Foreclosure Deal: Let the Buyer Beware

For David Williams, the American dream of home ownership started as a nightmare while he was a renter.

The four college students living in the unit adjacent to the San Fernando Valley condominium Williams leased “partied constantly,” blasting their rock music into the wee hours of the morning and littering nearby sidewalks with empty beer bottles.

Occasionally, he’d be awakened by the splash of someone diving into the pool from the top of the complex’s two-story clubhouse, or by a drunken and confused youth mistakenly banging on his front door.

Even more frustrating, the rowdy tenants’ landlord couldn’t be tracked down. Letters sent by the condominium homeowners association were always returned, stamped “Moved: No Forwarding Address.”

Running out of options, the 32-year-old dental assistant called the lender who had financed all the sales at the development when it had opened a few years earlier.

To Williams’ surprise, the lender had a problem, too: It had foreclosed on the absentee landlord a month earlier, and wanted to sell the property fast.

“We made a deal right over the phone,” Williams says. He agreed to put up about $5,000, roughly 5% of the property’s market value. Even though he had never owned property before, the savings and loan gave him an adjustable-rate mortgage that started out at 7%, about one point below market rates.

The lender also waived the fees it usually charges new borrowers, which saved Williams another $2,000 or so in out-of-pocket cash. The troublesome tenants soon moved out, and Williams quickly moved in--as a homeowner, not a renter.

Not all foreclosure deals go so smoothly; in fact, the road to what get-rich-quick real estate gurus call “fortunes in foreclosures” is loaded with potholes for unwary investors. Although foreclosure bargains can be found, it usually takes careful research and lots of patience.

There are three ways to purchase a house in foreclosure. One involves looking for legal notices that lenders must publish before forcing a sale, and then purchasing the home directly from the troubled borrower.

The second method entails buying at an auction ordered by a trustee or judge, and the third involves purchasing the property from a lender or agency that took the property back when the borrower quit making payments.

The first two methods are considered risky, especially for novice investors: If the original owner declares bankruptcy, he can tie up the property for several months.

Title insurance policies protecting the new buyer’s interest in the home can be hard to obtain because some insurers don’t like “rush jobs” or fear that desperate sellers may take out several loans on the property at the last minute.

Buying at auction has two other problems: Most purchases must be made on an all-cash basis, and the original owner can sometimes reclaim the property even after it’s sold.

As a result of these and other hazards, many experts say the best way to go bargain hunting in foreclosures is to purchase a home directly from a lender or government agency.

By the time an institution finally takes a property over, all other claims and liens usually have been wiped out and there’s plenty of time for a buyer to obtain a thorough title search.

“If you haven’t bought foreclosed property before, you should probably stick to buying one from a lender,” says Robert Bruss, a syndicated real estate columnist and investor based in Burlingame, Calif., “It’s usually the safest and simplest way to go.”

Lenders often account for foreclosures under the “real estate owned” section of their financial reports, so foreclosed properties are often called “REOs.” Since most institutions want to unload these homes quickly, they’re usually willing to sell them at good discounts with attractive financing terms.

There are several ways to locate foreclosed properties. Would-be investors can contact lending institutions and ask for the REO or foreclosure department, or they can buy newsletters that list recent foreclosures.

Some lenders will put potential investors on their foreclosure mailing lists, as will some government agencies. Many also take out newspaper advertisements.

Checking Neighborhoods

Other investors spot foreclosures by driving through neighborhoods and looking for run-down properties that appear to be unoccupied. These homes are often the best buys because there’s a good chance the lender has only recently foreclosed and will slash the price to make a quick sale.

“Tall grass, broken windows, old newspapers in the yard--they’re all hints that a property is vacant and the house may be in foreclosure,” says Hollis Norton, a real estate investor and author.

A vacant property’s owner or lender can usually be located through public records at the county tax assessor, recorder or courthouse. “If you find the property before everybody else does, you have a better chance of making a really good deal,” Norton says.

Some lenders market their foreclosures themselves; others hire outside realty firms. Many veteran foreclosure investors won’t buy property that a bank has listed with real estate agents, claiming that commission costs drive up the price of the home.

Foreclosures Declined

Realtors, however, disagree. “The lender’s asking price is based on an appraisal, and the appraiser doesn’t add or subtract anything if the home is listed with an agent,” says Stan Weinsheink, senior vice president of SW Realtors in Canoga Park. His firm handles all foreclosures of its parent company, Southwest Savings & Loan Assn.

The number of foreclosures in California and most parts of the nation has declined over the past few years, in part because lower interest rates have made it easier for troubled borrowers to sell before the bank closes in.

Still, foreclosure investors can expect to get discounts of between 5% and 10% of a home’s appraised value, even if the house is in a strong resale area, Weinsheink says.

Even greater discounts can be obtained in severely overbuilt markets, or on projects that lenders are unusually anxious to unload. Investor Bruss says some of his best foreclosure deals have been made with banks that are far away from a home they have financed because sheer distance “can create huge administrative headaches.”

Attractive Financing

The biggest bargain in buying foreclosed properties isn’t always a discounted price: It’s the attractive financing terms lenders typically offer buyers willing to take the properties off their hands.

When Bruss bought a foreclosed four-bedroom, two-bath home in San Mateo, Calif., last year, the lender allowed him to purchase the property with a relatively small, 10% down payment, and gave him a loan about one percentage point below market rates. “I didn’t have to pay an appraisal or documentation fee, either, and the lender even paid for the title insurance,” he says.

Some lenders will also loosen their credit requirements and sell their properties for just 5% down, two important considerations for most first-time buyers.

Not all foreclosures are great deals, especially if they need thousands of dollars in repairs. Weinsheink urges potential buyers to hire an appraiser or home inspector before they make an offer on a house.

Appraisals and Inspections

“Getting an appraisal or inspection does two things,” he says. “First, it can help you spot potentially costly problems. And second, it helps you figure out how much you should pay.”

Appraisers and inspectors typically charge at least $100 for their services, so they should only be hired when a buyer has narrowed his search to just one or two properties.

Buying foreclosures is a tricky task and the process varies according to state law and local custom. As a result, experts urge newcomers to talk with realtors, lenders, veteran investors or attorneys before plunging into a foreclosure transaction.

It also pays to read a good book that discusses the subject. Among the better ones are Bruss’ “The Smart Investor’s Guide to Real Estate” (Crown Publishers, New York); Norton’s “The New Real Estate Game” (Contemporary Books, Chicago), and Marc Garrison’s “Financially Free” (Simon & Schuster, New York).

The Federal National Mortgage Assn. publishes a free brochure, “How to Buy a Foreclosed Home.” It can be obtained by writing to Fannie Mae Properties, P.O. Box 13165, Baltimore, Md. 21203.

NEXT WEEK: Buying a home with creative financing.