Buying a foreclosed house can be a very rewarding experience if you do your research diligently. I know because I was lucky enough to purchase one in the summer of 2010, after many months of house hunting. A new property is a huge investment for most people and as such, should be considered carefully.
In this article, I’ll summarize some of the key questions to think about before deciding to sign a purchase contract for a foreclosure. I’ll also add some of my own personal anecdotes and share parts of my experience. If you’re interested in buying a foreclosure home, these points are important to consider and can help you build a healthier financial portfolio.
1. How long has the property been on the market?
Not all foreclosed properties are created equally. For example, a good property in an up-and-coming neighborhood will be purchased quickly – usually by a real estate investor or an eager person looking for a new house. Don’t expect these houses to stay on the market for more than 30 days.
However, if you’re buying a house in sub-par condition or in an area that has been hit hard by the mortgage crisis, a longer market time is expected. As a buyer, this can lead to more flexibility on the price: banks hate having a foreclosed property on their hands for more than 90 days (one fiscal quarter), and they will negotiate with a good buyer.
I purchased my home in Arizona after it had been on the market for close to three months. I saw that the price of the house was lowered by almost 7% each month, and therefore didn’t wait for the next month to buy the house. Instead, I bargained with the bank to lower the price another 12% from the most recent price. The bank counter-offered with a 9% discount. My final savings represented almost a 23% discount from the listed price (i.e. 7%+7%+9%).
2. How much are you paying per square foot of livable residence?
The price per square foot calculation is a good way to determine your home’s worth. Check out the average prices-per-square-foot of houses sold in the prior two months in the same zip code. Multiply that by your home’s livable area to determine an “average” price for your house.
For instance, if a home is worth $75 per square foot and there are 1,500 square feet, then the overall value of the home is $112,500.
Of course, if you want to pay the average price, there is a risk that you will overpay. Unless your house is in excellent condition and there is not much work to do on it (in which case, paying average is great!), look at the bottom two-thirds of the prices. With that in mind, let’s recalculate the home value and see what we get.
Since we are assuming that the home is not at the top of the market in terms of value, we’ll assume that it is worth $65 per square foot. Multiplied by the same 1,500 square feet as before, the house is now worth $97,500. Voila! You just saved $15,000. Think you can put that to better use? Definitely.
As a hard bargainer, I was determined to pay a very low price-per-square-foot for my home; I knew that the Arizona market was not going to get any better. I actually paid the second lowest price-per-square-foot in my zip code at the time of purchase in the 90-day period.
3. Are you paying cash or mortgaging?
If you are paying cash, your offer goes straight to the front of the bank’s stack of offers. Say you are offering $85,000 cash for a house that’s listed at $100,000. You probably have a better chance of getting it than the person offering $95,000. Cash means you are a reliable buyer, and the bank doesn’t have to wait two weeks for your check to come in. Use this to your advantage.
If you are buying your home with a mortgage loan, you have more flexibility on the price, since the initial down payment is going to be around 20% of the house. If you really love the house, don’t worry about paying a little bit more to get it.
As a cash buyer myself, I knew that I had leverage on many fronts. My real estate agent, who makes commission based on my purchase, wanted me to offer an amount very close to the asking price so that he had a definite sale. Of course, he wasn’t the one paying, so his opinion was put on hold.
4. Are there many foreclosed houses in the same area?
If there are a lot of foreclosed houses near the one you’re buying, an increased drop in value is likely coming. This scenario sends many negative messages to potential buyers about the neighborhood, the city, and the market. In our current economy, this is a ubiquitous scene, but don’t let that derail you from making a wise decision. Until all the houses on the block are sold, there is going to be one foreclosed house bringing down your property value. Run a quick zip code scan on a trusted website such as Redfin or Zillow to see how the area is doing.
Since the house I bought will be with me for at least half a decade, I was not too worried to see four more houses on the block in foreclosure. I believe five years is ample time for prices to drop and come back up again, guaranteeing that my investment is safe.
5. How much money will you have after the purchase?
Be prepared to spend a lot of money after your initial purchase to fix the house to meet your standards. Have at least another 20% of the house value tucked away in case of emergency. Even after a home inspection, you are going to find things that bother you and need to be changed. Don’t forget appliances, furniture, landscaping, and property tax. If possible, ask the bank to cover the escrow fees (or any of the other real estate fees or mortgage fees) so that you have more cash on hand. Even the $1,000 they pay is $1,000 more in your pocket, which is enough for a big screen LCD or plasma TV!
Personally, I have spent thousands on various home improvements. I was actually pretty surprised at how quickly these costs add up. Small purchases like security deposits for an electricity account and new doors for the house were things that I simply didn’t think of before.
There are many other questions to take into account before deciding to settle down, especially when buying a foreclosure property. Do you have any experience with foreclosures? What has your experience been like and what do you typically look out for?