10 Tips for Buying Distressed Properties

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A distressed property is any property whose owner is in default on the mortgage. In the late 2000s, sales of these distressed homes became extremely common. In fact, between 2008 and 2011, one third of home sales were distressed sales [source: [Gibbs]. Of course, just how many distressed homes are on the market varies by market conditions. Regions where home prices have plummeted, like California and Florida, tend to have more distressed homes, while areas with more stable home sales have fewer [source: Gibbs].

In a short sale, the final price of the home is less than the total amount owed to the lender, but the transaction closes before the lender forecloses, so you negotiate with the owner and the lender. A foreclosure is a home that has been repossessed by the lender for lack of payment. Foreclosed properties are either sold at auction or put on the open market as REO (real estate owned) listings.

If you're on the market for a home, and you'd like to get a deal, a distressed home is an option to look into. Banks want these homes off the liability column of their books, so they usually list them for comparatively lower prices [source: Re/Max]. But, there is a limit to what you can save, especially as competition for dirt cheap houses tends to spark bidding wars among hungry buyers [source: McQueen]. Distressed homes aren't easy to deal with, either. They are sold "as-is," usually need extensive repairs, and require a lot of time and paperwork. So, keep reading for tips on how to come out of a distressed property deal on top.

Get Preapproved for a Mortgage
Make sure you're preapproved for a mortgage before you make an offer on a distressed house.
Make sure you're preapproved for a mortgage before you make an offer on a distressed house.

One of the things to keep in mind when trying to buy a distressed property is that the bankers that need to approve your offer want to consider only very serious offers. So make sure you're preapproved for a mortgage before you make an offer on a distressed house [source: Re/Max]. For one thing, you'll be competing with investors. From "house flippers" who fix up damaged homes to resell at a markup, to larger property management companies, investors are taking advantage of historically low homes sales to make a profit. They typically pay in cash, so you'll have to prove you're a reliable prospect to get the bank to accept your bid [source: Gibbs].

There are a few pitfalls to look out for when seeking preapproval. If a house is too damaged, lenders will often refuse to finance the purchase [source: Gibbs]. So if the property is in need of extensive repairs, you might have to put up extra cash, or take out a second loan to cover the costs. And if you have trouble getting preapproved, you might consider alternative lending sources. Small regional banks and credit unions are often more willing to loan money to borrowers with imperfect credit than the big banks [source: Gengler]. Also, the U.S. government offers FHA loans (through the Federal Housing Administration) that require smaller-than-usual down payments [source: Re/Max].

Find an Agent Experienced with Distressed Sales

Distressed property sales have a lot of unique problems and pitfalls. So when picking a real estate agent to represent you, find one who has experience handling those issues [source: Perkins]. Luckily, there are several certifications available for agents who have taken continuing education courses in selling distressed properties. The National Association of Realtors introduced a Short Sale and Foreclosure Certification Program in 2009. To get the certification, Realtors need to take several hours of training and bone up on national and state laws around foreclosures and short sales [source: Perkins]. There is also a Certified Distressed Property Expert certification, offered by a group called the Distressed Property Institute [source: Re/Max]. But, whether your agent is certified or not, you need to make sure they have closed on distressed property sales before. About a dozen short sales or foreclosures is a good amount to show that the agent has been through the process enough times to guide you through knowledgably [source: Gibbs].

Don't Invest in a Distressed Neighborhood

Buying a distressed property in a good neighborhood can be great deal. You can spend a lot less for a house than you might not typically be able to afford, and build equity as it increases in value. But not every dirt cheap distressed house is a great deal. Be careful about looking for homes in extremely depressed neighborhoods. If every house on the block is going into foreclosure, or if every condo in the high rise is vacant, you should look elsewhere [source: McCrea]. There's just no telling when the market in an area like that might bounce back -- or if it will ever bounce back. You could end up stuck in a vacant neighborhood, watching as your cheap house gets even cheaper. In the worst-case scenario, you could end up in the same shoes as the person you bought the house from: owing more money on your mortgage than your house is worth.

