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Foreclosed homes present a cost-effective way to enter the property market or expand your investment portfolio. Typically sold at below-market prices, they are seen for their potential for significant savings and profit, especially among aspiring homeowners priced out of the market and investors adept at renovations and looking for a property to flip.
However, such properties often come with a few strings attached. Unless you're King Midas, turning a stone into gold can take a while too. So while foreclosed homes can yield significant financial gains, it's vital to approach them with caution and fully armed with information.
What is a foreclosed home?
A foreclosed home is a property seized by the lender, typically a bank, due to the homeowner's failure to meet mortgage obligations. The borrower may have fallen into financial hardship from sudden job loss or illness, or could no longer keep up with increased repayments when interest rates rose. Overborrowing and poor financial management can also drive borrowers to loan defaults.
A default notice is issued if the borrower has been in arrears for a certain period - typically between 60 and 90 days. If they're still unable to rectify the default within a specified period (usually 30 days), the lender can commence the legal proceedings to repossess the property.
Once the court grants an order for repossession, the lender may remove the occupants from the property to sell it through auction or private treaty to recover the outstanding loan balance.
Foreclosed homes are typically sold urgently because maintaining them can be costly for lenders. Expenses such as property taxes, insurance, maintenance, and security can add up, and an urgent sale minimises these ongoing costs.
Foreclosure vs repossession
In the Australian real estate context, the terms 'foreclosure' and 'repossession' (or 'mortgagee in possession') both refer to the process where a lender takes control of a property from a borrower who has failed to meet their loan repayments.
However, confusion often arises when considering the US meaning of foreclosure, which involves a formal judicial process to terminate the borrower's rights and sell the property. People might use 'foreclosure' in a general sense because of its widespread recognition.
Australian repossession usually follows a non-judicial process, relying instead on the terms of the mortgage contract, which typically includes a clause that allows the mortgagee (lender) to take possession of the property from the mortgagor (borrower) in the event of a default.
Distressed listings
While distressed listings typically feature lender-initiated sales of repossessed homes, they can also include those initiated by homeowners who are behind on their mortgage payments and want to avoid foreclosure.
These listings also include properties sold by couples going through a divorce and needing to divide assets, as well as by homeowners who must relocate as soon as possible, or deceased estates who want a quick sale.
Like repossessed homes, homeowner-initiated distressed sales are urgent, often resulting in below-market asking prices. Distressed listings offer an alternative avenue if you prefer to buy directly from a seller or if you're a bit iffy about purchasing a foreclosed property.
Is buying a foreclosed home ethical?
Because of the very nature of repossession, it is sometimes seen as an exploitative endeavour, feeding off someone else's misfortune.
"You have to consider if the property is an ethical choice," said Victoria-based property investor Goro Gupta.
Mr Gupta, who has purchased five foreclosed homes and is the CEO of an ethical property investment firm, believes it's important to "have a heart" if you intend to take this homebuying route - like allowing the residents to live in the property for as long as possible or being willing to let it go if the current owner wants to resettle their debts.
In Australia, the name of the homeowner of a repossessed property stays on the title until the new buyer settles.
Despite the ethical conundrum home foreclosures entail, it is now generally accepted that lenders need to recoup their financial losses by repossessing and then selling the property. Buyers, in turn, contribute to revitalising the housing market by purchasing and renovating these foreclosed homes.
How to find a foreclosed home
Sellers usually avoid advertising a sale as distressed or in arrears, as this could lower their chances of securing a more favourable price. That said, finding foreclosed homes may involve several strategies.
Real estate websites like Domain and REA often list foreclosed properties. To find the ones you're looking for, you could search using the following key terms:
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Distressed
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Must sell
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Mortgagee
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Mortgagee in possession
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Forced property sale
Property analytics firms such as Domain and SQM Research offer regularly updated databases of properties sold under duress or by the mortgagee in their distressed property reports, available for a monthly subscription fee.
However the limitation of these kinds of reports is it involves scraping property listings for terms such as 'urgent', 'must sell', and so on. This relies on the selling agent being forthcoming with this information - who wants to portray their desperation to sell?
You can also find foreclosed homes by monitoring property auctions, calling banks and lenders, or combing through government websites which may have a list of repossessed properties for sale in their state or territory.
Alternatively, you can seek help from a buyers agent who specialises in finding repossessed properties and has access to these kinds of listings off-market.
See Also: InfoChoice Free Property Report
Guide to buying foreclosed properties
Conduct due diligence
Foreclosed homes often involve several issues, from encumbrances to asbestos and pests, so make sure you do your due diligence before making an offer. Chances are, if the former owner has let the mortgage go, property maintenance has fallen by the wayside, too.
Firstly, ensure the property has a clear title, with no third-party claims, caveats, or legal disputes. Further, check for structural issues, maintenance needs, and any other potential problems. You may require professional assistance on these.
Find out more about the property and the local area. Aaron and Angelina Scott, co-founders of a prop-tech service firm, recommend asking these questions:
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Was there a death on the property that led to the foreclosure?
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Is the property part of a contested will?
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Could there be ongoing legal ramifications?
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Is there state or council plans to repossess the property as part of a larger land acquisition?
"None of these second-level questions and considerations are necessarily deal-breakers, but you do want to get to the bottom of why the property went into foreclosure in the first place, and if there are any outstanding issues," Mr Scott told InfoChoice.
