How to Buy Foreclosure Homes

By Steve Gillman - 2005

Yes, you can buy foreclosure homes as an investment strategy. It is not as easy as many make it out to be, though, and you may have some qualms about investing in this way. As for the latter, all I can say is be honest and accept that the owners are losing the home in any case, so your offer might be the best opportunity they have at the moment.

Foreclosure Homes at Auction

Of course you can buy at auction and avoid meeting the family that is losing their home. The problem is that the homes just don't go cheap at most auctions. There are too many investors getting into this area, so the chance of a great deal is pretty slim.

It can be a bit complicated as well. You will often have to arrange financing before the auction - despite the fact that you may not be the high bidder. A pre-qualification letter from your lender won't cut it most of the time. Find out exactly what you'll need to bring to the auction before you attend, or better yet, start looking at these homes before they are foreclosed on.

Buy Pre-Foreclosure Homes

If you know that a home owner is facing foreclosure, you may have an opportunity to help him and yourself. Many owners who are seriously in default are simple going to lose the home, and wreck their credit. They may even lose all the equity they have in their homes - unless you help them out. Let's look at an example.

Suppose your ad in the paper reads, "Losing your home? Maybe I can help." A man calls, and explains that he is several months behind on his payments, and has received a foreclosure letter from the bank. First, you need to know if about the situation. If it is a temporary situation, and the man may be able to catch things up soon, you can either make some money with a second-mortgage loan to him (if there is sufficient equity) or refer him to someone who does these.

For the sake of this example, we'll assume he is definitely going to lose the home. You discover that the home is worth about $160,000 and he owes a total of $120,000 including back payments and penalties. He wants to protect his credit rating from further harm and he is ready to move on, but time is limited. He has just weeks to get the place sold, and he is afraid he will lose all of his equity.

You agree that this is a real concern with time so short. In fact, to sell the home quickly, he would probably have to accept $150,000 or less, and pay a real estate commission of $9,000 (6%), plus he will have other costs of around $2,000 or so. You do the math for him, and point out that IF he gets it sold, he will likely walk away with just $19,000 ($150,000 minus $9,000 commission and $2,000 in costs equals $139,000, minus the $120,000 he owes).

However, if he doesn't get it sold real fast, he may get nothing after a foreclosure sale where investors try to bid low and the bank adds all legal fees to what is owed. You offer to get him out with $15,000 cash, and he doesn't have to take the chance. You buy the home for $137,000, which means he nets about $15,000 after some costs. This solves his problem and you get a home for $23,000 less than market value.

Now what do you do with it once you buy foreclosure home this way? You have a number of options. You could resell it, although the profit might be minimal after paying a real estate sales commission and other expenses, including holding costs. You could rent it out - buying for $23,000 less than market might make it more likely to have cash flow. Then there is another option.

If the seller really wants to stay in the home, you might sell it back to him on a lease-option arrangement. He can rent for two years until he is back on his feet (be sure this is likely), and then buy the home for the likely market price of $176,000 (assuming appreciation of 10% in two years). You avoid the need to pay a real estate agent to sell the home in this way, and the family gets to stay where they are.

Of course if you just bought a home in foreclosure from a family in this way, and then sell it back for a hefty profit, they may be resentful. Explain that they are likely to pay just as much or more when they are ready to buy again, but if it doesn't feel right, don't do it. You don't want resentful tenants, and they just might be happier moving on.

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