There are three main types of foreclosures: pre-foreclosures, trustee sales, and REOs.
There is profit potential in all three types.
A pre-foreclosure is a property on which the owner has failed to make timely payments and the bank has started the foreclosure process. You can find these using various websites such as foreclosurefreesearch.com and others. One investment strategy here is to buy subject to the owner’s existing loan. It is a way to get into a property with a low down payment and poor or non-existent credit. The downside is that for an owner to have ended up in this position, they probably have negative equity. They probably owe more than their place is worth or they would have been able to sell it. There may also be other liens because if the owner couldn’t pay their mortgage, they probably stopped paying other bills too. It is hard to profit from a property with negative equity. Some people will re-sell on a lease option or will take back a note (be the bank) and will get an inflated price or interest rate by selling to someone with bad or no credit.
There are other reasons for pre-foreclosures, such as divorce or loss of a job. Be careful, though. Courts don’t like it if they feel someone took advantage of a distressed person and stole there equity.
A trustee sale is what happens in deed of trust states when the owner continues to fail to make payments and the bank decides to take back the property. They will bid their loan amount (plus penalties etc.). If anyone is willing to bid more, the bidder wins. However, the winning bidder takes the property as-is, without title insurance, subject to any liens that exist. The winning bidder may also have to do an eviction if the owner still lives there. There is no opportunity to do a comprehensive building inspection. Here in Spokane, WA the real estate auctions happen at the Spokane County courthouse, at the entrance to the courthouse. Research can be done upstairs to see what liens exist on the property.
Note that some states require a judicial foreclosure process, which take more time and is more expensive. Even in Washington State, some loans require a judicial foreclosure process. This is the case, for example, with loans on agricultural land.
There is some profit potential here particularly on properties that have second loans on them. The second loan gets wiped out at auction unless the lender on the second wants to pay off the first. Usually, a place is going to auction because there is negative equity. So the bank with the second is not likely to recover enough money from sale of the property to justify them paying off the first loan and taking over the property. Negative equity is not always the case but is often the case. If there was equity, the owner could have sold the place instead of losing it to foreclosure. To bid at auction, bidders must show up at the courthouse steps at the designated time with cashiers checks for the amount they are willing to bid. If they don’t buy anything, they have to go back to the bank and redeposit the checks. I have done this many times.
There is also profit potential with auction in rapidly appreciating markets. The appreciated value may be more than the loan amount even if the owner being foreclosed upon overpaid if appreciation is fast enough.
Buying on the courthouse steps is a risky business because the property may be badly damaged or there may be big liens. There have been some cases where bidders accidentally bought a second instead of a first position loan and found out that they didn’t buy free and clear but are now on the hook for the main loan. Buying on the courthouse steps may be a good strategy if you have a lot of time. You can go to the courthouse before the auction and search for liens on the properties that are coming up for auction that day. You do not want to spend too much time researching, though, because many of the auctions get cancelled or delayed. Banks are always trying to work things out.
You can find auction properties on trustee websites or by watching the legal notices section of newspapers that print legal notices. Some trustees put a lot more information online than others. There is profit potential in bidding on the properties that will be sold by trustees who don’t make it easy to get information. You have to create a spreadsheet with information from legal notices and wait for the auction dates. When an auction gets delayed, you move it down your spreadsheet.
The third type of foreclosure is REOs, real estate owned by banks. These are the safest types of repos to buy. The banks have already taken care of all liens and you do get an inspection period. The downside is that you have to use the bank’s forms and will have to agree to buy as-is, where-is. If there is some boundary dispute or problem, you cannot go back to the bank to fix it as you do not have a warranty deed. If there is any environmental problem, you are indemnifying the bank and that problem is now yours alone. With most newer residential properties, you are not too likely to have big environmental problems but note that you are taking some risk by buying as-is, where is. These types of foreclosure properties are easy to find, they are usually on the MLS, including HUDs. HUD and VA repos can also be found on the HUD and VA websites.
REOs are not necessarily good deals. The banks are trying to recover as much money as they can from these. On the other hand, there is no minimum price that they must get as is the case with conventional sellers. Conventional sellers will be hard pressed to sell for less than they paid. Banks are already taking a loss, usually.
You will find that some real estate agents will price the REOs that they handle quite well to get more volume. The banks have to agree to the prices but the agents advise them in how to price the properties. You will also find agents who handle a big portfolio of REOs who don’t know all the areas as well as local agents. A good real estate agent can put you on an automated email list to alert you when a new repo hits the MLS. You should be ready to pounce when you see a good deal. Don’t hesitate. Don’t second guess yourself. Don’t ask a bunch of other people. Have your financing lined up in advance.
In sum, there are some good profits to be made with REOs with some risk but less than with other types of foreclosures.
HUDs are a bit different in that you are bidding against other buyers but do not know what they bid or if there are any other bidders. You also don’t know how close you have to get to the asking price to win the bid. If a HUD is overpriced, it will sit on the market and HUD will lower their asking price after a certain amount of time has passed. Sometimes, strict HUD appraisal rules will result in a HUD property being drastically underpriced because they are not able to count certain rooms as bedrooms, etc.
Not all foreclosures are good deals. Some are tear-downs. You may be better off buying vacant land so you don’t have to do the tearing-down!