How to Make Money on Foreclosures
Every real estate investor dreams of getting a sweet foreclosure deal and profiting from a sale. Buying a foreclosed home can yield a strong return. You just have to have an appetite for risk and the resources to make it happen.
Foreclosed homes don’t always lead to profits, though. It’s certainly possible. But you have to know what you’re doing. Otherwise, the project could quickly turn into a financial mess.
In this post, you’ll learn how to get ahead in the foreclosure market.
How to Make Money on Foreclosures
So how do you actually make money on foreclosures? The five steps below lay out everything you need to know to get started.
- Get Your Finances in Order
- Build a Network of Contractors
- Discover Opportunities
- Research Local Market Values
- Execute Quickly
1. Get Your Finances in Order
Participating in a foreclosure sale is a serious financial decision that requires you to be in solid financial standing. You’re either going to need a strong cash reserve or solid credit to secure a loan to scoop up foreclosure properties. That being the case, the first thing you should do is conduct a financial gut check to make sure you’re ready to move forward with the process. Otherwise, you might end up foreclosing on your own investment!
Hands down, the best way to buy a foreclosed property is with cash. Paying for a foreclosed home in cash allows you to move much faster than going through the process of securing a mortgage. And in some cases — like when buying a home from the IRS — you’re required to make a cash transaction. On the plus side, you won’t have to worry about making monthly mortgage payments and interest rates, either.
In addition to paying for the property itself, you’re also going to need plenty of flexible capital on hand to cover maintenance and repairs, which we’ll touch on in just a bit.
If you’re aiming to participate in a foreclosure auction one day, start by building up a large cash reserve and stash your money in a high yield savings account (HYSA) or money market account to maximize interest while maintaining flexibility.
Do You Have to Pay Cash for a Foreclosure?
It depends on how far along the property is in the foreclosure process. If the house is in pre-foreclosure — meaning it’s a distressed property where the homeowner has defaulted on a loan but still owns the house — you may be able to secure the property via a short sale, which typically means you’ll pay less than the true property value the previous owners paid.
If the house goes to auction, you’ll most likely have to pay cash to secure the property. This may require you to write cashier’s checks at certain intervals. If a house sells for $200,000, you may need to write two checks for $100,000.
Auction rules differ by state and county, so check with your local area to see what the rules are and what’s expected in terms of how much you have to pay upfront and when it’s due. And don’t forget about property taxes, either.
How Much Do Foreclosed Properties Cost?
Pricing is typically determined by the market price of the home — unless you’re buying the house at auction.
The general rule of thumb when making a bid on a foreclosed house is to make an initial offer that’s roughly 20% below market price. So if a home is valued at $300,000, you should be prepared to offer something near $240,000.
If you’re intent on winning the auction, it’s best to determine how much you are willing to put down ahead of time and bring extra cash to the table to secure the bid. For example, you may identify a property that’s a potential gold mine, causing you to increase your offer to 10% below the asking price (or $270,000, to continue our example).
It all depends on your risk tolerance, how badly you want to flip the house, and what the expected return is.
2. Build a Network of Contractors
If you’re looking to flip houses or sell them quickly, the next step is to build a team of trusted contractors.
Unless you are a skilled handyman with the time and resources to devote yourself to a foreclosed property, it’s a good idea to outsource work to a team of experts who know how to improve homes and prepare them for resale.
Contractors who do this for a living can advise you on the type of materials you should use in your home, and which ones to avoid. For example, flooring might seem simple. But it is actually very complex. The flooring you use can depend on a variety of factors — like the neighborhood or value of the home, the environment, your preferences, and your budget, among other factors.
A contractor will be able to offer crucial input that could significantly affect the potential return on your investment property.
Spend some time networking and partner with people based on recommendations whenever possible. And when it’s time to hire a contractor, it’s a good idea to put them through a vetting process to make sure they know what they’re talking about.
It’s also a good idea to inquire about their schedule and general availability. You need to move quickly when flipping houses, so you may want to avoid working with contractors who are spread too thin.
3. Discover Opportunities
At this point, you should have funding in place to secure a foreclosed property and the resources to make it market-ready. The next step is to discover foreclosed properties.
Here are some common places to find them.
If you’re looking to buy a foreclosed property, it pays to have a savvy and well-connected real estate agent. Oftentimes, real estate agents receive advanced insights into foreclosed properties before they are made available to the general public. In some cases, they can move you to the front of the line, so you can secure a short sale before the property goes to auction.
Check with local mortgage lenders, as financial providers often list foreclosed properties for sale on their website, too. This is usually the last chance to secure a property before it goes to public auction.