Get a Professional Home Inspection
A home inspection becomes even more important when you're considering a short sale or a foreclosure.
A home inspection becomes even more important when you're considering a short sale or a foreclosure.

Any time you purchase a home, you need to have a thorough home inspection. That inspection becomes even more important when you're considering a short sale or a foreclosure, because these types of sales are always "as-is" [source: Max]. Unlike typical home-sale situations, the seller of a distressed property won't take responsibility for damages to the home at the time of the transaction. Instead, you as the buyer take responsibility for any necessary repairs once you sign the sale contract. Since the listing prices for distressed homes are already typically lower than comparable sales, banks usually won't give price concessions to account for any repairs [source: McQueen]. The inspection will give you an idea of how much money you might eventually have to spend getting the house move-in ready. You should probably consider getting specialty inspections done, also [source: Gibbs]. Specialty inspectors will go into more detail in examining things like mold, pests and septic systems. And if an owner or lender ever refuses to allow an inspection, you should immediately walk away from the deal [source: Gengler].

Be Ready to Make Repairs
Distressed homes are sold "as is" and almost always need repairs.
Distressed homes are sold "as is" and almost always need repairs.

Foreclosed homeowners are often forced out of their homes, so they've been known to leave them with intentional damage. During the low point of the housing crisis that struck the United States in the late 2000s, some homeowners who were foreclosed on stole appliances and water and lighting fixtures, both out of anger and in an attempt to make some money out of their circumstances [source: Fulmer]. Of course, once a house is empty, it can become a target for squatters and vandals who can also do damage and leave it filthy. And empty foreclosures are susceptible to theft; appliances, fixtures, and even copper wiring and pipes can be lucrative to thieves who have been known to tear up the walls to gain access to the copper to sell it for scrap [source: McQueen].

All that damage can sound frightening, but if you're not afraid to sweat -- or if you hire someone to do the sweating for you -- you can save money on the more damaged, "fixer-upper" houses. Because you will usually end up making at least some repairs to a distressed home, it's a good idea to have a contractor take a look at the house before you buy [source: Gibbs]. That's in addition to the home inspection. The contractor should make estimates on what the repairs will cost, so you can take that cost into account when making your offer.

Be Patient

There are all kinds of delays, frustrations and red tape that you will have to endure if you are buying a distressed property. Unlike a normal sale, where you deal primarily with the homeowner, distressed sales involve dealing directly with the lender, who has to approve the final sales agreement. That can take a long time, since you are dealing with the bureaucracy of a large institution, not just an individual seller. It can take weeks or even months of waiting for the bank to respond to an offer [source: McQueen]. You might be able to get help from the government to speed up the process. Check to see if the house is eligible for the home affordable foreclosure alternatives program (HAFA). If it is, you can force the bank to reply within 30 days [source: Gibbs].

Closing the deal can also be held up if the owner had a secondary mortgage or was refinancing. That second lender will have to sign off on the deal, too [source: Re/Max]. You could hit another speed bump if the loan was sold through securitization [source: Gibbs]. During the real estate boom that came before the housing crash of the late 2000s, lenders sold off large bundles of their loans to investors, who then traded them as securities similar to stocks. Whatever investment manager currently owns the securitized loan will have to approve the deal, adding a fourth (or possibly fifth or sixth) party to an already crowded negotiating table [source: Gibbs].

Know Your State's Foreclosure Laws

Depending on which state you live in, there can be added obstacles to purchasing a foreclosure property. Some states make lenders go through a complicated judicial process in order to foreclose. That process, designed to help people facing foreclosure, can take up to 12 months, or even longer in states like New York [source: Fulmer]. States that require those extensive proceedings are called "judicial states" in real estate circles. Other states are more laissez-faire with their foreclosure laws. In these "non-judicial" states, lenders can seek foreclosure more easily and quickly [source: Fulmer]. For example, in Texas, it takes a lender only about 60 days to file for a foreclosure [source: Fulmer]. Find out how your state handles foreclosures, and when you find a house you like, ask your agent to determine how far along the property is in the foreclosure process. You might have a long wait in store.

