Foreclosures - Can I Buy One? Should I?

The economic downturn creates distress and opportunity, and recently we've received an increased number of calls about the potential of purchasing foreclosures.

Presently, foreclosures are not increasing substantially due to the number of forbearance and relief programs offered to borrowers. However, if the economic downturn is extended we may see foreclosures rise significantly in 12-24 months. 

With regard to purchasing a foreclosure property, while this can be a way of purchasing a property at a discounted rate, however there are several notable challenges:

• Auction - you must purchase the property at an auction.
  
  

• Cash Required - you must pay for the property immediately after winning the auction, which means bidders need to have access to cash on the day of bidding.
  
  

• Limited, Costly Financing - there are some lenders which provide this funding for auction bidders without cash. However they often require excellent credit and 25-30% down payment from a borrower to qualify for the loan. In addition, they charge interest rates and loan fees which are 400-600% higher than a conventional loan and require the loan be paid off (or refinanced to a conventional loan) within 9-18 months. Finally, most of these lenders will not lend for the purchase of a principal residence, as they do not want to be subject to limitations on their ability to foreclose on the property.
  
  

• No Inspection or Tours - you are not permitted to tour or inspect the property prior to bidding. This means you may not know the true condition of the property you are purchasing, which can add substantial sums in repairs.
  
  

• Eviction - if there is a tenant in the property (legal or otherwise) and you are the winning bidder, you must work through the legal process of eviction to remove them.
  
  

• Minimum Bids - the lienholder foreclosing on the property may set a minimum bid which is up to the total amount they are owed including principal, interest, fees and penalties. Because of this relatively few foreclosure properties sell for substantially (10% or more) less than their actual market value. Those with minimum bids 10% or more under their market value attract substantial competitive interest from bidders which often will raise the price to within 10-15% of their market value.

We find those purchasing foreclosures are buyers with access to large sums of cash and/or credit, and able to take larger financial risks where the potential loss of $50-100k is not devastating and all part of the process of trying to make substantially more. 

Best Alternative For Most Buyers

We understand the challenges of the high cost of housing, and the attraction of trying to find discounts on buying a home. However, we also understand making the wrong investment in the can lead to severe financial consequences. Therefore, we recommend buyers who are most interested in building equity quickly consider:

• Purchase a Fixer - find a property with good structure and systems which looks ugly either due to lack of maintenance/updating or ineffective design. Many of these properties are overlooked by folks wanting a move in ready home, and will sell at a discount to the market. Once you're an owner, with patience, work and investment you can build equity faster than the local market.
  
  

• Purchase in a Transitioning Neighborhood - look for neighborhoods which are experiencing growth and renewal, where demand will continue to grow potentially stronger than other communities. Right now, these are often found either in the areas adjacent to light rail and other transit options or in the neighborhoods near the city with protective zoning/covenants which help keep larger lots/privacy while still being closer to the economic centers.
  
  

• Consider Mortgage Insurance - some buyers wait until they have 20% saved for a down payment so they can avoid the $100-300/monthly mortgage insurance premiums which come with mortgages with less than 20% down. However, saving such a substantially down payment can take 5-10 years, meanwhile the values of homes often rise faster than they are able to save. This means in their effort to avoid $3,000 in yearly mortgage insurance premiums over the first 5 years of owning a home, they also lost out on 5%+ in annual value gains on the same home. While they may have saved $15,000 on insurance, they lost more than $100k of apprecation on their property if they would have bought and paid mortgage insurance.

We'd love to tell you there is a quick, easy and low-risk way to becoming wealthy with real estate, it just isn't reliably possible without simply being lucky.  We can make any path to real estate wealth easy to follow however you must choose:

• Time & Patience + Low Risk - near guaranteed path to wealth with very low risk. Simply save a small down payment, purchase a great property and hold it for a long time.
  
  

• Speed + High Risk - big risks which come with the potential for substantial rewards, or devastating losses. Essentially, this is the real estate equivalent of playing poker.. you can bend the odds to your favor with skill and wisdom, but at times you'll just get unlucky and be wiped out.

Based on our experience, most people should pursue the lower risk path and only venture on the high risk path with money they are comfortable losing. We know the low risk path makes a huge difference resulting homeowners having an average net worth rough 50 times greater than renters ($250k vs $5k). Often this simply comes from paying their mortgage to themselves as opposed to paying their landlord's mortgage.