Foreclosure auctions can be great places for investors to purchase houses to flip at good prices. New auction buyers need to know how to finance a foreclosure auction purchase once they have the winning bid. We dive into the details in this article.
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Foreclosure Auction Requirements
Foreclosure auctions require bidders to have a certain amount of cash on hand to place bids. This depends on the county and state the auctions are taking place in. It is up to the investor to contact the county or auction company and find out the funding requirements.
Most Foreclosure Auctions Only Accept Cash
NOTE: Cash means actual cash or certified cashiers checks.
Most foreclosure auction buyers pay cash for the property after they make the winning bid. A property auction is called a “trustee sale” and these usually do not allow financing. At most auctions cash or cashiers check is the only acceptable way to pay for the property.
In some cases, auctions will allow financing of auction property but they would not be true trustee sale auctions. These are usually REO’s that did not sell at auction and are now owned by a bank.
Auction companies generally require a minimum deposit of 10-15% of the winning price, with a requirement to pay the balance anywhere from 2 to 30 days later. In these cases, the buyer can finance the purchase, but must have the money fully committed by the lender and available for deposit into auction escrow. Otherwise, the buyer’s cash deposit will be lost.
Financing a Foreclosure Auction Purchase at Certain Stages
Financing a Short Sale
The step before a foreclosure auction is often a “short sale”. This is where the homeowner and bank have reached an agreement to sell the house below the mortgage amount due.
Short sale homes are typically sold through real estate agents and are open for inspection. However, these homes will often not be fixed up before sale, and can have a lot of issues. Because short sales are open market transactions and not auctions, financing is possible (even from the bank that currently owns the mortgage).
Financing a Foreclosure Auction
At the final stage of the foreclosure process, properties are sold to the highest bidder at auction. Homes at these auctions are usually sold only for cash and are “as is-where is” and all sales are final.
Some online auction services such as Hubzu allow buyers to pay using financing instead of cash. Online auctions tend to have longer payment periods than courthouse auctions, allowing time for third party financing. This practice has been increasing over the years.
Financing a REO Sale
After the courthouse steps auction, if the home does not sell, then the lender will take back the home. These properties are called “Real Estate Owned” or “REO” because the title and property is owned by the bank.
Banks list their REO properties with Realtors and sell them on the regular market. The bank will typically fix any major issues that affect livability and safety of the home, such as holes in the roof, electrical issues, etc.
Buyers can finance REO home purchases just like any other home.
So it is usually only before, or after the auction that financing will be available or acceptable to purchase a property. Loans must go through escrow with title insurance for approval.
Reasons Financing is Not Available for Auctions
The biggest issue with financing an auctioned property is that the short closing window often does not give the lender enough time for their required process. Even if the auction winner has a pre-approved loan amount in excess of the auction price, it may be difficult or impossible to meet the short payment deadlines (as little as 2 days).
Knowing this, most auctions do not allow financing because it means there is a risk that the auction sale will not be completed. Banks want to sell the home at auction to get their money back and the loan off their books as soon as possible. They don’t want the risk of the sale not closing.
In addition, banks do not usually finance homes in poor condition which is typical for auctioned properties. Mortgage lenders want to know that the properties they take as security for their loan will be marketable in the event you don’t pay.
The Auction Timeline is Key
Many auctions require a cash deposit and the balance must be paid in full within 2-30 days afterwards. Auction trustees cannot waste time with lender approval periods, or take the risk that the winning bid will fail.
There are many well-funded professionals with ready cash who will outbid you at auction. Remember, this is a competitive environment and trustees prefer bidders with guaranteed funds. Therefore, cash in at least some amount is required to bid at a foreclosure auction, with the remainder due according to the auction’s timeline.
Financing Depends on Auction Type
A home auctioned on the steps at the courthouse, called a “trustee sale” will not allow financing. Even a brand-new hard money loan may not necessarily work if the auction payment deadline is too short. Cash or cashiers checks are required in most instances.
However, a home offered at an online foreclosure auction, such as Auction.com, can often be purchased with loan, appraisal and inspection contingencies. Investors should research these online auctions to see whether financing is allowed. In that case a hard money lender is often the best choice because they can fund the loan very quickly.
