Buying a Foreclosed House: Top 5 Pitfalls

Buying a house in foreclosure is often touted as a way for both owner-occupants and investors to get a great deal on a property. However, the potential financial rewards are usually not arrived at without a significant amount of hard work.

Foreclosed properties have some common problems. In addition, there are some standard difficulties that you may encounter in purchasing one. While foreclosures can be great investments as fixer-uppers, either to live in or resell, they often come with challenges.

#1. Problems With the Property

The most important thing to keep in mind before deciding to shop in the foreclosure market is that these properties are given up by owners who can’t afford their mortgage payments anymore. In these cases, the house may have been poorly maintained—after all, if the owner can’t make the payments, they are likely falling behind on paying for regular upkeep.

Also, some people forced into foreclosure are embittered by their situation and take out their frustrations on their homes before the bank repossesses them. This often involves removing appliances and fixtures and sometimes even outright vandalism. After the occupants leave, foreclosures sit abandoned, often inviting criminal activity.

#2. Maintenance and Condition

Maintenance and condition can be a problem in foreclosed properties because of the circumstances under which the previous owner moved out and the amount of time the house may have been unoccupied. Bank-owned properties are sometimes disgustingly dirty because of time spent sitting empty, intentional neglect by the previous owner, or occupancy by vagrants. When a home is locked up with no air circulating for months, built-up dirt can cause the entire house to smell.

The previous owner may have made changes to the home without obtaining the proper permits. A typical example is converting the garage into a living space so more people can live in the house. These changes may be undesirable to new owners or create headaches for them with local government officials.

If the previous owner started to improve the home but fell on hard times, there may be partially finished work. The bathrooms may be redone while the kitchen has not been updated in 40 years, or there may be new floors in the living room while the bedrooms still sport outdated carpeting. Additionally, if any repairs were made, they may have been done by the owners themselves or by unlicensed professionals—in other words, people who may not necessarily have done the work correctly.

Sometimes foreclosed homeowners are locked out of the property before they can move their belongings, and, in some cases, they do not take everything with them. Many real estate-owned (REO) properties contain furniture, trash, clothes, and other items that you will be responsible for disposing of when you become the property owner.

#3. Vandalism and Neglect

Damage is not uncommon in foreclosure properties, and when houses are not lived in, it is easy for them to fall into disrepair from neglect. In extreme cases, it may be caused by vandals or even the former owner.

When a property sits vacant for too long, new owners may have to contend with graffiti, broken windows, and other damage. Broken windows can be common in REOs for several reasons. As mentioned previously, vandalism could be a cause. Also, when banks lock out owners while taking possession of the property, the former owner may break a window or door to retrieve belongings.

Previous owners may also purposely inflict damage at the bank’s expense by putting holes in walls or tearing off baseboards and crown molding in rare or extreme cases. The previous homeowners might remove items of value from a foreclosed home, including appliances, fixtures, doors, copper pipes, and more. In worst-case scenarios, anything that the homeowner does not take might be taken by thieves.

Either way, bank-owned properties may be missing things that generally come with seller-owned properties.

#4. Problems With the Purchase

Foreclosures can still be a good deal despite all of these potential problems. If you are willing to fix issues that most people don’t want to deal with, you can purchase a home at a significant discount. However, you may encounter additional problems when buying the property and improving it to move-in condition.

Lenders will not give homebuyers money for a dwelling that they consider uninhabitable or appraise below the purchase price. If you are an investor paying cash, this will not be a problem. The HUD Section 203(k) program can also help in some circumstances.

Common sense says that banks should want to unload REOs as quickly as possible, but in reality, banks sometimes drag their heels in considering offers and throughout the escrow process.

#5. No Seller Disclosures and Competition

Since no one from the bank has ever lived in the house, they are unlikely to have any knowledge of existing problems with the property. You will have to uncover everything yourself during the home inspection, by asking neighbors, or through experience after you become the homeowner.

Because foreclosures can be great deals, they are attractive to investors looking to flip properties or use them as rentals. Since investors can make all-cash offers with fewer or no contingencies and fast closings, their offers may be more attractive to the bank than those from would-be owner-occupants.

The Bottom Line

There is money to be made in foreclosures, but you should know the challenge you are undertaking ahead of time and choose your property carefully. Don’t overlook the fundamentals that make a property desirable because the purchase price is a bargain. You should also extensively research financing options for foreclosed homes.

While you can go the traditional route of using a private lender as you would for a conventional home, lenders can sometimes be reluctant to finance a foreclosed home, so it is worth looking into loans from the Federal Housing Administration (FHA) or Freddie Mac.