How To Invest In A Distressed Home
If you’re active in recent discourse surrounding real estate and the housing market, you might know that foreclosures are currently on the rise in the U.S.
ATTOM, a leading provider of property data nationwide, reported that foreclosure filings were up 115% last year compared to 2021. This trend continued into 2024, the first six months of which saw a total of 186,000 homes receiving a foreclosure filing.
This recent uptick in foreclosures is likely due in part to the dissolution of foreclosure moratoriums during the COVID-19 pandemic, in addition to hardships and personal finance difficulties related to rising housing costs and increasing inflation. Its effect is that there are now many more distressed properties on the market. From preforeclosure to short sale property situations, these properties are opportunities for real estate investors—one could even be your next property.
In this article, we’ll discuss the benefits of investing in distressed homes and how to close on one this year while the opportunity is ripe.
What is Foreclosure?
Before we can talk about distressed homes, we first have to define foreclosure.
Foreclosure is a legal process that begins when a borrower fails to make their mortgage payments to their lender. Borrowers are often given a chance to catch up on monthly payments or are sometimes offered a loan modification to restructure the mortgage or its terms so that the borrower can pay it back. But after a certain period of missed payments, the lender will initiate foreclosure. During the foreclosure process, the lender recovers the amount owed on a defaulted mortgage loan by repossessing the mortgaged property and selling it. Since the home is collateral for the mortgage payment, it can legally be seized by the lender.
A judicial foreclosure is a foreclosure that passes through the court system. Judicial foreclosures are permitted in all states but not extremely common. More common is a nonjudicial foreclosure, which occurs when the lender does not go through the court system to get a foreclosure judgment first. Provisions for these are not specified in every state, and the foreclosure process for them varies across states. The lender will likely need the help of a foreclosure trustee to help facilitate the process.
The foreclosure process is a slow one, taking anywhere from several months to several years. There are several stages in the process between the time a borrower defaults and the time that a foreclosure sale is conducted and finalized at a foreclosure auction.
Involuntary Liens
Liens are placed on property when the owner has defaulted on a debt. The property is used as collateral and is sold to satisfy the debt. When a home is in foreclosure, it usually has some kind of property lien placed on it. Property liens can be voluntary or involuntary liens. Voluntary liens (like a mortgage lien) are liens that you agree to while an involuntary lien (like tax liens placed by the government) is a lien placed on your property involuntarily.
For instance, if a property owner fails to pay their income taxes, the government can place an involuntary federal tax lien on the property. If the owner continues to neglect unpaid taxes, the government can seize that property and sell it to cover the owner’s tax debt. This is an example of an involuntary lien. However, foreclosures also commonly occur with voluntary liens like mortgage liens. In this case, the mortgage holder has agreed that their banks or lender will have a lien or legal claim to their home until they have paid off their mortgage in full. If the homeowner fails to make mortgage payments for long enough, the bank can activate that voluntary lien on your property, foreclose on it, and sell it to recover your unpaid debt.
Buying a home in foreclosure or one with a lien is a real estate investing strategy utilized by many investors that will be discussed in the following sections. While there are many benefits of foreclosure investing, there are also substantial risks that cause many investors to avoid foreclosure properties. We’ll discuss these shortly.
What is a Distressed Home?
A distressed home is one that is currently or soon to be foreclosed on by the bank or mortgage lender. This is usually because the owner fell behind on mortgage payments or property taxes in a time of financial difficulties. Under federal law, the mortgage-holder typically has at least 120 days after they first fall behind on payments before the bank can legally foreclose on them. Then, the bank starts the foreclosure process and eventually takes back legal ownership of the home.
There are several types of distressed properties:
- Preforeclosure – Properties on the verge of foreclosure.
- Real Estate Owned (REO) – Lender- or bank-owned properties that weren’t sold at an auction.
- Short Sales – A short sale property is a property for which the mortgage-holder had negative equity (they owed more than the property is worth), and the bank agreed to a lower payoff.
- Government-Owned REOs – Homes bought with federal mortgage loans which were defaulted on.
Despite the unfortunate circumstances under which a home becomes distressed, these properties are a profitable niche targeted by many real estate investors. However, it often depends on which stage in the foreclosure process the property is at.
For example, the short sale process occurs when a financially distressed homeowner sells their home for less than they owe on the mortgage. The lender of the original mortgage gets all of the proceeds of the sale, and either forgives the difference or gets a deficiency judgment, which requires the homeowner to pay what’s left over. Short sale transaction properties have several benefits for buyers, including a less competitive market and potentially less expensive prices. However, each sale is unique and investors should due their due diligence regardless of the circumstances of the sale.
Why Would I Want to Invest in a Distressed Home?
