A house goes into foreclosure when the owner can’t make his or her mortgage loan payments. The house gets repossessed by the lender and put up for sale at an auction in order to satisfy the outstanding loan. Most often, these homes have been abandoned, sometimes by very angry former homeowners.
Other times, people refuse to leave their homes, meaning you may have to deal with eviction issues (which can add to your costs). In many cases, you’ll have to make offers on the house without seeing inside, so you won’t have any idea what condition the house is in; they’ve often been neglected, damaged, or ransacked and require a lot of fixing up.
Sometimes the sale will go through without the buyer having been allowed to get the home inspected.
Plus, the house may also be subject to additional liens; it’s not uncommon for someone who stops making mortgage payments to also stop making property tax payments, for example. Finally, many foreclosures are sold for cash only, so you may need to bring a lot of money to the table.
Potential Loan Issues
If you’re planning to finance a foreclosure property, you may face some additional hurdles. For one thing, the property may not pass the lender’s inspection guidelines, making it ineligible for financing. Plus, because prices can be bid up at auction, your purchase price may exceed the home’s appraisal value, which can severely limit your loan amount.
Finally, foreclosed homes may come with title issues, which hold up closing; since house flipping is a speed game, this can drastically alter your timeline and profit potential.
The Move to REO
Foreclosure homes go first to auction, and any that aren’t sold there end up in the bank’s inventory as real estate owned (REO) properties. These homes come with the same cautions as standard foreclosures plus more: they’ve been vacant longer, meaning they’ll probably need a higher level of cleaning, repairs, and renovations, which can add significant costs to the flip budget.
Banks may require large (often non-refundable) deposits when you sign a purchase contract (sometimes as high as 5 percent of the total purchase price), so you’ll need plenty of cash on hand to go this route.
That deposit may have to be paid before you’re allowed to inspect the property, so if you walk away from the deal, you’ll lose the deposit (which may be the wisest move if the property’s a wreck).
On the plus side, a home that’s gone REO usually comes with a clear title (which is not always the case with foreclosure properties). While not all REO properties end up selling at ultra-low prices, they’re more likely to be sold below market value because:
- They’re vacant, which can lead to problems (vandalism, etc.).
- The bank has to keep up with property tax, insurance, and utility payments.
- The bank has to keep the property maintained so it doesn’t deteriorate.
Banks do not want to be in the homeownership business, so they’re motivated to sell…but they’re also motivated to squeeze every possible penny out of buyers.
Finding Foreclosed Homes
The best way to find a quality, undervalued homes in foreclosure is through an experienced real estate agent. They’re often familiar with bank (pre-and post-) auction inventory and will be able to find a property that matches your requirements.
If you’re going DIY to find foreclosed homes, you can look online; there are several legit sites that list homes in foreclosure and REO status. The downside: you only have pictures to go by, and pictures can lie about the true condition of the property. Check out these sites to start your search:
- RealtyTrac (www.realtytrac.com)
- Redfin (www.redfin.com)
- Trulia (www.trulia.com)
- Fannie Mae HomePath (www.homepath.com)
- US Department of Housing and Urban Development (www.hud.gov)
All of these sites have extensive lists of foreclosed homes in virtually every price range, so you’ll have a lot of properties to choose from.
Tax-sale homes are similar to foreclosed homes in that the home was repossessed from an owner who stopped making payments; in this case, property tax payments. There are two types of tax sales—tax lien sales and tax deed sales —and they work differently.
With a tax lien sale, you basically take over for the taxing authority and now have the right to collect the tax payments plus interest. In a tax deed sale, you’re buying the property and its unpaid tax bill. Both sound simple, but they’re not quite as straightforward as they sound.
Either can make a good investment in the right circumstances, but they can also be quite cumbersome to deal with if things go wrong.
Tax Lien Sales
Most states allow tax lien sales, but the rules are slightly different everywhere. Generally, here’s how a tax lien sale works:
- A homeowner skips property tax payments, triggering a state “waiting period” that can last up to a few years.
- The lien gets auctioned off and goes to the highest bidder.
- The homeowner has to pay the new lienholder the back taxes plus interest; if he or she doesn’t, the lien holder can foreclose.
It’s actually better from an investment standpoint to collect the taxes plus interest rather than go through the expense of a foreclosure, especially when the property is likely to be in bad shape.
Tax Deed Sales
Tax deed sales are also usually auctions. Here, though, the property has typically been seized by the government and sold for (at least) the total amount of back taxes, interest, and fees.
In most cases, though, the sales price gets driven up by bidders, sometimes substantially, despite the fact that they usually cannot see the inside of the house before they bid. If you win a tax deed auction, you immediately own the property.
That means you’ve just bought a distressed property sight unseen, without a home inspection. It could be chock full of code violations, damage, or hazards (like radon gas or black mold). So while the purchase price may seem like a steal, you could be paying much more than the property is actually worth. Take this path with extreme caution.
Learn more about how to make money flipping houses.