As you probably already know, interest rates have risen for homeowners with adjustable mortgages, causing a wave of foreclosures that we are just now starting to recognize. Late-night infomercial Carleton Sheets fans, this is your lucky day!
Or is it? I'll give you the moral to this story in a nutshell, then you can read on if you like.
Moral to the story: you and everybody else thinks that there's a deal to be found in foreclosures. The problem is, when you and everybody else are seeking for the same deal, prices get bid up to an amount that doesn't allow for nearly as much profit as the hyped-up sources would have you believe.
Think E-Bay. Obscure items that bargain hunters used to find at a flea market are now exposed to the entire world, creating an efficient marketplace. Have you shopped for something on E-Bay recently? It's efficient enough that I find I don't get as good of a deal as I'd like to, precisely because everybody else can see it too.
Finally, going after the REALLY big profit potential situations requires you to take on A TON of risk (oh, and one more thing--you'll often have to have the entire amount of the purchase price in the form of a cashier's check in your hand to do it).
Are you still feeling brave? Then read on. This excerpted article from Wall Street Journal explains the different kinds of opportunities and their risk/reward profiles.
Novices face a host
of risks. Foreclosed homes can come with hidden debts. Homeowners
generally won't let you inspect the home before you try to buy it out
from under them. Not knowing the local rules, which vary from state to
state, can also cost you big.
The notion that $250,000 homes can be had for a
few thousand dollars "is largely a myth," says Peter O'Connell, a
former banker who has invested in foreclosures for years, including
near his home in the Florida Keys. "If there is any equity in a house,
you're generally not going to get it cheaply."
Here's a primer:
The Process
The process usually begins when mortgagees fall
three months behind on payments. The lender sends a default notice to
the homeowner and to the county. If the homeowner can't pay up, a
foreclosure date is set. County officials handle the auction and use
the proceeds to pay off the mortgage and any other debts secured by the
house. Leftover money goes to the foreclosed homeowner; leftover debt,
in some cases, is the new owner's responsibility.
The mortgage lenders typically bid up to the
remaining principal amount plus any foreclosure fees. Their goal is to
recoup what they are owed, either from investors bidding more or by
buying the home and reselling it. Foreclosed homeowners sometimes join
the bidding and win the auction, even though they don't have the money,
effectively delaying their eviction until another auction is held.
Investors can get in the game before or after
auctions, too. They can try to buy directly from homeowners beforehand
or from lenders who win the auction.
What's Available?
Just about every type of home ends up at
auctions: wood-frame houses in downtrodden neighborhoods, high-end
homes in gated communities, condominiums, mobile homes, partially built
residences and vacant land.
To find them, get free foreclosure listings from
county court clerks or sheriff's departments; some counties post them
online. Commercial services provide access to local and national
listings. Foreclosurenet.net provides information on bank-owned real
estate for about $30 a month. RealtyTrac.com has nationwide listings of
homes in foreclosure and offers geographically tailored email alerts
for $50 a month.
Professionals specialize in niches, such as
low-income housing or condominiums. Less-seasoned investors should
stick with single-family homes in lower-middle- to middle-class
neighborhoods, where resale likely will be easier.
Legal Issues
Hidden liens can be a big problem. If a
homeowner had two mortgages and defaulted only on the second, the first
is still binding. Auction officials aren't obligated to tell you about
debts outstanding, so unwary investors could be saddled with having to
pay off that first mortgage, generally immediately.
A full-blown title search on a house can cost
$400 or more. But for as little as $25, some title companies will do
quickie "pencil searches" that detail existing liens -- raw data that
you weed through yourself.
In many cases, it is the property's first
mortgage in default, in which case subordinate liens are eliminated in
foreclosure. But watch out for exceptions: Internal Revenue Service
liens and some utility bills will need to be paid off.
Here is another pitfall: Some states give
foreclosed homeowners time to reclaim their property by paying the
auction price, often plus an additional percentage. In Colorado, they
have 75 days (though the state is set to eliminate that grace period).
So you could spend tens of thousands of dollars remodeling a house,
only to have the original owner grab back the newly improved home.
Investment Stages
Many investors scour default notices in search
of homeowners willing to sell cheap before auction. The competition is
stiff, given the many services that report new filings to subscribers.
"There are a million investors looking to
contact that homeowner with letters and phone calls and drive-bys,"
says Todd Beitler, president of Real Estate Library, an online provider
of foreclosure information (www.trel.com). What's more, homeowners in
preforeclosure know their home's value, so don't expect a big bargain.
Preforeclosure investing is medium-risk,
medium-return. Executed successfully, an investor could make a 20% to
30% profit, longtime foreclosure investors say.
Buying at auction is riskier. You are typically
buying "a mystery box" seen only from the outside, says Ken Kulpa, a
real-estate agent specializing in foreclosures around San Jose, Calif.
Sometimes, the house is a gem, but other times, there are big, costly
problems -- faulty plumbing, a 1950s-era kitchen or a leaky roof.
Then there is the belligerent homeowner who
trashes the place on the way out or refuses to vacate, requiring a
costly eviction process.
Another risk: In the excitement of bidding, many
novices overpay. If you are careful, auction investors can expect to
notch gains of 40% to 50% or more, professional investors say.
Most bankers won't finance a foreclosure bid, in
part because current owners aren't likely to let them inspect the house
to appraise it.
The lowest-risk option is buying foreclosed
homes from banks that acquired them at auction. Most major banks list
properties they own on their Web sites, and some will provide financing.
Banks often list homes in good condition near
market value, so there isn't much upside there. But banks also end up
with mediocre properties and some real dogs. You can try to negotiate
these houses' prices down to less than the outstanding principal, rehab
them and then resell quickly at market value or just below.
Profits on such properties can be in the
15%-to-20% range, experts say. Real Estate Library's Mr. Beitler says
this is a good place for novices to start. You won't have title
worries, because banks do that work, and you can inspect the house
beforehand.
That "will help you gain confidence and
experience buying and selling a property, negotiating and closing a
deal, and doing the rehab work," he says.
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