Have Cash on Hand

Money may not buy happiness, but it can get you a lot closer to buying your dream home at a great price, especially if your dream home happens to be a distressed home. Having a lot of cash at your disposal will make the process a lot smoother in several ways. For starters, the larger a down payment you can make on the home, the more seriously the lender will take your offer. A payment of 20 to 25 percent of the asking price is enough to convince the bank you're a safe bet [source: Gengler].

All those parts of the process that make distressed home sales unique tend to cost money. Remember that detailed home inspection you need to get? That costs about $350 [source: Gibbs]. And those extensive repairs that you might have to make? You would think you could just cover them with the loan you take out, but if the damage is too extensive, lenders may not even approve your loan. You might need to create an escrow account to cover the repairs, or even take out a second home improvement loan to convince your own lender that the house will be livable [source: Gibbs].

Finally, buying bank-owned properties puts a lot of the onus on the buyer to settle costs that the seller would cover in a normal sale. For example, you will usually need to pay closing costs and any real estate transfer taxes, and settle any liens on the home before the sale closes [source: McCrea].

Be Ready to Make a (Serious) Offer

Making an offer on a distressed home can be trickier than you think. While you might think you could just make a lowball offer and expect the desperate homeowner and lender to take it, that's not the case. Banks are willing to take a financial hit to get the house off their balance sheets, but not too big a hit [source: Re/Max]. Usually, the listing price on a foreclosed home is close to what the bank thinks they can get for the house, even taking a terrible market into account [source: Gibbs]. The asking price will be based on comparable sales in the area, much like listing prices for non-distressed homes [source: Gibbs]. So, if you want to make a lower offer, make sure it's backed up by some comparable sales [source: Gibbs]. You don't want to insult the lender's intelligence. Banks don't spend a lot of time with multiple counteroffers, so you can't start too low. If they think they can get a better price, they will be happy to reject you after two or three offers, or even one [source: Gibbs].

Use Your Lender's Appraisal Strategically
Use your leverage as a buyer in negotiating a price with the lender.
Use your leverage as a buyer in negotiating a price with the lender.

Buying a distressed home is not all problems and headaches. You do have some leverage as a buyer in negotiating a price with the lender. That's especially true if the distressed home is in poor condition. If the bank refuses to make any concessions in price for a home in bad need of repair, ask your lender to conduct their full appraisal of the property. (An appraisal is a detailed valuation of the home that lenders use to determine the amount they will loan you). If the appraisal comes in below the asking price, you can use that to try persuading the bank to accept a lower offer [source: Gibbs].


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More Great Links


  • AOL Real Estate. "How to Buy Bank Owned Property." Aug. 4, 2008. (April 30, 2011)http://realestate.aol.com/blog/2008/08/04/how-to-buy-bank-owned-property
  • Fulmer, Melinda. "Buying a Foreclosure? Plot Your Strategy." MSN Real Estate. (May 31, 2011)http://realestate.msn.com/article.aspx?cp-documentid=20508059
  • Gengler, Amanda. "Making the Right Moves." Money. Vol. 39, No. 3. Page 81. April 2010.
  • Gibbs, Lisa. "Why to Buy Trouble." Money. Vol. 40, No. 3. Page 78. April 2011.
  • McCrea, Bridget. "This Old House?" Black Enterprise. Vol. 40, No. 3. Page 21. Oct. 2009.
  • McQueen, M.P. "Are Distressed Homes Worth It." The Wall Street Journal. Oct. 1, 2009. (April 31, 2011)http://online.wsj.com/article/SB10001424052970203803904574430860271702396.html
  • Perkins, Broderick. "Is Your Agent Experienced in Distressed Properties?" Realty Times. Nov. 5, 2009. (March 31, 2011)http://realtytimes.com/rtpages/20091105_agent.htm
  • RE/MAX. "Buying Distressed Properties." (April 30, 2011)http://www.remax.com/learningcenter/realestate101/realestatedistressed.aspx
  • The Wall Street Journal. "How Not to Buy a Home: Learning from a Rookie's Mistakes." (March 31, 2011)http://realestate.msn.com/article.aspx?cp-documentid=21301877&gt1=35000