Buying foreclosed properties, fixing them up, and selling them looks easy on TV, but in reality, it's a more complicated process than most people think. Here's how to buy a foreclosed house and actually make a profit.

Those foreclosure programs you see on TV make the foreclosed housing game seem way more exciting and entertaining than it actually is. But, if they’ve convinced you it’s an easy way to make money and you’re looking to take a shot at it yourself, there’s a lot you need to know.

Buying, renovating and selling a foreclosed house is incredibly profitable for some, but be warned—it’s a complicated process, and the potential to lose a lot of money is very real.

So how can you buy a foreclosed house in such a way that it’s likely to be a profitable venture?

First order of business: know market values

Your entire foreclosure adventure will rise and fall on your knowledge of the market area where you’re purchasing the property. The more you know about values in the area, the greater the likelihood of success.

A foreclosed property has two values—the purchase price you’re likely to buy the house at, and the market value that the finished property is likely to sell for. The difference between the two will determine how much money you should spend on rehabilitating the property, and how much profit you can expect to make on the trade.

There are different ways you can make this determination. A quick method is to use online resources, such as Realtor.com and Zillow.com. Both sites provide a “high altitude” look at the value of a property, or at least the general neighborhood.

That’s a good starting point, but you’ll have to drill down deeper, eventually. If you plan to make an offer on a foreclosed property, you’ll have to have a more accurate picture of what the specific completed value is likely to be. The best source for this information is a trusted real estate appraiser. With just the address, an appraiser can determine final market value based on sales of comparable homes in the area.

This is not a formal appraisal, since the appraiser will not be inspecting the property. However, you’ll want to develop a relationship with an appraiser who can provide you with quick summary values that can help you determine if a property you’re interested in is a solid deal. Appraisers normally charge between $300 and $500 to do a full-blown appraisal. But you can likely get an appraiser to provide summary reports at a greatly reduced rate.

Where to find foreclosed houses

There are actually several sources where you can find foreclosed houses. Each has its own benefits and drawbacks.

Newspapers

These can be good sources since foreclosures are typically posted in local newspapers. They can allow you to get into the process before the general public. For example, if a property is listed as a Notice of Default (NOD) you may be able to contact the current homeowner and work out a purchase before the property goes to auction.

The drawback is that you will probably need to be an all-cash buyer if you come in at this stage of the process. And competition from other foreclosure buyers can be heavy for these properties.

Foreclosure websites

There are actually websites that specialize in foreclosures. Zillow.com is a source here, but you should also check out RealtyTrac.com, since foreclosures are most of what they do. There are also online county public records databases, but this can be akin to sifting through the sand, since they include so much detail and much of it is dated.

The advantage of foreclosure websites is that you can search for many prospective properties quickly. Some of the websites often provide tools and calculators to help you in your search, and can even enable you to zero in on specific searches.

Eventually, you will still have to contact the lender selling the property or the real estate agent who listed it in order to get the process moving.

Real estate agents

Real estate agents are an excellent source IF you can find an agent who specializes in the foreclosure field. They have the advantage in that they can let you know as soon as foreclosed properties hit the listing services. The downside is that not many real estate agents actually specialize in foreclosures.

Mortgage lenders

This is really about working directly with the property seller—which is the bank. That can simplify the whole process. Banks will allow you to inspect the property before you make an offer. However, that inspection may have limited value. When you purchase foreclosure properties they are typically being sold “as is”. There’ll be no ability to negotiate certain repairs.

Also, be advised that competition for properties through banks can be heavy. For this reason, the banks may not be entirely cooperative in dealing with your offer. They may prefer to wait and see if they get better ones.

Government agencies

This can include government owned mortgage lenders and insurers, such as Fannie Mae, Freddie Mac, the FHA and VA. They can also include other government agencies, such as the Internal Revenue Service (IRS).

The advantage with government agencies is that they usually have a large number of foreclosures available. They can also provide you with an opportunity to buy foreclosures before they reach listing services.

In addition, some agencies, such as the FHA, may offer you financing in order to purchase those properties. Conversely, the IRS typically requires that you pay cash on any properties they are offering for sale.

Also be aware that buying a property from a government agency tends to be a highly bureaucratic process. You’ll need to be extraordinarily patient, and fully prepared to cooperate with any agency requirements.

How to obtain financing for a foreclosed house

This is something of the Achilles’ heel of the foreclosure buying process. The absolute best way to purchase foreclosed properties is to pay all cash. Not only does this enable you to move quickly, but it also avoids the need for lender required repairs. But, if you don’t have that kind of cash, financing is available for certain types of foreclosed properties.

Understand that if you are going to use financing to purchase a foreclosed property, the process will be much more complicated than it would be if you were to purchase an owner-occupied home. For starters, lenders typically require that any issues regarding safety or livability are completed prior to closing.

In most cases, traditional conventional mortgage financing will not be an option, but there are other potential sources.

