This article discusses some of the risks of a foreclosure auction and steps you can take to avoid them.
Buying real estate at foreclosure auctions can be a lucrative endeavor. However, there are many risks involved that can negatively affect the profitability of these investments.
It is up to the investor to become educated about the process, develop a high risk tolerance, and take steps to mitigate the risks whenever possible.
The risks of buying a foreclosure at auction are similar regardless of the type of auction. There are Trustee Sale Foreclosure auctions. There are REO/Bank owned property auctions for properties that have already been foreclosed on. There are online foreclosure auctions.
All foreclosure auctions involve the risk of buying a lemon that eats up your time and money. Buyer beware!
Risks of a Foreclosure Auction
These risks can include:
- Occupied properties
- Limited or no inspection period completed prior to auction
- Clouded Titles
- Unpaid liens
- No mortgage or appraisal contingencies
- Non-refundable earnest deposits
- Vandalism in the Home
- Limited time to Look at Homes
- The Speed of the Auction
- No Seller Discounts or Warranties
- Poorly Done Inspection
- Owner Redemption Period
- Possible low resale price
- Other hidden Issues
Auction Price Risk
Everything moves quickly at an auction and if you bid impulsively without having a set price limit, you could end up paying too much for a property.
Occupancy Risks
Dealing with occupants is the auction buyer’s responsibility. You might need to evict the former owner, family members and/or tenants after the purchase.
You should be aware if the property you are signing for is occupied or not. If so, it can add significant time, cost and complexity to your investment.
Repair Cost Risks
Foreclosure auction properties likely need repairs or general maintenance. The previous owners usually neglect these things as they fall behind in their mortgage.
In many cases there can be major problems with the home because of deferred maintenance, neglect and vandalism issues. Always take such costs into account by adding a 20-30% buffer before deciding the final amount you are willing to pay.
Home Inspection Risk
Home inspections are usually done before bidding, but these are quick and generally incomplete inspections. If you are not the winning bid you are out the cost of a home inspection unless you inspected the property yourself.
Some auctions will allow you up to 72 hours for inspections. But others will not allow full inspections at all. The best you can generally do is a “drive by inspection” to check the exterior. You should also look up old online walk-through photos from previous open houses.
Knowing the Auction Rules
Each auction company may different rules for their auctions, so be sure to find out what they are beforehand. For example:
- Is it sufficient to show a minimum deposit amount in cash or cashiers check? (for example 10%) Or do you need to show you have the ability to pay the entire minimum bid amount?
- What happens if you’re in a right of redemption state and the property owner comes up with the funds?
- What is the bidding procedure?
- Will the auctioneer extend the auction if he or she detects more buying interest?
- Is there a minimum reserve price on the property you’re interested in, or is it highest bidder wins?
- etc…
Find Foreclosed Properties In Your Area
Ways to Lower the Risks of a Foreclosure Auction
Do a Title Search
Definitely make sure you pull a title report for all properties you intend to purchase at foreclosure auction, because the title may be cloudy. The bank may be unaware of fraud or pending liens on the property to be auctioned.
Do not assume title will be clear only because it’s a bank’s property. Banks always de-risk themselves by stating the buyer has done the required research and they will not be held liable for any liens or frauds.
Use an Experienced Realtor
It is highly recommended to talk to a Realtor before going to an auction. You can even use one to assist you through the entire process. Realtors are not paid as much to bring a buyer to auction as a normal sale, so this can be a useful investment if you’re new to the auction game. Most auction companies will allow a Realtor to represent the buyer at their foreclosure auctions.
If you decide to purchase through the auction process without an agent, be aware that the auction company’s loyalty is to the seller. You will have to represent your own interests.
Become an Expert on Foreclosure Auctions
If you want to buy foreclosures at auction, plan on making that your primary interest. It is serious business when dealing with foreclosed properties.
Successfully profiting on foreclosed properties requires your A-game of bidding, time management, knowing the marketplace, financing and rehab skills. This likely means having a team in place to help you complete the entire process from purchase to sale.
Have Your Money Lined Up Beforehand
To participate in the auction interested parties must often deposit money, which can be 5-10% of the reserve price. If the bidder wins the property but fails to pay, he or she loses the deposit.
Auction companies typically require the winner to pay the remaining balance quickly. The total amount is usually due within two working days. In some instances 15% of the reserve price may be due within two working days, with the total amount due between within 15-30 days. Before participating, make sure you can arrange the required payments in the timeline provided.
If you plan to borrow, get a pre-approved loan from a bank, hard money lender, or private investor. Make sure they will lend on a foreclosed auction property. Also ensure the loan commitment letter will still be valid 15-30 days after the auction winner is announced.
Get Clear on Taxes
Before you bid, clarify with the bank on withholding tax rules for the property. You might have to pay out 1% of the agreement value from your own pocket. This issue is related to the previous owner and the lender who has control of the property.
You could get a good deal AND make significant profits if you follow these steps and avoid the risks of a foreclosure auction.
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