Keep in mind that a substantial non-refundable cash deposit is generally required, and you will lose the deposit if your financing does not come through by the required date.
Foreclosure Auction Financing Options
Home buyers who place the winning bid at a real estate auction may be able to use a traditional mortgage in some auctions — particularly if the auction allows a 30-day close period. Those planning to live in the property as a primary or secondary residence can get a conventional mortgage, as long as the financing is lined up and fully committed beforehand.
Keep in mind that traditional mortgages normally require the property to be immediately livable when purchased. Since most auction properties have issues with their condition and cloudy titles, most lenders will not loan against them using a traditional mortgage.
Even if you’re pre-approved for a traditional mortgage, you cannot make the auction purchase contingent on getting mortgage financing. A non-refundable cash deposit is required to win the bid, equal to 10-15% of the auction price in most instances. If there is a chance the mortgage may fall through (for example a home inspection shows major structural issues you didn’t know about) then the lender will not approve the loan and you will lose your cash deposit.
It’s best to use a traditional mortgage to refinance an auction home purchase after the home has been made livable. This allows you to take advantage of lower rates and longer terms with a traditional mortgage.
Short Term Construction Loans
Buyers of homes that need serious repairs or fail to meet lender occupancy requirements can get a short-term construction loan to cover the purchase and estimated repairs.
Homes that sit empty for months or years often suffer from neglect and vandalism. Construction loans are intended to facilitate rehabbing these types of properties.
The typical term of a construction loan is 6-12 months, with a higher interest rate to compensate for project risk. The upside of these types of loans is flexibility — they can be structured to reflect the actual costs and timing of rehabbing the property.
After repairs and renovations are done, the investor can apply for a cash-out refinance mortgage, which will allow them to pay off the construction loan. Lenders may require buyers to wait 6-12 months after the purchase before providing a cash-out refinance mortgage, since the mortgage amount is determined by a post-improvement appraisal value rather than the original auction purchase price.
There are many guidelines that determine eligibility for a Federal Housing Administration (FHA) backed loan. FHA loans are designed for first time homebuyers intending to live in the property (not for investment only). Since many auction properties have issues with livability due to vandalism or neglect, this makes getting an FHA loan questionable.
There is a type of FHA loan that will allow a buyer to purchase a property in bad condition. However, it is not made for buying at foreclosure auctions and often takes too long to meet the auction deadlines.
Personal Loans or Lines of Credit
Another option is to get a large personal loan or line of credit on your own. Use this to pay for the property at auction and then refinance with a hard money loan or traditional mortgage later on.
This is an expensive option, but can be viable if you have solid credit and the loan can be obtained at a lower rate. For example, you could take out a HELOC on your main home and use that to purchase a house at a foreclosure auction.
Hard Money Loans
Hard Money Loans are a potential way to finance a foreclosure auction purchase. These type of lenders can supplement the cash you have available to win bids at auction using a loan secured by the property.
Hard money loans typically have higher fees and interest rates and are short-term in nature. But they are relatively easy to get and hard money lenders work much faster than banks.
Borrowers can replace a high rate hard money loan with a conventional mortgage later once the property has been made livable. Doing this can allow you the chance to rehab the property to the bank’s liking, then refinance at a lower rate if you decide to hold onto the property, rather than flip it.
Hard Money Not For Individuals?
In some states it might be required to form an LLC to get a hard money loan. For example, hard money lenders in New York cannot or will not loan to individuals. A credit check will also be needed as well as filling out a financial statement. Once everything is complete, an investor can close on a property fairly soon after.
In a Nutshell
New investors need to know how to finance a foreclosure auction purchase. In most instances auction foreclosure sales are cash only.
However, depending on the auction type, investors may be able to use financing instead of paying all cash for properties. You can buy a house at auction without cash using bank financing, hard money loans, personal loans, lines of credit, construction loans, or any combination of these. It all comes down to the auction payment schedule and how quickly you can secure financing to make payment by the deadline.