When it comes to investing in real estate, buying a foreclosure or pre-foreclosure is a whole 'nother ball game. It's very different from normal real estate investing where you buy property that the owners intended to sell.
With foreclosures or pre-foreclosures, you'll probably have to deal with a frustrated bank, a distraught homeowner, and some serious repair costs.
But buying pre-foreclosures and foreclosures has its perks, namely the opportunity to buy houses at a huge discount before anyone else. So it understandably draws financially savvy investors like moth to a flame.
Of course, there is no yellow brick road here and buying a foreclosure or a pre-foreclosure does come with its pitfalls that could nullify any great savings you get from buying property at a discount.
So before you jump right into making it rain in the foreclosure world, make sure you avoid these common mistakes.
11 Mistakes to Avoid When Buying a Foreclosure/Pre-Foreclosure:
- Not Having Your Finances in Order
- Not Researching the Title
- Buying a Junior Lien Thinking It's Senior
- Not Inspecting the Property
- Paying More Than the Property is Worth
- Buying the Property Inside of the Redemption Period
- Fixing Up the Property Before the Owner is Out
- Closing on the Property Before the Owner is Out
- Underestimating Repair and Closing Costs
- Trusting Everything the Owner Says
- Being Too Stubborn or Too Greedy
Let's take a look at these in more detail below and see what you can do differently.
What are Foreclosures and Pre-Foreclosures?
Typically, when you purchase a house, you take out a mortgage with a bank to cover the costs. The bank uses the house as collateral for the loan. Subsequently, you are required to make monthly payments to the bank to pay back your loan.
So you never truly own the house until you have paid back this debt. The problem comes when you miss a few payments. Miss one too many and the bank will take your house.
To do so they will start the foreclosure process which will eventually lead to your house being sold at an auction to the highest bidder.
Pre-foreclosure is the period when the homeowner is behind on the payments but haven't received a notice that foreclosure proceedings have started.
If you can get in contact with the owner during this time, you could negotiate a deal to buy their home. This is buying a pre-foreclosure.
11 Mistakes To Avoid When Buying a Foreclosure or a Pre-Foreclosure
As always, investing in any kind of asset has its risks and pitfalls. Let's take a look at some of the mistakes made when buying a foreclosure or pre-foreclosure so hopefully you can avoid them.
1. Not Having Your Finances in Order
Before thinking about purchasing a foreclosed property you need to have your finances in order. That means you need to have more than enough cash ready to buy a property and pay for repairs, closing costs, etc.
Previously, access to foreclosures was limited to people with the cash to buy it. But nowadays, instead of cash, you could take out a loan.
Not many people are aware that there are some banks that will give you a loan to buy foreclosures and pre-foreclosures. But do some research and see if you can secure a pre-approval for a loan from a bank before you go out to buy a foreclosure.
You don't want to find a great property only to realize you can't buy it because you didn't get your finances in order ahead of time.
Start early putting your money together and lining up those loan pre-approvals. That way, when an amazing deal comes your way, you'll be ready to take action immediately.
2. Not Researching The Title
No matter what kind of real estate you are into you should always, always, always research the title for the house. Do this because you'll want to make sure the house you are purchasing is free from any complications that might come up later to bite you in the butt.
Doing a title search ensures that the owner you know is actually the owner on the title. Also, the search will ensure that there are no claims, liens, or other issues against the title that could affect your purchasing of the property.
You don't want a claim to come years later, after you've fixed up the property and moved in, stating that you aren't the true owner.
If you don't do a title search, a long lost cousin may come back to fight you for the property! This could cost you lots of time and money. So always do a title search!
3. Buying a Junior Lien Thinking It's Senior
In the world of real estate, all debt is not equal. There are some debts that have precedence over others. The one that does is called a Senior lien while the others are all junior liens.
If a property is sold in a pre-foreclosure or foreclosure sale, then lien holders will be paid in order of seniority starting with the most senior. In some cases, lien holders may be able to buy the property themselves before anyone else
For instance, should a property go into foreclosure, the holder of the senior lien will have first dibs on buying the property. But, should they choose to pass on the property, it may fall to the next person on the list and so on, in order of seniority.
As far as properties are concerned, an example of a senior lien would be the mortgage on the house and a junior lien might be unpaid contractor bills. A general rule to use to determine lien seniority is the lien that was recorded first has the higher priority.
4. Not Inspecting the Property
This is a huge rookie mistake. Just going by the looks of the property or taking the owner's word for it, is a terrible idea when you are buying foreclosures.
You never know what kind of things have happened to the property over time. And it is best to be prepared for it so that you can properly estimate how much it'll cost to renovate.
Furthermore, because the previous owners were clearly having financial problems, chances are they didn't allocate money as they should to fixing the property up. So there is probably much more wear and tear than you would initially think.
5. Paying More Than the Property It's Worth
The number one thing you don't want to do as a real estate investor is to buy a property for more than it's worth. That could ruin your expected returns for the next couple years or more.
Besides, isn't the point in looking for property in the foreclosure market to buy a property for far less than it's actually worth?
People just starting out make this mistake for one or two reasons. One, they didn't properly research and compare home values in the area for the type and layout of the home they want to purchase.
