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Foreclosures: diamonds in the rough
Looking to invest in foreclosed homes? Proceed with caution!
January 2, 2003: 10:11 AM EST
By Annelena Lobb, CNN/Money Staff Writer

NEW YORK (CNN/Money) The real estate market looks more like a modern-day land grab every day.

With prices still soaring and demand on the rise, homeowners nationwide are rushing to cash in on the sometimes staggering appreciation in their homes. Those who don't yet own are scrambling to buy, fearing prices will continue to outpace their ability to save.

Then there are those with dollar signs in their eyes -- pure investors, speculators looking for diamonds in the rough. Increasingly, they're finding them in foreclosed homes.

"Over the past year, there's been plenty of buzz about [investing in] foreclosed homes," said Alexis McGee, president of "You hear about investors who profited from a foreclosed home, fixing it up and turning it into an investment property."

Mortgage lenders initiate foreclosure on a home when its owners default on their payments. The lender then sells the property to satisfy any remaining mortgage debt. And, if the lender wants to move the property fast, they'll sell it at a discounted price.

With the weakened U.S. economy, in fact, a growing number of homeowners are falling behind on their payments. The Mortgage Bankers Association of America reports the number of foreclosure proceedings initiated by banks has risen consecutively since the second quarter of 2000.

But buyer beware: all foreclosed properties are not created equal. The degree of the discount varies widely anywhere from 5 percent to 30 percent, said Eddie San Roman, a real estate agent who sells distressed properties in the Miami, Fla. area.

"People often think they're getting better deals than they actually are," he notes.

They also often have a distorted view of the types of homes they'll be able to find.

Modestly-priced homes tend to go into foreclosure more often than McMansions. The average mortgage debt on a foreclosed home owned by the Federal Housing Authority ranges between $85,000 and $90,000, said Jerry Brown, an FHA spokesperson, though he mentioned that mortgages in foreclosure from banks and prime lenders could be significantly larger.

That said, if you know what you're getting into you can make a decent buck. Here's what you need to know:

The foreclosure process

As an investor, it's important to know that foreclosures are regulated on the state rather than federal level. Each state determines the grace period it gives owners who have defaulted on their loan. In California, it's four months; in New York, it's 12 to 18 months. During that period, called pre-foreclosure, owners still live in the house and may sell it they're just delinquent on the payments.

If the grace period ends and the owner is still in default, a public notice goes on record and an auction takes place. It's a public sale, typically at the steps of the courthouse, in which potential buyers bid on the balance of the loan. Mind you, you won't be able to see the house from inside before you buy -- the best you'll probably get is a drive-by before the auction gets underway.

Such transactions, however, are best left to professional investors.

"Buying at the auction is very risky," McGee said. "You don't go inside the house before you buy it, you have to evict the former owner, there may be liens on the property and you don't necessarily get clear title."

San Roman agrees: "You need a lot of expertise to buy at the courthouse steps. You assume all liabilities, even title liabilities. If you're not buying foreclosures on a regular basis, buying from the bank probably is the best way to go." The bank may sell at a 5 percent discount or a wee bit more, according to San Roman.

If no one attends the auction, or it doesn't sell, the lender gets title to the home and it becomes the bank's responsibility to unload.

Getting your hands on a good deal

Interested buyers may jump in at any stage of the foreclosure process. Click here to read about everyday people who made investing in foreclosures work for them.

McGee said the best deals are had in the pre-foreclosure stage. It's in the owner's best interest to sell before they actually foreclose because a full foreclosure decimates their credit rating and forces them to lose all the equity they've accrued.

To find a candidate, check your state's pre-foreclosure lists. The lists have owners' contact information on them, and you can phone the person or even stop by the house to see if they are interested in selling.

A word of caution: you may find it tough to get owners in pre-foreclosure to respond to your entreaties. If they're already sick of answering phone calls from lenders asking for money, for example, they may not want to talk to you. And if you do manage to get in touch and make an appointment to see the house, you may be in for a shock: many homeowners in default have fallen on rough times and their homes reflect it. If they can't pay their mortgage, after all, they may not have money for basic repairs or utilities, either.

The third and most common way to invest in foreclosed properties is to buy bank-owned homes, known in foreclosure jargon as REOs, or real estate owned properties. Almost every bank's Web site has a list of foreclosed properties currently available for sale. Banks usually sell through a real estate agent.

When you buy from the bank, however, you probably won't get the discount you'd get on a pre-foreclosed home or a home sold at auction. As such, McGee recommends that interested buyers devote their attention exclusively to pre-foreclosed homes.

"Banks don't take losses on homes," she said. "They hire a crew, they paint, they carpet, and they put it up on the market and sell it for full price."

Home Depot lovers, however, may still be able to score. According to San Roman, a bank may sell a home at a discount if it's been on the market for ages. That typically depends on the condition of the home. If the bank doesn't or can't repair the home, it likely will take longer to sell and may go for cheap to an interested buyer.

"Banks have one trigger that determines how much money they're willing to lose, and it's how long the house has been on the market," San Roman said. "Banks really aren't suited for doing repairs. To have a room painted, a bank would have to pay six times what you'd pay to paint it yourself, for insurance and license reasons. "

Investors interested in purchasing distressed properties also can head to the Web sites of the Federal Housing Authority, Fannie Mae and Freddie Mac, all of which have information on the foreclosed properties they own in different areas of the country.  Top of page

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