If real estate agents had a nickel for every time they got asked this question-well, none of us would still be in real estate.
So if you’re thinking you want to buy a foreclosure in Delaware, Maryland, or Pennsylvania because of HGTV-or maybe you heard from a friend, family member, or coworker that they can be a good deal? Great! There are a couple things to think about here.
First, are you looking for a home or are you looking for an investment property?
Secondly are you looking to pay cash or are you looking to use a mortgage?
So here’s the deal on foreclosures: can they be a good deal? Yes, they can and here’s why: Foreclosures can be a good deal because 99% of foreclosures are not in livable condition.
Obviously if homeowners living there previously were having financial difficulties and couldn’t keep up with their mortgage payments they probably didn’t do the best job of keeping up with the condition of the home either. Couple that with the fact that foreclosures can often be vandalized-sometimes by the owner that is losing the home-and once a bank does take ownership they can often have it sitting there for months, maybe even years before putting it on the market which causes it to fall into more disrepair.
As a result of this condition, most foreclosure homes will not meet the minimum standard property requirements to pass for financing.
Now let’s dig into that a little bit. As part of the mortgage process the bank you are getting your loan from is going to send out an appraiser. The appraiser is going to go to the home they’re going to look at everything to basically do a mini inspection and they’re going to go back to their office and look at what other homes have sold for and come up with their opinion of the value of the property.
This happens because the bank does not want to lend you $400,000 of their money if the property is only worth $300,000.
In addition to coming up with their opinion on the fair market value of the property, the appraiser is going to inspect and stress several systems throughout the home; they will test the heating system, plumbing system, electrical, look at the foundation, look at the windows, and inspect the roof (as much as possible) to make sure there are no active leaks or missing shingles which could cause an active leak in the near future.
The appraiser has a list of guidelines depending on which type of mortgage the buyer is using, but every one of your common mortgages (conventional, FHA, USDA, VA) is going to have their own minimum property standards. If the property in question doesn’t meet one of those standards, then your mortgage company is going to require that those items be repaired before settlement. Here is where you run into a problem; most banks sell the property in “As-Is” condition, so they will not budge on making the repairs. That leaves a few options, but they could all be longshots. One option is to “escrow” for repairs, which is where you have the closing attorney hold money in an escrow account to be released only to the contractor who will be making the repairs to the property for you. This way, you can close on the home and get the repairs done afterwards. There are a lot of ways this can go wrong, and generally lenders and even attorneys don’t like doing this. The next way would be to get permission from the bank to make the repairs before closing; again, this is going to carry a pretty high level of risk as you are putting money into a property that you don’t actually own yet. As with anything, take this on a case by case basis. If the home needs some small fixes, one of these strategies might be worth it. If it needs major work, there’s a slim chance that either of these solutions will work.
So let’s get back to foreclosures. Foreclosures can be a good deal because 90% of people buying homes are using mortgages. This can fluctuate based on your price point, market and geographic location but as a guesstimate 90% of people that buy homes buy them with a mortgage.
When the property is in disrepair and won’t qualify for a mortgage you are left selling to the other 10% of the public that could pay cash. Renovating a home takes a lot of time, money, energy, and also carries a level of risk to the buyer as there could be unknown issues that come up down the road. Since it’s a smaller pool of people buying rather than 100% of the market to capture and with all of the work considered it needs to be discounted to incentivize all of those previously mentioned things.
Now let’s talk about the rare foreclosures that are actually in good condition. These are few and far between, but sometimes a bank will take possession of a property that is still in good condition, or they may choose to do some updates themselves. In this case, you should be able to use any kind of financing as the home should meet the minimum property standard requirements. The caveat here is that if the home can be financed, then the home is open to 100% of the market rather than just the cash buyers, in which case the property will most likely sell at fair market value rather than at the discount you were hoping to get by buying a foreclose in the first place.
One other thing to keep in mind is that banks don’t use your standard state Agreement of Sale. Each bank typically has their own contract which is very one sided and is designed to protect the bank, not you as the buyer. These contracts need to be read very carefully; you run a high risk of losing your deposit or suffering other damages if things go sideways with the transaction.
Foreclosures can also be hard to come by depending on how the market is. At the time of this writing, we’re in one of the hottest sellers markets on record and there are only 51 foreclosures for sale in Delaware, out of 1,921 total homes for sale on the market.
At the end of the day, if you think it could be the right choice for you, then just make sure you have an excellent agent who is an expert in the market, and be ready for a less than fun process, and losses of time, energy, and potentially money.
Remember, what you see on HGTV is not reality!