What are the Pitfalls in Buying a Foreclosure if You’re Getting a Mortgage Loan?

31 Jul What are the Pitfalls in Buying a Foreclosure if You’re Getting a Mortgage Loan?

Some people like the idea of buying a foreclosure but don’t actually enjoy the experience of buying one. A lot of investors and bargain-hunting homebuyers tell me that they want to buy a foreclosure.

I ask, “Why do you want a foreclosure?”

A common response is, “Because I want a deal.”

My reply is, “Tell me more about what you consider to be a deal.”

They say, “I want something cheap.”

I reply, “Bargains are everywhere, if you look. Some foreclosures are overpriced or come with hidden problems. Not all foreclosures are good deals.”

Here are some potential pitfalls in buying a foreclosure if you need mortgage financing:

• Inspections, or lack thereof. If you hear that the asset manager for the servicer or lender wishes to accept your offer, there may be a catch. They likely have addenda with additional terms that supersede language in your offer. For example, an investor might be allowed to conduct an inspection but will forfeit their deposit if they terminate the contract. A move-in homebuyer might have a limited time to conduct an inspection and terminate if they are unsatisfied what they find. A buyer of any kind will likely not be allowed to negotiate over inspection results. Of course, if there are other offers, the asset manager may very well pick one that waives all inspections. So, to have a chance of getting your offer accepted, you may have to waive all inspections from the start. Even if you’re allowed to inspect the property, your home inspector may have their hands tied. Read below.
• Utilities may be off. Not only do many foreclosures have the utilities turned off, but those properties may also be winterized. If the lender allows it, the buyer will first have to incur the cost of de-winterizing the property. Then they will have to pay to turn the utilities on. That means the buyer could have to wait 4 to 8 hours at the property on certain days because the utility providers require that someone be present when their technician arrives. The lender may only allow the utilities to be on for a brief period of time. In addition, the lender may require that the buyer re-winterize the property with a professional after the inspection. (In past purchases of foreclosures, instead of re-winterizing, I would leave the utilities on in my name until the closing.)
• Appraisal gap contingency. Since there are relatively few foreclosures due to rapid price appreciation in recent years, the foreclosures on the market can receive many offers. To compete with so many offers, some of which are probably cash buyers, a buyer needing a loan may have to include an appraisal gap contingency. For example, let’s say a house is listed for $150,000 and there are 15 offers. You offer $205,000 with an appraisal gap contingency. You state that you’re willing to come up with as much as $30,000 if the house appraises for less than the purchase price. If the property appraises for only $175,000, your lender will give you a loan based upon that amount. You state in the contingency that you’ll make up the $30,000 difference. That means you need extra cash just in case. You may even have to show proof of funds to show that you have the additional $30,000.
• No appraiser allowed inside. Your lender’s appraiser might not be allowed inside. Some foreclosures actually still have the owner or tenant living there, and it’s unlikely they will cooperate. Even if the property is vacant and easily accessible, you might not want the appraiser to go inside. If the house is in need of significant repairs, your lender’s underwriter might not approve the loan based upon what they see in the appraisal report.
• Waiver of appraisal contingency. You may have to waive the appraisal contingency. The appraisal contingency protects a buyer if the value comes in lower than the purchase price. Generally, it allows the buyer to terminate the contract and receive their full earnest money deposit back, or it permits the buyer to negotiate the price down to the appraised value. However, to get your offer accepted in a competitive situation, you may have to waive the appraisal contingency. That implies that you’ll make up the difference if the property under-appraises. It’s also possible that the lender’s addendum will require a waiver of the appraisal contingency.
• Waiver of mortgage contingency. It’s possible that the addendum from the seller will force you to waive your mortgage contingency. What if your lender denies the loan in the 11th hour? You might forfeit your deposit.
• Closing date extension, if you can get one. If you need a few more days or a couple more weeks to get your loan finalized, there is a chance that the lender will refuse to grant an extension. Even if they do, they may charge a per diem rate. Imagine if you have to pay $100 a day for every additional day that you don’t close. Most lenders will only allow up to one or two extensions. Delays in the closing date could happen due to title issues, difficulties in your appraiser getting into the property, or because of underwriter stipulations. Read below for more on those stipulations.
• The underwriter for your lender. The underwriter protects your lender (and you, essentially, from yourself) by ensuring that the loan is only granted if the property meets certain requirements. If the underwriter sees fungal growth in a photo in the appraisal, they may require that a licensed contractor evaluate and remediate the potential mold prior to the closing. You would need to have a contractor go in and either remediate at your expense or provide a letter stating that the fungal growth is clearly not mold. Then the underwriter would have to review the contractor’s paid invoice or letter and determine if that is satisfactory. All of this can take days or even a couple weeks. This could force you to request an extension from the seller and possibly pay per diem. And what if the underwriter denies the loan because the house needs too much work? You could not only lose the deal but you might forfeit your deposit.
• Deed delay. You may have to wait a few weeks to receive the deed. That could delay your ability to pull permits or evict the current occupant.
• Occupant in the house. If the owner or tenant is still in the house, you will be responsible for finding a way to get them out once you’re the owner. That may entail eviction or ejectment proceedings. It could involve a renegotiation of a lease. It might involve cash-for-keys, whereby you pay them to move out. In rare cases, it may take over a year to legally remove the occupant.

Some foreclosures are screaming hot deals. Some are money pits. Many foreclosures are purchased by experienced cash investors. It is possible to snag a foreclosure deal and use a mortgage loan to buy it. You will probably have to jump through some hoops.

Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania.  He became a full-time real estate investor in 2004 after serving in the U.S. Navy.  Tai made colossal mistakes in investing (and learned some things along the way).  Tai has coached hundreds of entrepreneurs, real estate investors, and real estate agents on how to increase their income and net worth. He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics.  Send an email to tai@investandtransform.com.