By Stephanie Brimo
First, let me describe a foreclosure. Also known as an REO sale or a bank-owned sale, a foreclosure takes place only after the home’s original owner has stopped paying the mortgage for a long enough time (often a year or more) that the bank has the legal right to repossess the home. After repossessing the home, the bank sells the home to recover the unpaid money on its loan.
People are interested in foreclosures because they can be had cheap. Banks want to sell the home quickly and only need to cover the amount owed on the mortgage, which often means that the home will sell well below market price. But before going after that discount, you need to understand all that’s involved.
Unless you have a high tolerance for stress, an excellent real estate agent, lots of financial liquidity and above-average knowledge of construction and home rehabbing, I would advise a first-time buyer against making an offer on a foreclosure. Why would a first-time buyer stay away? Here are eight reasons:
- When you’re a first-time buyer, even a normal transaction can feel overwhelming. Most first-time buyers experience some stress, even if they have an excellent real estate agent. So don’t add to it by taking on a foreclosure, which is high stress and requires quick decision-making and expert knowledge. For a first-time buyer, it’s often too much.
- Disclosures aren’t required on foreclosed homes. Because the bank (the seller) hasn’t lived in the home, it is not required to disclose problems with the home. In many respects, the bank’s guess is as good as yours. So you need to be very careful (and have expertise) in evaluating the quality of the home. You really need to have a thorough, high-quality inspection done.
- The contract will heavily favor the bank. You won’t get a standard contract. The bank wants to get rid of the property as soon as possible, with no liability. The bank will dictate the closing date and terms, with little wiggle room. If this makes you uncomfortable, the bank will find another purchaser.
- Getting a loan for a foreclosure can be more difficult. Federal Housing Authority (FHA) loans require that the home be “habitable” before the loan is issued and the habitability standards often require that there aren’t any missing appliances, peeling paint or holes in the drywall, for example. For a conventional loan, you would need to alert your lender that you’re interested in buying a foreclosure and be approved for a loan on that particular property before you make an offer. If the property appraises to decent condition or better (usually C4 or higher), then the terms of the loan would be the same as a normal home purchase.
- Banks prefer cash. Because they don’t need market value, banks will often underprice the property to get multiple offers, in hopes that one (or more) is all cash. If you’re not able to pay all cash, your offer won’t hold up against those who can.
- Property repairs are almost inevitable. Frequently in foreclosures, no one’s lived in the home for at least a year. So even if there aren’t major structural problems, there are going to be repairs. The previous owner knew the place was being repossessed and may not have taken good care of it.
- Making repairs is time-consuming and requires expertise. Be prepared to hire a general contractor, or to fill that role yourself. Depending on the home’s condition, you may not be able to move in for several months after you buy.
- Paying for repairs requires liquidity. Especially if you’re stuck doing major repairs,you may end up spending tens of thousands of dollars making the place livable. This is above and beyond the amount you need to buy the place. If you don’t have the cash for it, rehab loans are harder to find and have less favorable terms than mortgages.
So there are a number of reasons you may not want to get involved in a foreclosure as a first-time buyer. That said, you can find a good deal if you happen to have a lot of cash, have specialized knowledge of home repair, are a patient and thorough person and are committed to a long-term project. Just make sure that you work with a knowledgeable agent, such as those at Redfin, and make sure that you have an expert team in all respects – including your lender, lawyer, inspector and general contractor.
Stephanie Brimo is an Agent at Redfin, a national real estate brokerage. She’s a proud University of Michigan alum who has worked in real estate for nine years. Brimo lives and works in Chicago and has closed over 130 deals for Redfin.