Buying Foreclosures and Fixer-Uppers

"Free real estate!" "Save thousands on your next home!" "Make millions with no money down!!" Those ads and late-night commercials make it sound easy, don’t they? All you have to do is fork over $14.95 or $29.99 (plus shipping and handling), and the secrets of buying foreclosed properties will be revealed. Operators are standing by.

Let ‘em wait. The truth is you can save money buying a foreclosed home, but you don’t need to hand over your credit card number to anyone to do it. (The same is true for those who promote fixer-uppers, too.) You just need to understand the process and determine whether the potential rewards are worth the inherent risks.

The Facts About Foreclosures

Simply put, foreclosure is the process by which a bank or other lender repossesses a home when the owner fails to make payments on their loan. And since banks make their money lending money, not managing property, they’re often eager to unload their repossessed properties.

So, are foreclosed homes a good deal? Maybe, maybe not. They may sell for less than other comparable homes, but they often entail added risks ranging from physical damage (displaced owners do strange things) to undisclosed legal and financial constraints. Before you even consider buying a home in foreclosure, be sure to:

• Visit www.hud.gov, the Web site of the U.S. Department of Housing and Urban Development, which provides general information and links to specific property listings.

• Search the foreclosure listings found on the Internet, in local newspapers, and in real estate magazines.

• Work directly with the lender who holds the mortgage on the property, rather than via the auctions where many foreclosed homes are originally offered.

• Tour the property and insist on the right to have it inspected.

• Compare the home to comparable, non-foreclosed homes to calculate perceived savings and potential market value.

• Be prepared for added paperwork, an extended closing period, and unforeseen problems.

• Most important, work with a real estate agent who is experienced with buying foreclosed homes. Don’t go it alone unless you are very experienced.

Finally, be aware that those late-night ads and inside guides have enticed a lot of people into pursuing foreclosure homes. Increased competition means more pressure (and yet even more stress) as well as fewer bargains. Like instant wrinkle removers and machines that promise four-minute, six-pack abs, the reality rarely lives up to the promise.

Fixer-Uppers: The Sweet Smell of Sweat Equity

Still looking for something lower than the average home in an area? If you’re handy, have the time, and want to avoid the hassles of foreclosure sales, perhaps a fixer-upper is more your style. Neglected and in need of work, they’re the kind of houses where a little "sweat equity” can create a wonderful home and a substantial return on your investment.

How can you tell if a fixer-upper is worth fixing up?
There’s no hard and fast formula, but there are several factors that can help you decide:

• Are the repairs required cosmetic or structural? Generally speaking, cosmetic repairs cost less, are easier to complete, and provide instant eye appeal.

• Are the repairs required worth it? If a repair (a new roof, for example, or upgraded kitchen) costs more than it adds to the resale price, it may not be.

• Who’s going to do the work? Whether you do it yourself or hire others, you’ll pay for it — in time, money, and/or stress

• How well do you handle disruption? From dust and debris to the daily parade of workers, some people would rather just pay more for a more finished home.

That last one may be the most important of all because, let’s face it, repairs and renovations always take longer, cost more, and involve more stress than expected. That may also be why it feels so wonderful when they’re done.

The Principle of Progression

A good fixer-upper offers a prime example of one of the main tenets of buying real estate: Whenever possible, buy the worst house in the best neighborhood you can afford. The reason is the principle of progression, a fancy way of saying that nicer, more expensive homes have a positive effect on the perceived value of their smaller, less expensive neighbors.

Why? Because most people want to live in nice neighborhoods and will pay a premium to do so, even if it means getting less home than they might somewhere else. So, even if that long-neglected cottage has a bit more "character” than you’d really like, it may pay off in the long run.

Real Life Example

Who: In July 2004, John and Kelly bought a home for $200,000.

The house: A 1,150-square-foot, 40-year-old home in the suburbs. Neglected for years, it definitely needed work.

The work: They spent most of their free time painting, putting up gutters, and turning the property’s backyard jungle into a landscaped oasis. Two years later, thanks to their efforts (and a hot housing market in general), their home had a market value of $330,000.

They say: "We haven’t had much of a social life,” says John, "but at least we have a nice home.”

Related links: Home Equity Loans and Lines; Refinancing Your Home; Choosing Your Home Type