Once they’ve reassumed ownership of the home, the bank or lender wants to get it off their hands as quickly as possible—they typically don’t want to maintain the property. This means they’re highly motivated to sell the house and may do so at a discounted rate or below market value. This is the primary reason why you might want to buy a distressed home – they will often cost less than a similar home in the same neighborhood. The lender wants cash now, and as an investor you can use that to your advantage to buy a property substantially cheaper than you would be able to otherwise.
Distressed homes and short sale properties also make good fix-and-flips or BRRRR deals. By renovating a distressed property and selling or renting it later at higher rates than you paid for it, you can profit immensely. Hiring a real estate agent to help you find distressed properties is an ideal strategy: You can find profitable distressed properties without real estate agents, but they can help you simplify and streamline the process.
However, there are also risks associated with distressed properties. The property could be in poor condition, or substantial repairs could be needed. This is especially true if the property is sold as-is, meaning you would not get the opportunity to have the seller make repairs before you acquire the property. You may also encounter title issues due to unpaid property taxes that cost you more than you were anticipating.
How to Find Distressed Property
If you’re interested in this strategy and want to know how to find distressed property or start making short sale transactions, your best bet is to look for properties that haven’t actually been foreclosed on yet but are at high risk for foreclosure. These are homes in “pre foreclosure,” or the period after the mortgage-holder has received notice that they are in default but before the property is actually foreclosed on. Owners of homes in pre foreclosure have high motivation to sell, but their homes aren’t available for public auction yet, so this period is an ideal time to buy for investors.
You can find these homes using MLS data for your local market, or zero in on properties in the area you’re looking on listing sites like preforeclosure.com.
Where Do I Find Distressed Property Near Me?
If you’re looking to invest locally, you might start with a search like “Distressed property near me.” A better strategy, however, is to visit local credit unions, banks, or bank REO sites that have listings of foreclosed properties in your area. You might also be able to find this information at a local tax assessor office, where property tax records are tracked. This information is publicly available, and going to a source directly within your community could be a faster way to find distressed homes than searching a nationwide public records directory.
Of course, you can also look for fully foreclosed properties at public auctions in your area. A local realtor will also have information about foreclosures near you, and they also have experience working with the MLS and identifying these properties.
Where Can I Find a Distressed Property List?
If you’re simply looking for a master distressed property list to browse online or filter through, there are several to choose from. Here are a few to investigate:
Closing the Sale
How you go about closing a deal on a distressed property depends on which stage of the foreclosure process the property is currently at.
Let’s assume for our example that you want to buy a home in preforeclosure. Here’s the steps you’ll need to undergo to purchase this home:
1. Get Pre-Approved for a Loan
Whenever you finance a property, you need a lender who agrees to lend you money and is willing to issue you a pre-approval letter. This letter is proof that you are able to borrow the amount of money you’ll need to purchase the property. Cash purchases are faster, but you won’t always have the ability to purchase in cash. Make sure you’ve done your research on the property you’re thinking of buying before heading to the bank, as having a solid plan prepared for your investment and its repairs can help persuade the lender to approve your loan. You’ll also need to demonstrate a strong credit history and proof of income (e.g., bank statements) to qualify for the loan.
2. Get the Home Inspected
Next, have the home inspected by a professional home inspector. A qualified inspector will review all the major systems and components of the property, including its infrastructure, electrical wiring, plumbing, roof, foundation, etc. The inspection will identify any major property damage, mold, HVAC issues, structural problems, and other concerns that could decrease the value of the property.
3. Make an Offer
With the inspection results in consideration, make an offer on the property. Typically, this offer needs to be approved by the bank even though the deal is a private one between you and the homeowner. Unless the deal is short sales, the bank is looking for an offer at least as much as the outstanding balance on the mortgage. Short sales means you buy the property for less than the outstanding mortgage due.
4. Negotiate for a Fair Price
If the homeowner doesn’t accept your first offer (which many do), it’s time to start the negotiation process. You should present evidence from the home inspection to prove why you believe the property is worth what it is, given the repairs needed and the amount left owed on the mortgage. You’ll also want to include contingencies on your offer, which are conditions that must be fulfilled before the purchase or else you are allowed to back out of the sale. Common contingencies include title contingencies (the seller must have clear title) and appraisal contingencies (the property must appraise for at least the proposed listing or purchase price).
5. Close on the Deal
The final step in acquiring the property is to close the deal and complete any necessary paperwork. This includes receiving a date for the property’s closure from a title company or closing attorney, then transferring the property title and obtaining the deed. You will likely have to wait between one to two months before officially closing on the property, which has to do with ensuring your loan will come through. You’ll also be responsible for paying closing costs at this time, including title insurance, taxes, and lender fees. Once closed, just like a traditional sale, you will make monthly mortgage payments to pay off your mortgage balance until your remaining debt has been paid. An experienced real estate agent can guide you through the entire financing process while you secure the distressed home.
Conclusion
Closing on a distressed property is a popular way for investors to buy below fair market value and make a profit. By following the steps above and taking the time to do the proper research and preparation, you can make a distressed home the newest addition to your portfolio.
