Should You Buy a Foreclosed Home?

Jeremy Glaser: I am Jeremy Glaser with Morningstar. Even as data suggests that the housing market has reached a bottom and appears to be stabilizing, foreclosure activity has been accelerating. Here to discuss if individuals should look at foreclosed properties is Dave Hanna, president of the Chicago Association of Realtors and Managing Partner of Source One Realty. Dave, thanks for joining me.

David Hanna: Morning, Jeremy.

Glaser: In general, do you think that most individual investors or individuals should be looking at foreclosed properties as a potential home or as a rental property?

Hanna: I think that there's some great opportunities for individuals who have a specific game plan and understand the foreclosure process. These properties are currently quite abundant in some areas of our marketplace [in Chicago], and I think around the country.

However, condition is an issue and understanding the process would be really critical. The one thing that is most challenging for anyone who's looking at foreclosed property, is making sure they have all their financial ducks in a row before they enter into that marketplace.

Banks expect a quick response, they negotiate differently than the average homeowner would and you need to be prepared for how the process is going to go.

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Glaser: Can you walk us through what the basic process would be for someone who is thinking of buying a foreclosed home?

Hanna: First and foremost, determine an area or areas of interest. What part of a community--whether it's a city, or small town or neighborhood--is ... attractive to you? Why are you looking to be an owner of this real estate?

You want to go in either looking at it as an investment or a possible residence, trying to do both at the same time is going to be a challenge. From that point, you need to get familiar with the marketplace itself, in terms of what the inventory is. Look at the price points. How much of the disparity is there in the market between what foreclosed properties are selling for versus what traditional sales are showing.

If you have a knowledgeable realtor you're working with, they should be able to get you that information. You could probably find most of it online as well. You may be surprised to find that there is as good a bargain for you--especially if you're going to be a homeowner, if you're going to live in this property--to be looking for a good deal in a non-foreclosed sales environment.

Glaser: When you're looking at trying to find comparable sales, for a foreclosed home to come up with a bid, what are some of the factors that you want to consider about the condition of a foreclosed home versus a traditional home? And what are some of the things that you want to watch out for?

Hanna: You see and hear about individuals who bought foreclosed property with virtually no viewing of that property ahead of time. That's a big mistake in this particular climate here. The homes that we have are not engineered or build to be unoccupied for long periods of time. When they're not occupied, they're not being maintained as though they're being occupied, so they don't have utilities on. They're closed up.

These all create a number of challenges for the house itself. If you're not able to get in and get a good look, you may be in for some unwelcome surprises. Mold, for example, a big problem. Water: Many of the homes that we have, especially the newer homes, were built with drainage tile systems in them that require an active sump pump to keep the water table around the house low enough so that there's not water seepage into the foundation.

Mold can become a very big issue, and it can happen almost overnight. You have issues with pipes freezing, you have issues with infestation of rodents and all kinds of other critters, and at the end of the day you want to make sure that you got a good look at the property and then you have some ability--either on your own, or by working with someone else--to assess what is going to be needed to be done to make that home inhabitable and attractive--especially if you're going to look at it in terms of buying it and reselling it; which is one of the options for someone buying foreclosed homes.

Glaser: Are there any special considerations for getting a mortgage on a foreclosed home? Is that more challenging than in traditional sale?

Hanna: I think that we are seeing some instances where lenders are more biased towards a cash offer. A cash offer doesn't necessarily mean that you're going to have cash, but you need to understand when you enter into that situation that you're going to be tied to a very tight timeline.

Regardless of whether it's cash, or you're getting financing, I think it's important for you to make sure that the lender knows ahead of time what the money is going to be for. You're going to find out that there may be some special considerations they have. In general, foreclosed homes, especially in terms of condition, [are] going to get much closer look by a lender than a traditionally sold home might be.

Glaser: In terms of the number of foreclosures, there's been reports that there's a lot of people competing for relatively small foreclosures as banks may be withholding inventory as they're waiting for prices to come back or homes are still working through the legal system. Would you expect for there to be a pretty big backlog of foreclosures going forward?

Hanna: We continue to hear about what will refer to as a ghost inventory foreclosure properties that are out there. I do believe that there are still a substantial number of homes that haven't made their way into the marketplace. I believe that you're going to see a lag, long after the market, or least for some period of time after the market begins to turn, those properties are going to continue to show up.

There were always some foreclosed properties in the market, but we weren't looking at the delinquency rates on mortgages--last time I heard around 14% of all homes are delinquent at some point in their mortgage. That's a substantially higher number than the 2% or 3% which was the norm before.

Glaser: Investors shouldn't be too worried about--if they decide to wait six months or even a year, that there still won't be anymore foreclosures or that they'll have missed the opportunity to buy a home.

Hanna: No, I would not be in a hurry. I think it's really important that you have a game plan before you start this process. Know what your assets are, know in terms of how familiar are you with the marketplace, how good is your information, what is your ability to actually go and get the financing you need?

There are a number of individuals out there who promote programs that allow the so-called individual investor to get into a foreclosed property for little or no money down. These are the same things you've heard for years and years. You need to know what you can and can't do, because banks look at contracts completely differently than homeowners do, and you can find yourself in a position of substantial risk if you're not properly prepared.

Have a game plan, know what your goal is going to be, be familiar with the marketplace and then make an educated decision. Like any other investment.