Hey, we all want a great deal, right? Recently, lots of buyers have been asking me to help them find foreclosures (or their close cousin, short sales, which I'll cover in a later post.) The common perception is that foreclosures are the Filene's Basement of real estate, the section of the market where the really great deals are hiding. But most buyers don't really understand what's involved in a foreclosure purchase, and many aren't necessarily good candidates for delving into this market sector.
Foreclosure buying is the down and dirty, rough and tumble of real estate, more suited to savvy, cash-laden investors than owner-occupiers shopping for that dream home, for a couple of reasons. First, most foreclosures are generally sold "as-is", without the ability to conduct the same due diligence that a buyer might in a more "normal" purchase. When a bank takes over a property, they turn over responsibility for it to an asset manager who's first job is to secure the property. That typically means draining the house (to prevent any freeze damage), having heating systems turned off or disconnected, and sometimes even turning off electric service to the house (to minimize the risk of an electrical fire.) In some areas, they'll even have the windows boarded over with plywood to prevent vandalism or squatting.
Many banks will allow a potential buyer to conduct a home inspection, but if the systems aren't on, the buyer has to pay to have the house de-winterized and systems turned on before the inspection and re-winterized and turned back off afterward, usually the same day. That can cost hundreds of dollars in addition to the cost of the inspection.
While you may be permitted to conduct an inspection, the bank will generally not agree to include an inspection contingency in a purchase contract. They take "as-is" seriously. So buyers usually have to do whatever inspections or due diligence they want prior to submitting their offer and knowing if their offer will be accepted. The governing thought is: kick the tires, get a mechanics to look over the car, do what you want (at your expense), and then if you still want the car, we'll talk. If your offer isn't accepted, or you're bumped by another party offering a higher price or better terms for the lender, you're out the cost of your inspection and turning those systems on and off.
The second big factor in a foreclosure sale that buyers need to be aware of is the unrelenting and virtually immovable closing deadline. A bank expects a purchaser to close on the transaction within 30 days of their acceptance of your offer (or 30 days from when they issue contracts, which is often just a couple of days after accepting your offer.) If you don't close within 30 days, you could forfeit your deposit or face pretty hefty extension fees (of up to $100 per day.) That's why any I tell amu client I work with who's looking to buy a foreclosure that they need to have all their horses at the gate ready to go the minute their offer is accepted.
A buyer's ability to close within 30 days is almost as important as price when a bank decides to accept or reject your offer. That's why cash buyers, particularly ones who have purchased other foreclosure properties, have a big advantage over buyers looking to finance the property. Financing is a hiccup that the foreclosure owners just don't want to deal with if they don't have to.
The appraisal process for financing can present a Kafkaesque Catch-22. An appraiser for a conventional (i.e. not a rehab loan) loan wants to see that the house is in liveable condition, with functioning systems like water, plumbing, heating and electric. But that stuff is probably all turned off. So sometimes the buyer has to pay to have those things turned on (and off again) for the appraisal. Sometimes an appraiser will accept a recent inspection report to indicate that there are operable systems, or may agree to come back on the day of closing when the systems are turned on for a final walk through (with the mortgage contingent on that final check by the appraiser.) But the bottom line is that the financing and appraisal system is just not designed to dovetail with foreclosure properties.
If a buyer is looking to use FHA financing, the prognosis is even worse. Years ago, to qualify for FHA financing, houses had to meet this ridiculously high standard for safety and code compliance. Those days have passed, but appraisers still need to evaluate houses en sure they meet standards for "safe, sound and sanitary condition." The utilities have to be on for the appraisal, and the appraiser has to see things like window screens (in non-airconditioned houses), no evidence of rodents, and that windows open. Those deficiencies have to be repaired by the seller prior to closing with an FHA loan. In a standard purchase, those aren't that big a deal, but with a bank-owned property, the bank doesn't want to do any repairs. The likelihood of getting an FHA repair list, however minor, is a big risk that a bank just doesn't want to take.
But at the end of the day it isn't financing, whether conventional or FHA, per se, that the banks don't like. Rather, it's anything that can get in the way of successfully closing in 30 days. The asset manager, who is handling the disposition of the property for the lender (and is usually the decision maker regarding which offer to accept) has a razor-sharp bead on that 30 day clock, for two reasons. Their compensation is tied to it — asset managers typically get less compensation for deals that don't close within 30 days. And if an asset manager gets a reputation for a high percentage of closings that are delayed or, worse, don't close at all, the foreclosure owners will stop feeding them properties to dispose of, and shift their inventory to other asset managers.
Foreclosure purchases can certainly be great deals. But there are plenty of downsides. Anyone looking to buy a foreclosure property needs to be prepared, do a lot of reading and get your financial ducks in order.
P.S. I personally think the whole foreclosure disposal system is screwed up. The best candidates for these less expensive, bargain priced homes should be starter home buyers, who usually have more limited down payments and turn to loan programs like FHA loans to help them get into their first home. Instead, the deck is totally stacked against them, and is stacked in favor of investors who can sweep these properties into their portfolios.
It takes a skilled professional to navigate through the process to get a foreclosure. Unless you are going to go to the sheriff's sale and bid on a pig in a poke, you should use a good realtor who is experienced with the process. Get in the process before it is foreclosed and try to buy a negociated short sale. This will give you ability to see the property and be assured of it condition upon closing.
Posted by: Richard Stabile Bergen County Real Estate | April 05, 2009 at 07:29 PM