"All that said, if it's a simple foreclosure where the previous owner simply couldn't make their repayments, but there's nothing wrong with the property, then you could be onto a winner."
Get pre-approval
When purchasing at a foreclosure auction, you generally cannot pull out of the settlement if you fail to secure financing. Therefore, it's crucial to have pre-approval from your lender before participating.
Additionally, pre-approval demonstrates your seriousness as a buyer, which can be advantageous in highly competitive mortgagee-in-possession sales.
Engage professionals
Things can be fast and overwhelming in foreclosure sales, so it's best to seek professional help to support you through the process. Hire an agent experienced in foreclosed homes, engage a solicitor to handle all legal aspects, and enlist a building inspector to assess the property's condition and potential repairs.
Prepare for renovations
Foreclosed homes often require some sort of repairs and updates which, depending on the extent, can be costly. You may need to get a home renovation loan or construction loan to finance these costs.
Construction loans are typically ideal for extensive renovations. Unlike standard home loans, the loan amount is based on the projected value of the property, which can be different from its current value. And instead of a lump sum, funds are disbursed in stages.
During the construction period, borrowers typically make interest-only payments on the disbursed funds, thus keeping initial payments low. The loan then converts to a standard principal and interest (P&I) mortgage once the construction is finished.
If you've built up sufficient equity in your current home, you may consider a home equity loan or top-up to finance the renovation costs on the foreclosed property you purchased. A home equity loan allows you to borrow against the equity you have in your home.
Alternatively, you can take personal loans to fund minor repairs and updates. Do note though that you are likely to pay higher interest on personal loans.
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Advantages of buying foreclosed homes
Buying a foreclosed home can offer several advantages for buyers who are well-prepared and understand how it works.
Lower purchase price
Lenders are typically more eager to offload a repossessed property to recoup their losses rather than hold out for the highest offer, thereby resulting in below-market pricing. According to Mr Gupta, buyers can typically get a foreclosed property at a 30% discount or better.
However, buyers agent Peter Ly noted that purchasing a repossessed property advertised on public domains and popular real estate platforms may cost more than if it were sold off-market.
"They can sometimes be sold for higher prices due to the attention that they can attract from buyers," Mr Ly said.
Less competition
Some buyers perceive mortgagee-in-possession sales as undervalued or in poor condition, which may lead to fewer viewings and offers, especially if sold off-market.
"If it's not listed online to the public, there is an opportunity to avoid a bidding war and to buy at a discounted price due to reduced competition between buyers," Mr Ly added.
Quick settlement
Banks and lenders are motivated to sell foreclosed properties as fast as possible, which can lead to fewer back-and-forths and shorter settlement periods than in typical home sales.
A short settlement period can be great if you want to move quickly and have your ducks in a row. However, it can be stressful especially if you haven't arranged finance or if you are moving into it, and your old home hasn't sold yet. This is where a bridging loan could come in handy.
Investment potential
Foreclosed properties can be good investment opportunities if they are in high-demand areas. "Investors often purchase these homes to renovate and sell for a profit (flipping), or to rent out for regular income," said book author and buyers agent company founder Lloyd Edge.
And if you're the type who can spot a diamond in the rough, you could potentially unlock lucrative yields.
"Foreclosed properties are usually not presented in the best light - there could be lots of rubbish and broken services - and people generally do judge a book by its cover. So simply fixing it up, increasing the street appeal, and relisting it can be a great way to make a decent profit," Mr Scott said.
You may consider applying for a renovation home loan to fund huge repairs and improvements, or a personal loan if the renovations are less extensive.
Also keep in mind stamp duty costs, which can act as a handbrake on flipping properties.
Risks of buying foreclosed homes
Before diving in headfirst, make sure you fully understand the risks involved in buying foreclosed homes.
Condition of the property
Getting a money-draining fixer-upper is perhaps the biggest drawback of buying a repossessed property.
"Banks are not going to put more money into the property to fix it up for sale, so essentially what you see is what you'll get," Mr Scott pointed out.
"And because foreclosure means that the owner has not kept up their repayments, it's reasonable to assume that regular property maintenance has also not been kept up, so keep a watchful eye out for any broken services, leaking roofs/gutters, or general rubbish build-up."
Unfavourable terms
The urgency of the sale may not offer enough room for you to negotiate more favourable pricing or terms. "If a property is in foreclosure, you're not dealing with another human seller, you're dealing with the actual bank or credit provider which may be less flexible with price negotiations," Mr Scott said.
Legal disputes
Foreclosed properties may have unresolved liens, back taxes, or other title issues that can delay the purchase process and cost you more in legal fees.
"Consult with a legal professional to review all documents and ensure the purchase is free from legal complications," Mr Ly advised.
This is where engaging the services of a conveyancer and survey/title report could be handy.
See Also: Essential Reports You Need for Buying a Property
Financial obligations
It is not uncommon for buyers of foreclosed homes to inherit not only the property's existing issues or damages but also its unpaid bills, including utilities, taxes, and association fees. Don't be surprised that you have to deal with power companies that have shut off the power supply, and potential body corporate issues with fees unpaid.
Photo by Robin Jonathan Deutsch on Unsplash
In-text photo by Freepik