Buying a foreclosure? You need a strategy

Buying a foreclosure property is neither easy nor a guaranteed bargain. Hereís a beginnerís guide on how to approach this complicated part of the market.

You've seen the ads: Investors in expensive suits boasting about the easy money they've made snapping up foreclosure bargains. But truth be told, buying a foreclosure property is neither easy nor a guaranteed bargain.

Sure, with the number of foreclosures surging, it's possible to find a distressed home selling at a discount to those around it. But often there are pitfalls surrounding these abandoned homes that buyers should be aware of.

By the time you get them fixed up, in some cases you have paid more than retail (or market value)

To effectively shop for a foreclosure home, you need to understand the foreclosure process, the risks and the timing necessary to close the sale.

It also doesnít hurt to have some help from a seasoned agent who has handled a lot of bank-owned sales as a buyer's representative. But be wary of anyone who claims to know too much about what lenders will accept and when,.

"This market is so crazy I would be cautious of anyone who says they know where the market is going.

The foreclosure process

Letís start with a basic definition of foreclosure, how it works and how long it takes.

The foreclosure process is a means by which a bank can recover the amount owed on a defaulted loan, by repossessing the property that secured the loan.

The average foreclosure starts when a homeowner misses a mortgage payment and the lender files a notice of default. This is a public record and can be a first step for buyers in finding distressed properties, says Alexis McGee, co-founder of and author of "The Guide to Advanced Investing Techniques You Won't Learn Anywhere Else "

If the property owner doesnít pay the owed amount in 60 to 90 days (or whatever timeline is dictated by the state you live in), a public auction notice is generally recorded that sets a sale date for the home.

If the property doesnít sell at auction, the lender takes ownership of the property with the intent to sell it and recover its money. These bank-owned homes are often referred to as REO properties, a term that stands for ďreal-estate-owned.Ē

However, the foreclosure process differs widely from state to state. States with so-called judicial foreclosure laws require banks to go to court or file a lawsuit to repossess a home. This initial filing is called a ďlis pendens,Ē meaning ďsuit is pending.Ē

Nonjudicial states do not require this. The deed of trust signed by buyers typically includes a power-of-sale clause, authorizing a trustee to sell the real estate to pay off the debt if itís in default. The notice of default kicks off this process.

Itís important to be familiar with what the laws are in your state before embarking on your search, as they can affect the amount of risk you must shoulder and the timing for buying a foreclosed property.

A foreclosure in a judicial state such as New York can take more than12 months, while one in Texas can take as little as 60 days.

Now that you know the process, letís move on to your options in buying distressed properties, and the risks and rewards of each.

3 ways to buy a foreclosure

1. Short sales

When the value of a home has gone below the balance of the mortgage or mortgages on it, owners will often try to get the bank to agree to a short sale.

Under this arrangement, if you make a fair-market offer on a home that is less than the amount owed, a bank can agree to accept this offer and forgive the remaining debt on the property, staving off a foreclosure for the owner.

It can be a good deal if it works, experts say. But getting the bank to agree can be a lengthy and aggravating process both for the seller and the buyer.

ďWhat you are going to find is many potential buyers go into a short sale, then the bank wonít say Ďyesí or Ďno.í This can go on for six months where they wonít give you an answer.

Thereís a lot more paperwork for the owner to prove his insolvency, and if there is a second mortgage on the property, you have to persuade that lender to remove or reduce its lien, something that may or may not happen. Short sales do not wipe out these junior liens.

Itís best for: buyers who are in no hurry to move, or investors who are having a hard time finding deals in their community.

2. Foreclosure Auctions

Another way of purchasing foreclosures is to buy them at auction on the courthouse steps. Plenty of investors do this, often because itís a way to buy an attractive property with multiple liens.

But for most people, this option is fraught with risks, experts say. For one thing, you donít get to see the interior of the house before you buy, you donít get to conduct your own inspection, and often you have to evict the former owner.

There can be horrendous things wrong with the property. You better know what youíre doing or know that the price is so good, that even if itís a disaster inside it will still be worth it.

You also have to be ready with a check that day for the full amount you plan to bid.

Moreover, you must do your own title search ó there are no title insurance policies here ó or else liens on the property could prevent you from getting clear title when you are trying to sell.  And many states offer a right of redemption for the previous owner ó a time period in which he can get his property back if he pays the lender the outstanding loan amount, plus interest and the lenderís costs in foreclosure.

Youíd hate to buy a property at auction, pour money into it to fix it up and then have the owner reclaim the property and these improvements. Itís rare, but investors typically try to head this off in right-of-redemption states by purchasing the ďredemption rightsĒ from the previous owner for a few hundred or a few thousand bucks before or after the auction.

Itís worth noting that online auctions are emerging in the foreclosure space. If you investigate this option, be careful that the auction house youíre dealing with is selling the property and not a lien on the property, experts caution.

Itís best for: seasoned investors only. There is too much risk involved for people who donít make their living in real estate. And frankly, investors say, often the minimum bid is no great bargain.

3. Bank REO

These are the properties that went to auction but were not bid on, and so they reverted to the lender holding the mortgage.

In a hot market, these properties will sell for full market value, which in many cases is above the listed price. 

If you are willing to buy into a neighborhood with some blight ó a lot of foreclosures ó thatís where you will see some heavy discounts

However, itís more common to find REO properties running 10% to 20% lower than market value. That may not sound like much of a discount, but on a $450,000 house, a $45,000 discount can mean the difference between qualifying for a loan or not.

The good news, experts say, is that REO homes are lot less risky to buy than properties bought through a short sale or auction. For one thing, all of the junior liens have been wiped out. And, unlike an auction property, you can tour and inspect the home just like any other home on the Multiple Listing Service.

But, investors say, they are not without their own set of complications, including damage from an unhappy former owner. Some agents recall irate borrowers pouring cement down the toilet to mess up the plumbing, or intentionally flooding the house to inflict water damage and mold.

If a property has been sitting empty for a while, thereís a chance it might have missing appliances, dead landscaping or damage from squatters. So it might be a good idea to bring a contractor along to find out what kinds of repairs are needed and what they will cost before you make a bid. For every dollar you spend on repairs you should knock $2 off the price of the home. You shouldnít do the work for free, Investors caution that while you want to look for a fixer, you don't want to choose a place that needs to be gutted, because you will have a hard time getting financing for it.

Conduct a little research with the homeís last listing agent, if you can. Some Bank REOs have wound up in foreclosure multiple times, because thereís something wrong with the property or its location.

Sometimes thereís a reason the thing went into foreclosure, Just because itís a foreclosure doesnít make it a good buy.

Itís best for: anyone who is interested in buying a property below market value and who is willing to do a little research.

The key pieces of advice for successful foreclosure buying, experts say, are to be educated, be thorough and be unemotional about the houses you bid on.

Thereís a lot of competition for some of the better bank-owned properties, our office fields dozens of offers a day on some properties.

The good ones get multiple offers. Iíve had people whoíve made a dozen offers before getting one of them,.

Be prepared to look at a lot of foreclosures and get a feel for the market before hopping in there.

Renovated homes that have been improved on by the owners are selling better than empty homes due to the deplorable condition of the majority of REO properties. Improvements used to be a way of jacking up the price which might be good for the seller but disadvantageous for the buyer who had to pay for all improvements done in the final price. With house prices that are so low, improvements have become the selling point belittling the value of the property itself. Nice and shiny kitchens and baths have long lured people into getting the value they want from homes and having them in a house they intend to buy lessens the strain of having to get it done before they move in. Be sure all work is well documented with amendments to the original plans in place so you donít end up dealing with nuances later More Real Estate headlines