Commercial loans

Sometimes referred to as “fix-and-flip” loans, this financing is generally provided by banks. The advantage is that they’re specifically designed for investors in foreclosure properties. They can be used to purchase and renovate even dilapidated properties. Even better, they can be used repeatedly.

The downside of these loans is that lenders often require that you have a demonstrated history of success buying and selling properties. That means that this will not be a source of financing for a first-time purchaser.

Down payment requirements can be high, as much as 35%. And rates can go well into double digits, plus origination points. The loans are convenient for career foreclosure flippers, but expensive nonetheless.

FHA 203(k) loans

This is a loan program offered by the FHA specifically tailored for properties that need extensive renovations. Since it’s a government loan program, it’s fairly complicated, so I won’t go too deep into it.

These mortgages are available at rates that are slightly higher than those of standard FHA mortgages, but they can run for terms as long as 30 years. Down payment requirements are low—3.5%, and you can purchase properties up to four units.

The downside of FHA 203(k) loans is that they’re only available for owner-occupied properties. If you intend to purchase a foreclosure and either rent out the property to generate income, or to flip it for a profit, this loan will not work for you.

FHLMC HomeSteps loans

This is a good loan for buying foreclosed properties as an investor. You can purchase single-family and two to four family unit properties with down payments ranging from 15%to 25% of the purchase price. Loan terms run for up to 30 years, and interest rates are slightly higher than what they are for comparable conventional mortgages. Of special note, the program does not require appraisals or mortgage insurance.

The program is only available in 10 states—Alabama, Florida, Georgia, Illinois, Kentucky, North Carolina, South Carolina, Tennessee, Texas and Virginia. Additionally, HomeSteps loans can only be used to purchase properties that are owned by Freddie Mac.

The HomeSteps website provides a list of FHLMC owned foreclosed properties in your area.

Foreclosure traps to avoid

Buying a foreclosed property is much more complicated than purchasing a home for owner occupancy. Some of the traps and workarounds you should be aware of include:

You’ll need plenty of extra cash

Even if you’re able to get financing to purchase the property, you’ll still need to have plenty of extra cash to:

  • pay renovations
  • cover unexpected expenses
  • cover carrying costs (debt service, insurance, property taxes, and utilities)

Buying foreclosures should never be attempted on a shoestring budget.

Right of redemption laws

Most states have laws that give the original homeowner the right to reclaim the property if they can pay past-due amounts and fees on the house within a certain time limit. This means that you can lose a property you’ve successfully bid on.

Beware of auctions

You likely think of auctions when you think of the foreclosure process, but it’s best to avoid them. The property is, quite literally, put up for auction, either on the courthouse steps, at the property itself, or at a convention center.

Be very careful if you’re bidding on such a property. Competitive bidding can lead to the value being run up so high that you end up losing money on the purchase. I’ve seen a couple of examples of auction-bought properties that were purchased over market value, which can be a financial black hole.

Related: How To Buy A House At Auction

Sellers may not be cooperative

Though it may seem logical that a bank or a government agency will want to unload a property quickly and cleanly, this is usually not the case. The bank or the agency stands to lose money on the sale, and will hold out for the best offer they can get. For that reason, the process may drag out a lot longer than you planned.

Time is money

If you’re buying a foreclosure to flip and make a profit, you will have to make the entire process move quickly. Once you close on the house, you will have to have your contractors lined up and ready to get to work immediately. The longer it takes to get the property ready for sale, the more money you’ll be paying for carrying costs.

Always get a home inspection

Foreclosures are sold “as is”, but you still need to know exactly what the deficiencies in the property are. The seller should enable you to bring in a competent home inspector, which you will have to pay for out of pocket.

Like a preliminary appraisal, it will be money well spent. You need the inspector to give you a detailed list of everything that’s wrong with the property, as well as a breakdown of how much it will cost in order to complete the renovations. This will help you know if the property is actually profitable, or if it’s likely to turn into a money pit.

Summary

Buying and selling foreclosures profitably is not as clean or easy as they make it look on TV.

Do your research and make any advance preparations. If you want to try your hand at a foreclosure but don’t feel entirely ready, consider taking in a partner who has experience in previous deals.

Foreclosures can be incredibly profitable, or they can turn into unmitigated financial disasters. What you do in advance can make all the difference.

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About the author

Total Articles: 152
Since 2009, Kevin Mercadante has been sharing his journey from a washed-up mortgage loan officer emerging from the Financial Meltdown as a contract/self-employed “slash worker” – accountant/blogger/freelance web content writer – on Out of Your Rut.com. He offers career strategies, from dealing with under-employment to transitioning into self-employment, and provides “Alt-retirement strategies” for the vast majority who won’t retire to the beach as millionaires. He also frequently discusses the big-picture trends that are putting the squeeze on the bottom 90%, offering work-arounds and expense cutting tips to help readers carve out more money to save in their budgets – a.k.a., breaking the “savings barrier” and transitioning from debtor to saver. He’s a regular contributor/staff writer for as many as a dozen financial blogs and websites, including Money Under 30, Investor Junkie and The Dough Roller.