are foreclosures priced so low? First, banks cannot lend money when their assets are tied up in bad loans. They need to dump them to free up lending capital. Two, they have so many bad loans on their books that their asset managers do not have time to cater to buyers who want things fixed, like bad furnaces, water damage, etc. They price them to get rid of them as quickly as they can without investing in repairs.
3. Buying As-is means “as-is.”
Many foreclosed homes have no utilities operating – no lights, no gas, water lines disconnected, etc. Some have been winterized properly; others haven’t been winterized at all. Even if the home appears to be winterized, there is no way to tell if it was winterized before freezing weather had already done damage.
Many lenders and third-party foreclosure companies will NOT agree to turn the utilities on for a buyer to perform inspections. If competing offers are submitted, the bank will most often choose to accept the offer which waives any and all inspections (i.e. the buyer is willing to assume all risk regarding frozen pipes, bad furnace, etc.) While experienced real estate investors may have the cash on hand to assume such risk, most home buyers do not.
In some cases, the lender or asset manager will allow a buyer to assume responsibility for the utilities so the buyer may perform inspections. The buyer must pay to connect utilities in the buyer’s name; they must pay for any and all utility connection fees; they must pay to de-winterize the property and then pay to re-winterize it after the inspections are performed.
4. Sales may not be subject to inspections.
In non-distressed home purchases, a sale is usually subject to inspections. That is, if a buyer finds the property's condition to be unacceptable based on the inspection report, he has the right to terminate the transaction and get his earnest money refunded. This is not necessarily the case with distressed properties. Many banks and asset managers require that buyers sign an addendum stating the sale is not subject to inspections and in the event the buyer opts to terminate the contract as a result of his inspection results, the buyer will forfeit his earnest money to the lender.
5. Earnest Money Deposit must be received before offer is submitted.
Earnest money deposits must be received from the buyer before an offer is submitted to the lender. Most lenders and asset managers require a minimum $1,000 earnest deposit in certified funds (bank money order or cashier’s check) and made payable to and held by the lender’s title company. Even if the sale is subject to inspections, imagine how difficult it could be to get your earnest deposit refunded if your inspections uncover major defects and you want to get out of the deal!
6. You must provide proof you can get a loan.
Banks and asset managers will require that a Letter of Prequalification accompany your offer. They won’t even look at your offer without one.
7. Low down payment financing will require necessary repairs to be completed prior to closing.
Many first-time home buyers are intending to finance their home purchase through a low down payment F.H.A. (Federal Housing Authority) loan or P.M.I (private mortgage insurance) financing. Neither F.H.A. nor P.M.I. will underwrite a home purchase if the collateral (the property) has water damage, a bad furnace, or even minor defects like broken windows or missing handrails.
In either form of underwriting, the lender's appraiser will typically require inspections be performed. If the buyer wants to continue with the transaction, he must pay to have the lights turned on, etc. (see Paragraph 2 above). The costs of paying for utility connections and de-winterizing & re-winterizing will increase the price of inspections considerably. A typical set of inspections will cost $400 - $600 – structural, electrical, heating & cooling, plumbing, radon, termite, and, where applicable, fireplace and chimney, swimming pool and equipment. Add in the cost of utility connections and winterizing and the cost for inspections may exceed $1,000 -- money you lose if you choose to walk away.
Additionally, any repairs which are required as a condition of financing must be completed (and paid for) prior to closing. A buyer attempting to purchase a foreclosure property may be faced with repairs ranging in cost from a few thousand to tens of thousands of dollars. Most home buyer simply do not have unlimited resources to make the required repairs in addition to their down payment, closing costs and the higher costs of inspections.
Before you jump on the foreclosure bandwagon, know what you’re getting into!
8. Short Sales face additional challenges.
As if buying foreclosures isn’t difficult enough, try to buying a “short-sale” property! A short sale occurs when a home is being sold for less than what is owed to the bank. However, there are three significant additional headaches a buyer will encounter when attempting to purchase a short-sale property.
9. Listed prices mean nothing to the bank.
Here's an example: Several buyers are interested in a home listed at $100,000. However, the outstanding balance on the mortgage is $150,000.
The Realtor® representing the bank may already know the bank will not accept $100,000 but lists it on the MLS anyway, hoping to entice buyers to make offers. The Realtor may even be attempting to generate multiple offers from buyers who recognize the $100,000 list price is an exceptional value.
When the Realtor receives an offer for $100,000, the Realtor submits it to the lender for approval. Before responding to the offer, the bank will require at least one appraisal. The bank's acceptance or counter-offer will be based entirely on the appraiser's estimation of value, not on the Realtor's list price on the Multiple Listing Service.
For purposes of this illustration, let's pretend the appraiser determines the value to be $130,000 and the bank counters accordingly. Understandably, a buyer who doesn't understand the rules of the short sale game may feel they've just been baited by a low list price. Despite offering full price, they didn't get the house.
As a real estate professionalism for more than 23 years, I believe this type of pricing is, at best, misleading to the public … if not fraudulent.
10. Lenders have very little incentive to make a decision.
If you make an offer on a short sale, be prepared: You may not hear a decision from the bank on your offer for weeks or even months. Short sales are notorious for sitting on the desk in a bank’s Loss Mitigation Department. Bear this in mind: You and the homeowner are asking the bank to accept a loss. Banks don't typically enjoy losing money. They are in no hurry to make a decision. In one short sale I was involved in, it took 10 months to get a response from the bank and then another three months to get it closed. If you need to be in a home in a reasonable period of time, short sale properties may not be your best option.
11. Lenders have no reason to take a loss.
Most mortgages are underwritten by a mortgage insurance company like F.H.A or P.M.I. If the property was underwritten by F.H.A. or P.M.I., The bank has virtually no incentive to take a loss. After all, the loan is insured and they will most likely get more money by foreclosing and having the mortgage insurer pay them off.
12. Abandoned short-sale properties may become foreclosures without notice.
Many short sales properties are abandoned and face the same risks as foreclosures regarding the costs of inspections. Additionally, if the lender discovers their collateral (the property) has been abandoned, the bank may opt to secure their investment by starting the foreclosure process immediately and accelerating the bank's right to possession of the property due to abandonment by the homeowner. Such acceleration will supersede any short sale being considered. If you still want to buy the home, you will need to wait until it returns to the market as a foreclosed property.
13. Still interested in foreclosures and short sales? Find a knowledgeable Realtor to help you.
If you still want to pursue buying distressed properties after reading this, choose a Realtor who is knowledgeable about the process. He or she will most likely know how avoid as many pitfalls as possible and to deal with those you can't avoid as expeditiously as possible.