Financial Education

Foreclosed properties can offer homeownership and a smart investment

By Joe Freeman, Chief Operating Officer, Pioneer Services

Owning a home is a part of the American dream, giving a family a place that is truly their own—a place where they can have the type of stability not provided by renting. And most important, it provides them with a tangible asset that, historically, gains value over time.

But the recent downturns in the housing market and economy have made it difficult for some to live that dream. The end result of this turmoil is a glut of empty houses all across the nation, many of which are available at drastically reduced prices.

A good deal may turn disastrous, however, if home seekers fail to do the work and research necessary to get the best deal. The following tips and information can help those looking to buy a foreclosed property, and keep the American dream from turning into a nightmare.

Create a budget
The first thing you need to do is decide how much you can realistically afford right now. This not only includes how much house you can afford in terms of total price, but also other expenditures:

  • Down payment—While usually 20 percent of the home's asking price, qualified first-time buyers may only have to pay three percent, and those in the military can also get special deals through the Veterans Affairs (VA) loan program.

  • Closing costs—These are in addition to the down payment, vary by lender, and can be several thousand dollars, depending on the cost of the home and type of loan. There are government programs that can help defer these costs, depending on eligibility requirements, and some sellers (and even lenders) might even offer to pay them, so ask.

  • Escrow—This usually includes taxes and insurance, and can either be paid in one lump sum each year or, if offered, wrapped into the monthly cost of the loan.

  • Miscellaneous—Things like home repairs, appliances, utilities, and other items not needed while renting should be factored into your budget.

Get pre-approved
Knowing what you can actually receive from a lender will save you a lot of time and headaches, forcing you to only look at homes for which you will actually qualify. Some may discover they don't qualify for nearly enough and end their search, while others may be surprised at how much home they can afford. Regardless, this is a very simple, but important, step that some people skip, only to discover they can't get enough money to buy the house they wanted.

Property types and due diligence
It's easy to get too excited about buying a new home and rush into the process. But when it comes to foreclosed properties, it is vital that you do research in a number of areas.

  • What type, and who owns it—Not all foreclosures are the same, and different types are owned by different entities, each with its own advantages and drawbacks.

  • Pre-foreclosure—This is when an owner of a home is in the foreclosure process, but still has a chance to stop it by selling the property. In most cases, the property is sold by the original homeowner directly, but can involve the lender as well. The process can be tricky since it can take several months, the original owner may not be happy about the situation he is in, and he may need as much money as possible, making a good deal difficult.

    In some cases, however, the bank and owner may be willing to "short sale" a home: the seller asks the bank to take less than the owed amount, and the bank weighs that offer with how much a foreclosure would cost it. If it appears that the loss would be less, the bank will usually entertain the offer.

  • Contractor defaults—When a home builder was not able to sell his houses and defaulted on his loans, a bank takes ownership. While you'll need to contact the bank that owns the property or the listing agent to buy one, the upside is that these houses are usually brand-new. You can find some of these types of properties at MidCountryBank.com.

  • Government owned—Still other homes may be owned by the government, usually the department of Housing and Urban Development (HUD), Agriculture (USDA/Rural Development), or the VA. The government takes control of these homes when a government-backed loan defaults, and many are sold through an auction for pennies on the dollar. The only drawbacks are that they are sold "as is" with no warranties, and you'll need a broker or agent to submit a bid. More information about government owned homes is available at www.HomeSales.gov.

  • Inspection—Once you find a home you like, ensure it is in livable condition. Contractor defaults may be simple since they are usually new, but standard foreclosures may have damage, so make sure the inspector does a thorough check. You will also need to check on liens and judgments that may be attached to the property, and make sure they are resolved before you close.

Close the deal
The most important thing you can do at this point is read every single word on every single piece of paper you receive. If you don't understand something, ask. And if your questions and concerns are not adequately addressed, do not sign the paperwork—buying a home is too large a commitment, and jumping in uninformed can turn into a financial catastrophe.

Some other things to look for:

  • Rental provisions—This is important for military families who move frequently, since selling a home in the middle of a permanent change of station (PCS) is just more stress. Many loans will prevent you from renting the property after you vacate, but ask if the loan can be modified due to your unique situation, or get a loan that does not prevent you from doing so.

  • Adjustable rates—Adjustable rate mortgages (ARM) now have many restrictions, but they are still available and can be great options for the right people. If you are getting an ARM, know what both the beginning and adjustable rates are before signing, and do not assume you will earn more several years down the road and will be able to afford a much higher payment. Instead, ensure you can afford both on your current income so you are not overwhelmed when the rate resets.

Once you are comfortable with the paperwork, all that is left to do is sign you name and get ready to move into your new home.

About the author
Joe Freeman, Chief Operating Officer for Pioneer Services, has more than 17 years of experience in accounting, operations, consulting management, and marketing. A successful entrepreneur, he is a former manager in a Big Five accounting firm, and an expert in managing operational processes, improving efficiencies, and developing strong executional teams.

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