Buying a foreclosure (FCL), or a property that the bank has taken away from the owner because he or she stopped paying the mortgage, is often touted as a way for both owner-occupants and investors to get a great deal on a property. However, the potential financial rewards of buying a foreclosure don't come without their share of hard work and headaches. Read on to learn about the problems these properties commonly possess and the difficulties you may encounter in purchasing one.
Problems With the Property
The most important thing to understand before jumping into the foreclosure market is that these properties were given up by owners who couldn't afford the payments anymore. If the previous owner could not afford to make the payments, it is likely that they also have not maintained or fixed anything in months at the minimum. Also, some people, embittered by their situations and wanting to take out their frustrations, will deliberately trash the property before they are forced out. After the occupants leave, foreclosures sit abandoned, often inviting criminal activity.
The following are some of the specific problems you may have to fix before you or your renters move in:
Maintenance and Cleanliness
Filth and stench. Bank-owned properties are sometimes disgustingly dirty because of time spent sitting empty, intentional neglect of cleanliness by the previous owners or occupancy by vagrants. When the place is locked up with no air circulating for months, built-up dirt can cause the entire home to smell.
Unpermitted changes. Being strapped for cash, the previous owners may have made changes to the home without getting the proper permits or hiring good labor. A common example is converting the garage into living space so more people can live in the home and help pay the mortgage. These changes may be undesirable to future owners or create headaches for the new owners with city government officials due to the lack of proper permits. (Learn how to find qualified contractors and other professionals in The Better Business Bureau's Tool Belt For Saving Cash.)
No electricity. With no one living in the home, the electricity may be off unless the bank has intentionally kept it on. With no electricity, it can be hard to see what you are buying in some rooms, particularly basements and windowless bathrooms.
Water damage. A small leak under the kitchen sink can lead to a mold problem, and a roof leak or burst pipe can lead to major water damage. With no one around to take care of small problems as they occur, small problems can turn into big ones, and big problems can turn into disasters. (Learn how you can minimize some major maintenance costs in 4 Overlooked Homeownership Costs.)
Way behind on basic maintenance. If the previous owners couldn't afford their mortgage payments, you can bet that they also could not afford repairs, such as roof leaks, termite damage, a broken garbage disposal or anything else. (Read about how much work is necessary to maintain your home's value in Will You Break Even On Your Home?)
Unfinished upgrades and poor repairs. If the previous owners started to improve the home but then fell on hard times, there may be partially finished work in the house. The bathrooms may be redone while the kitchen has not been updated in 40 years, or there may be new floors in the living room while the bedrooms have filthy carpet. Also, if any repairs were made, they may have been done by the owners themselves or by unlicensed professionals - in other words, people who may not necessarily have done the work correctly. (Read about which repairs are worthwhile and which are a waste of money in Fix It And Flip It: The Value Of Remodeling.)
Dead or overgrown yards. Depending on the climate where the home is located, the lawn and landscaping may be totally dead or extremely overgrown. Banks usually do not pay for gardeners to maintain the yard.
Personal property left behind. Sometimes foreclosed homeowners get locked out of the property before they can move their belongings, and in some cases they do not take everything with them. Many real estate owned (REO) properties contain furniture, trash, clothes and other items that you will be responsible for disposing of when you become the property's owner.
Vandalism and Neglect
Vandalism. Sometimes when a property sits vacant, especially if it is in a moderate-to-high crime area, bored punks will tag the property, smash windows and do other things to cause damage. (Vandalism may be a red flag on a potential property. Read Foreclosure Opens Windows For Investors to learn more.)
Broken windows. Broken windows can be common in REOs for several reasons. As mentioned previously, vandalism could be a cause. Also, when banks lock out owners while taking possession of the property, the former owners may break a window to get back in and retrieve their belongings. Windows may also get broken for a normal reason, like an errant baseball, but with no one living in or actively monitoring the property, the window is unlikely to get fixed. At best, broken windows may get boarded up by the bank or by concerned neighbors.
Damage to walls. Previous owners who took poor care of the property or wanted to inflict damage on it at the bank's expense may have put holes in walls and/or torn off the baseboards and crown molding.
Removal of valuable items. To get revenge against the bank and to make an extra buck, the previous homeowners might have removed items that had value, including appliances, fixtures, the kitchen sink, bedroom doors, closet doors, copper pipes and more. Anything the homeowners do not take might be taken by thieves. Either way, many REOs are missing things that generally come with seller-owned properties.
Location Issues
Poor/subpar location. Where there is one foreclosure, there may be others in the same block or neighborhood. Lower-income neighborhoods are more likely to have foreclosures, because they are more likely to have homeowners who were given predatory loans or who don't have the resources to endure economic hardship.
However, as a result of the subprime mortgage meltdown, sometimes even nicer neighborhoods have a high number of foreclosures. You have to look at the usual indicators of value to determine if the high number of current foreclosures might be indicative of a longer-term problem or if it is only a temporary issue because of the current economic climate. (Learn more in our Subprime Mortgages Special Feature.)
Problems With the Purchase
Despite all these potential problems, foreclosures can still be a good deal. If you are willing to fix problems that most people do not want to deal with, you can buy a home at a significant discount. However, you may encounter additional issues when it comes to actually purchasing the property and getting it ready to move in.
Issues With Lenders
Financing. Lenders will not give you money for a home they consider uninhabitable or that appraises below the purchase price. If you are an investor paying cash, of course, this will not be a problem.
Significant time delays in dealing with the bank that owns the property. Common sense says that banks should want to unload REOs as quickly as possible, but in reality banks sometimes drag their heels in considering offers and throughout the escrow process. (Learn more about the steps leading up to closing in Understanding The Escrow Process.)
No seller disclosures. Since no one from the bank has ever lived in the house, they are unlikely to have any knowledge of existing problems with the property. You will have to uncover everything yourself, either during the home inspection, by asking neighbors or through experience after you become the homeowner. (Read more about the value of hiring a professional in Do You Need A Home Inspection?)
Competition between owner-occupants and investors to buy the property. Because foreclosures can be great deals, they are attractive to investors looking to flip properties or use them as rentals. Since investors can make all-cash offers with fewer or no contingencies and fast closings, their offers may be more attractive to the bank than those from would-be owner-occupants. (Read more in Investing In Real Estate.)
Issues With the Property
Feasibility of repairs. If you are a potential owner-occupant, you may not realistically have enough time, energy or cash to make the repairs. Before proceeding with the purchase, realistically assess your handyman skills, calculate how much cash you will have to fix up the property after your down payment, closing costs and moving expenses and get rough estimates for repair times and costs.
Inspection reveals hidden defects, or that visible issues are worse than they appear. This can happen with any property, but unlike traditional sellers, banks always sell properties as-is and will not make any significant repairs. As long as the purchase offer includes an inspection contingency, the buyer's loss will be limited to the cost of the inspection and a little bit of time.
Double housing costs. Foreclosures are not often move-in ready, and for potential owner-occupants, a foreclosure that needs significant repairs can mean double housing costs (rent on the old place plus a mortgage on the new place) until the property is ready. The other possibility is that the new owner-occupants will have to live in a construction zone or stay with friends/family for a while in order to avoid paying double for housing.