Lenders also post foreclosed properties in newspapers in hopes of attracting local buyers. Check your local paper often so you don’t miss out on any deals.
4. Research Local Market Values
When buying a foreclosed home, there are two key metrics to consider: the purchase price that you can acquire the home and the amount you can likely sell it for (or how much you can rent it for).
Start by scanning real estate websites for surrounding properties and try to get an estimate of what other homes are selling for in that area. You should also talk to a real estate agent and an appraiser to get an accurate final market value report.
5. Execute Quickly
One of the hardest parts about winning the foreclosure game is you have to move quickly based on the information you have, your real estate agent’s opinion, and your gut instinct.
Buying houses at foreclosure can be very competitive. If you don’t act quickly enough, you’re bound to lose to another buyer. Your best bet is to learn how to quickly identify a money-maker and have the pieces in place to act on it when it’s available.
The trick is to identify properties that are well below market value after the cost to renovate. If you can get the house for 80% of market value after repairs, that’s how you know it’s a winner.
Tips for Making Money from Foreclosures
Don’t Be Afraid to Walk Away
Buying a foreclosure is a very risky investment. Even under the best circumstances where you get a great deal on a property, there’s no telling how the market will move once you secure it.
Don’t be afraid to walk away from a deal if you’re not completely comfortable going in. If you get the sense that the property is going to be more of a headache than you can stomach, you’re better off putting your money elsewhere.
Know When to Rent or Flip
A foreclosed unit can either be flipped or turned into a rental property.
Talk to your real estate agent to determine the value of the house and the expected return that you would be able to generate from renting. In some cases, it can be more profitable to keep a house long term and pay down the mortgage slowly (or replenish your cash stash) with rental income.
If you choose to go this route, keep in mind that it will cost you more long-term in maintenance and upkeep. You may want to consider hiring a property management company to take care of it for you so you can focus your attention elsewhere while receiving residual income.
Find an Agent Who Knows How Foreclosures Work
Not all agents specialize in home foreclosures. Shop around and find a real estate agent who knows the ins and outs of this niche area of real estate so that you get the best possible deal. The real estate agent you work with is one of the most important parts of the process.
This can’t be overstated: A foreclosure usually requires a massive amount of work. If you’re looking to break into the real estate market but want a more hands-off approach, consider exploring a real estate investment trust (REIT).
A REIT is a security that focuses on real estate investment. You can invest in REITs and receive dividends, potentially profiting without any of the hassle of dealing with physical property. It’s not risk-free. But it’s a heck of a lot safer.
Frequently Asked Questions
What is pre-foreclosure?
A house is considered to be in a pre-foreclosure state after a homeowner defaults on a loan or falls behind on their payments. At that point, the bank should get involved to try and work out a deal with the homeowner.
In some cases, the bank may try to arrange a short sale to replace the owner with another buyer. During the pre-foreclosure process, you can secure a property with a loan or you can make a cash offer.
What are Fannie Mae and Freddie Mac?
Fannie Mae and Freddie Mac stand for the Federal National Mortgage Association and Federal Home Loan Mortgage Corporation, respectively. These organizations buy mortgages from lenders and often sell them as mortgage-backed securities.
What are distressed properties?
A distressed property is one that is under foreclosure or in the process of being sold. When a homeowner fails to make payments or taxes, the property becomes distressed, triggering the lender to take action and arrange a sale.
It’s important to note that just because a property is distressed doesn’t mean that it’s necessarily a bad property or in dire need of an overhaul. However, investors should keep in mind that distressed properties often arise out of negligence or financial trouble. They can have structural damage or need to be gutted before they can be brought back to market.
Do you need a good credit score to buy a foreclosed home?
It depends if you apply for a home loan. If you want to secure a mortgage, you’re going to need a credit score that’s in good standing. If you have a low credit score, you can still buy a foreclosed home, but the bank likely will require you to put more into a down payment. You will also probably have to pay a higher interest rate on your mortgage.
The truth is if your credit score is damaged, you should look into why it’s low and assess whether you are in a good place to be buying new properties. If you’re honest with yourself, the answer is probably not.
The Bottom Line
Buying a foreclosed property is an excellent way to acquire real estate at a price that is below market value. Real estate investors should understand that the process is risky, especially if you don’t really know what you’re doing. But if you know how the foreclosure process works and you have the resources in place, a foreclosed property can be a great investment.
If you’re thinking about investing in a foreclosed property, consider talking to a financial planner first to make sure that your personal finance situation is in good standing. An advisor can let you know whether it makes sense to buy or if you should put your money into other investments other than the real estate market.
Take your time and do your due diligence, and you’ll make the right decision.