The two largest dangers in foreclosure properties are paying too much and buying property that is still subject to other claims.
Paying too much is a common risk any time you enter a situation thinking you will automatically receive a significant discount. You have to know the value of things, and you have to shop wisely.
Real estate agents selling foreclosed properties like to advertise them with the word foreclosure plastered over half the photo of the house. That is because people are attracted to such ads. Buyers automatically assume the advertised price is a bargain. In reality, most foreclosed real estate is offered for sale at its appraised value, or in accordance with something called a broker price opinion (BPO).
Some brokers will quote a low value in their BPO, hoping to get the listing, and then make a quick sale and a fast commission. Buyers should never assume the listed price is a discounted price.
Many people pay too much at auctions. Their competitive juices kick in and override their common sense. In the alternative, they fall victim to something called the validation syndrome, which works like this. Ken thinks a house being foreclosed is worth $125,000 at the most. He plans for that to be his highest bid. At the auction, there are four bidders, Ken, Elsie, Rhonda, and Zack. The bidding is spirited and soon reaches $125,000. Elsie bids $127,500, Zack bids $130,000, and Rhonda bids $132,500. Ken thinks, “If they all think the house is worth more than $125,000, then it must truly be worth more than I thought.” Ken bids $135,000, which is $10,000 more than he originally intended to bid.
Ken should not have allowed the other people’s bids to validate the higher value for the house. The other bidders might simply be wrong because they did not know the market. Elsie might be buying a home for herself and is willing to pay a higher price than an investor. Zack might have other rental houses in the neighborhood and knows he can save money on insurance and maintenance as a result. Rhonda might have sold another property recently and needs to buy something right away to avoid a large income tax bill. If Ken is the winning bidder at $135,000, he probably paid too much.
You might also pay too much because you do not know the condition of the interior of a house, and it turns out to be completely trashed. Obviously, if you are working with owners for preforeclosure purchases, you have an opportunity to inspect the home. Buyers of postforeclosure houses can inspect them before buying. It is only the auction buyers who are buying something unknown. You can guess at the condition of the interior by driving by and looking at the outside. People rarely maintain their lawns if the interior of the house is falling apart. Aside from that, you have to guess at the condition and set your maximum foreclosure bid at a level consistent with the risk you are taking.
The other danger is the risk that the property is still subject to other claims. You run this risk any time you buy any property at all. How do you know the seller is the one entitled to sell the property, no other persons have to sign the deed, and all creditors will be paid out of sale proceeds so that there are no liens on the property? You never know this for sure. All real estate lenders require title insurance to protect their interests. The title insurance company researches these issues before writing the policy, and problems are usually disclosed before closing. If some problem has been overlooked, and there are other claims, then the title insurance company hires lawyers to defend the buyer, or it pays off the other claimants.
Although lenders always require title insurance, many buyers do not request that their interests also be protected. There is an additional premium, but it is well worth the risk.