After huge upheavals in the housing market throughout the 2000s, the market showed signs of leveling off by late 2010 and early 2011. Still, despite hopeful economic indicators, as of 2011 a full third of all houses on the market were distressed properties -- those whose owners have defaulted or are about to default on their mortgages [source: Gibbs]. Largely because of desperation on the part of the owners of these properties, and their lenders, distressed homes can be much cheaper than comparable homes for sale. There are a few basic types of distressed properties.
In a short sale, a property is headed for foreclosure, and the owner of the home tries to sell the house for lower than what is owed on the mortgage. The lender takes a hit on the price to avoid foreclosure and cut its losses. When prices in the area have plummeted so far that it would be nearly impossible to sell the house for the value of the mortgage, short sales give lenders and homeowners a way out of the loan agreement.
At a foreclosure auction, banks and other lenders auction off properties that have been repossessed from owners who defaulted on their mortgage loans. Auctions are held at public facilities like courthouses and are best left to investors with large amounts of cash to spend. Individual buyers should usually steer clear, since all bids have to be backed up with a check in-hand for the entire sale price [source: Fulmer]. Even more frightening is the fact that houses at auction are usually purchased site unseen.
An REO (real estate owned) foreclosure is what people are usually talking about when they describe a property as a "foreclosure." This is a bank- or lender-owned home that you purchase directly from the lender in a process similar to typical home sales.
All distressed properties have the same basic advantages and disadvantages. On the plus side, a distressed home will typically be priced significantly lower than it would be sold for if it weren't distressed [source: Re/Max]. But these houses won't necessarily be dirt cheap. Widespread foreclosures drive down prices of non-distressed homes, so you might not need to seek out distressed homes to get a bargain [source: McQueen]. On the down side, distressed homes take more time and effort at virtually every stage of the process, require a large amount of paperwork and frequently need major repairs [source: Re/Max]. Read on to learn when you should go for it, and when you shouldn't, when it comes to distressed property purchases.
Questions to Ask
Ask yourself the following questions to decide whether or not buying a distressed property makes sense for you and your family.
How quickly do you need to move? Short sales in particular can take a long time to finalize. They require extensive paperwork and documentation. Among other things, you will have to submit an application to the bank proving that the former owner cannot meet their mortgage payments. For example, you might have to convince the homeowner to provide documentation that they are receiving unemployment benefits, or that a death in the family caused financial hardship [source: Dempsey]. Needless to say, that can be a touchy process. You'll also need to prove to the lender that it would be impossible to recoup the entire balance of the mortgage by selling the home through a foreclosure. Documentation like pictures of damages and examples of nearby comparable homes sales can help make that case [source: Dempsey]. The more evidence you can provide that the actual value of the home is drastically lower than the bank expects, the more likely they will be to approve a short sale to get the problem house off the books.
Short sales can also be delayed up to six months while you wait for approval by the lender, and any secondary lenders, if the homeowner took out a second mortgage [source: Re/Max]. Laws in some states might require the lender to file with a state court in order to finalize a foreclosure. Depending on your state's laws, there could be a mandatory waiting period of anywhere from 60 days to 12 months to complete that process [source: McQueen].
Do you need your house to be move-in ready? Distressed homes are always sold "as-is," which means you, the buyer, will be the one responsible for any repairs needed to get the house into shape [source: Gengler]. If you can find a home with minimal cosmetic damage, this might not be a problem. But keep in mind that foreclosures are emotional. Often, a homeowner has made huge financial and personal sacrifices to try to keep the house and ended up losing it anyway. Some former owners have been known to take out their frustrations on the homes themselves by damaging it or stealing valuable appliances and fixtures [source: Re/Max]. Also, since foreclosed homeowners have limited financial resources, they might have let necessary improvements like a new roof or plumbing repairs fall by the wayside while trying to keep up with payments. So, be prepared to stay in a hotel, rent or live in chaos if extensive repairs are needed. If you need to move in and settle into a routine immediately, a distressed home might not be a good fit.
What kind of house do you want? Since the housing crisis, smaller homes have become much more popular than larger ones. Buyers have begun to care more about energy efficiency and cost effectiveness than space. So smaller homes are more in demand, and bidding wars are more likely to break out among potential buyers [source: Gengler]. Larger homes, however, are less in demand, since there are more on the market from homeowners who couldn't keep up with the larger payments [source: Gengler]. If you can afford a larger house, and you're looking to upgrade, you can probably get a good deal on a distressed home. You might also want to consider a vacation home, if you can afford it. There is a large number of foreclosed vacation homes on the market [source: Duffy].
How financially stable are you? In the wake of the housing crisis, banks have become more picky about who they will lend to. So, if you don't have good credit and enough capital to offer a large down payment, you might have trouble getting a loan for that distressed home [source: Re/Max]. The lender you buy the home from will also want to see that you're financially stable, so they won't be left in the lurch at the last minute by an unreliable buyer who backs out of a deal. Distressed sales typically require the buyer to pay for expenses like closing costs, transfer taxes and even tax liens on the home. So, it's a good idea to take those expenses into account when considering your offer [source: McCrea]. If you add up all those expenses and come up with a price that is the same -- or more than -- non-distressed homes in the area, you probably would be better off with a traditional sale [source: Wall Street Journal].
Deciding whether to buy a distressed property instead of a normal listing is complicated. But by asking yourself these questions, you should be able to decide whether or not the pros outweigh the cons for your lifestyle and financial situation. Happy hunting.
- AOL Real Estate. "How to Buy Bank Owned Property." Aug. 4, 2008. (March 30, 2011)http://realestate.aol.com/blog/2008/08/04/how-to-buy-bank-owned-property
- Dempsey, Bobbi. "10 Steps to 'Short Sale' Buying." Bankrate.com. (March 31, 2011)http://www.bankrate.com/finance/money-guides/10-crucial-steps-to-short-sale-buying-1.aspx
- Duffy, Jack. "Vacation Areas See Opportunity in Foreclosures." New York Times. Feb. 19, 2009. (April 5, 2011)
- Fulmer, Melinda. "Buying a Foreclosure? Plot Your Strategy." MSN Real Estate. (March 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. (March 31, 2011)http://online.wsj.com/article/SB10001424052970203803904574430860271702396.html
- RE/MAX. "Buying Distressed Properties." (March 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>1=35000