Or, two, they are banking on some outside factors to make such a purchase worth their time and effort.
Believe it or not, some investors will buy a property that is overpriced thinking that the market will go up soon. Or the neighborhood will encourage people to pay more for it, etc.
This is a terrible idea because you have no control over these outside factors. And by buying something overpriced, you are not giving yourself any margin of safety or profit on the property.
So be sure you do adequate research, hire an appraiser, and never rely on hopes and wishes to make a profit on the property you purchase.
If you don't inspect the property, you may find yourself saddled with 10s of thousands of dollars in repair costs.
6. Buying the Property Inside of the Redemption Period
A redemption period is a time in which the owner of a property in default has the right to pay those back taxes or late mortgage payments in order to reclaim their property. It applies during the pre-foreclosure period and after the house has been foreclosed on.
Not all states have redemption periods and these periods can vary from a few days to a year. So be sure to check your state for this information.
The problem with buying a property within the redemption period is that the previous owners still have the chance to buy the property back. And it would be a waste of time and money to take out a loan and purchase the property only to have it taken back.
However, it is very rare that people are able to get back their house during the redemption period. Considering, to do so, they would have to pay back all of the fees from the foreclosure as well as the mortgage in its entirety.
Alternatively, there is a way you can buy these properties without all the added risk of redemption. And that is by getting the owner to sign a waiver of redemption. Once that is done, you own the house free and clear.
7. Fixing Up a Property Before the Owner is Out
A big no-no that is done too often is fixing up the property before the owner is out. Sometimes investors think when they sign on that dotted line the house is theirs completely.
But the difference with buying foreclosures and pre-foreclosures is that in many states there is a redemption period. And in the off chance that the owners do manage to get enough money to buy their house back, you would have essentially fixed up their property for them for free.
And yes, this does indeed happen.
8. Closing on a Property Before the Owner is Out
It's easy for the excitement of buying a property at a huge discount to push you into rushing ahead and buying the property fast. After all, you don't want anyone else getting a whiff of this deal and buying out from under you.
But problems can occur when you buy the property before the owner is actually out of it. Because now you have the task of evicting them if they do not move out willingly. And that can get pretty costly and messy.
9. Underestimating Repair & Closing Costs
One of the biggest mistakes that rookies make when buying a property is underestimating repair and closing costs. And this goes for buying a foreclosure or a pre-foreclosures.
Many think that in buying pre-foreclosures you are only dealing with the homeowner, but in most cases you are dealing with the bank as well. And when it comes to that, there are definitely fees that must be paid upon closing on, or buying the house.
Also, many times, with foreclosures, you won't be able to see into the house. So it is difficult to estimate just how much repair the house will need. And with a pre-foreclosure, you just never know truly how much wear and tear the previous owner has put on the property.
So it is very important if you are just starting out, to fully research repair costs and when in doubt, overestimate those costs. It is better to be over prepared than not prepared at all.
And if you can, check with other experienced investors to get their opinion on these costs as well.
10. Trusting Everything the Homeowner Says
When you are investing in pre-foreclosures, you don't want to be too trusting of everything you hear from the homeowner. At the moment, they are in some serious financial straits so they might tell you the things you want to hear to ensure they can make the sale.
Of course, not all owners will go into the deal with the intent to make things sound rosier than they are. Some owners will genuinely not know everything that is going on with their house.
Maybe they haven't done an inspection since moving in and are unaware that there are termites or mold growing around a leaky pipe.
So definitely talk to the owner about the house but always have an expert come to take a look and check it out for themselves.
11. Being Too Stubborn or Too Greedy
When it comes to purchasing pre-foreclosure and short sales, there will be a lot of back and forth between the owner of the property, the bank, and other interested parties.
Because of this a lot of finesse and compromising will go into making this deal take place so that everyone all around is satisfied with the result.
If you come into it, set in your ways and holding on to any pre-determined things from your wish-list, you may find that all the parties involved may decide to move on to someone who is more willing to compromise.
And the same goes for being too greedy. Yes, there is a potential to get huge discounts on the property you purchase but there is a point where you can be too greedy.
When you get too greedy, the parties involved can feel like they are being taken advantage of. And when this happens, they are more likely to not go through on the deal.
Being too greedy or too stubborn can really hinder your chances of securing a great property through foreclosure, pre-foreclosures, and short sales. Not only does it leave a sour taste in the mouths of the involved party but it could hurt your reputation as a real estate investor.
Don't be too greedy! Closing great deals is about making it a win-win for everyone involved!
All in All
Buying a foreclosure definitely comes with a bit of a learning curve, but through continued education and mentorship, you'll eventually get the hang of it.
When you are just starting out, you are bound to make some mistakes. And making mistakes isn't bad. It is actually necessary for you to learn and grow.
So, while I hope you take these 11 mistakes to avoid to heart, know that it is okay to make mistakes. The most important thing is that you learn from them.
So...What have you learned from your real estate investing mishaps so far?
*DISCLAIMER: The Information provided in this post is simply the opinions of the blogger and is given in the spirit of educational fun. It is not investment advice. Please do your own research and decide what is right for you before investing in any asset. If necessary, seek the help of a certified professional in discussing your options.