Shopping for a new home on Long Island after the birth of their daughter, Chris and Diane Moore fell in love with a 1920s Mediterranean-style home with a storied history. Built by Columbia Pictures to house visiting stars like Charlie Chaplin, the five-bedroom home in Baldwin, N.Y., has a bell system for servants and a sweeping indoor balcony. The home was sold as a short sale, in which a lender must agree to accept less than what's owed on a property. And as often happens with such deals, the buying process soon turned into a horror show: Negotiations dragged on for 10 months. After the sale of their first home closed, the Moores had to stash their belongings in storage and bunk with Diane's parents.
Eventually a squatter moved in.
Just as the couple decided to give up, their $510,000 offer was accepted -- for a home that was appraised for more than $600,000. "In the end it was worth it," says Chris, "but this process is not for the faint of heart." If you're in the market for a home, you'll almost certainly be looking at distressed properties -- that is, short sales and foreclosures. That's particularly true in boom-and-bust markets like California and Florida, of course, but even in less bubbly markets such as Portland, Ore., and Atlanta, distressed properties make up about a third of sales.
Moreover, distressed homes are likely to be a significant part of the market for years: At the current pace of sales, it would take 2½ years just to clear out the more than 1 million unsold foreclosures -- and another 550,000 probable short sales -- currently on banks' books, and then there's another 1.4 million properties likely to become short sales and foreclosures over the next 12 months, according to data firm RealtyTrac. Unfortunately, buying a distressed property is far more onerous than purchasing a regular house. Instead of an individual, you're often negotiating with multiple third parties, each with a particular agenda and a standardized process to follow. The house may be in worse condition than you expect. And though new laws and government relief programs are speeding up deals, they can drag on for many months, as the Moores discovered. "The buyer has to be twice as diligent," says Greg Markov, a Phoenix distressed-property specialist who teaches classes in short sales to real estate agents. So why go through the hassle? Because if you do it right, not only will you get a home you love, but you'll get it at a lower price than comparable properties in your market. To find out how to take some of the stress out of buying distressed, read on.
Bid low -- but not too low
Given the overload of troubled properties in the market, you might assume you can drive a hard bargain on a foreclosure. But since banks are eager to unload the properties they own, they list the home at a price at which they think it will sell quickly -- and in markets where eager investors are swooping in with cash (in California, 31% of recent deals were cash), offers above list price are common.
Also, the bank that services the mortgage on a foreclosed home may not actually own the loan; during the boom many loans were securitized and sold off to other investors. In that case, the bank that now owns the property also has to consider the amount that investors who own the loan are willing to accept, says J.K. Huey, the executive in charge of Wells Fargo's short sale and foreclosure servicing department. Some have rules preventing them from accepting less than a certain percentage off the list price based on how long the property has been on the market. On loans insured by the Federal Housing Administration, for example, lenders can accept no less than 88% of "as/is appraised fair market value" in the first 30 days; that declines to 84% after 60 days.
For short sales, banks will price close to market value, but they're often willing to take less rather than see the home fall into a costlier foreclosure. In the Minneapolis area, where about a quarter of the sales are distressed properties (roughly the U.S. average), the average short sale in the past year sold at a 14% discount off the list price, compared with a 7% discount for foreclosures and regular sales.
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When it comes to bidding, forget that negotiating class you took; banks generally aren't interested in multiple counteroffers. After your initial bid, there may be one counteroffer, then a request for the buyer's "best and final" offer. So you have to come up with a fairly realistic bid the first time. First, remember that the longer a property sits on the bank's books, the more negotiating power you have. For a newly listed short sale or foreclosure, an initial bid that's 10% to 20% below list price is reasonable, says foreclosure expert Patrick Burton, an executive with Quicksale.com, an online home-auction company. If the bank nixes an offer and the property doesn't sell quickly, resubmit.
"An offer that's rejected on day 13 might be accepted on day 113," says Savannah broker Joe Drescher. If a home has been sitting for a few months and your area is saturated with distressed properties, go for at least 20% below list price, says Burton. You'll also have leverage if you can prove that a property's condition justifies a lower price. If you think the home needs serious work, ask your mortgage lender to go ahead and order its required full appraisal (about $350) to submit to the selling bank. If the appraisal comes in lower than the bank believed the property was worth, it may bend, because it knows the appraisal is necessary for you to get financing.
Find a bank that's ready to make a deal
For a short sale, the bank that serviced the seller's loan has to agree that the homeowner is at real risk of default -- meaning that some hardship (a job loss, for example) has made payments unaffordable. The servicer will also evaluate the home's market value and determine the price it's willing to accept. If that bank doesn't own the mortgage, it will need to involve the investor that holds the loan, and possibly a mortgage insurer as well. That complicates negotiations further. This is why short sales take longer to close than any other type of sale: In the Miami area, for example, the average short sale has been on the market 144 days, vs. 88 days for a regular transaction. "If you have any kind of deadline -- a lease that's up or a school schedule -- then you don't want a short sale," says South Florida agent Toni Reeder. Foreclosures, on the other hand, sell faster because the bank actually owns the home and has eliminated other lien holders, such as a condo association or second-mortgage holder, before it lists the property. "This dramatically simplifies the process," Burton says.
To speed up a short sale, find out from your realtor if the property qualifies for the federal HAFA program (Home Affordable Foreclosure Alternatives). If so, it will move faster because HAFA has required servicers to weigh in on the price within 30 days. Also keep your eye out for properties listed as "approved short sale," meaning the bank has already signed off on a sale and a contract price. Jerry Tamayo bid on one such listing in a Fort Lauderdale suburb; by the time the bank approved the deal, the buyer had gotten frustrated and walked away. Tamayo bid about $15,000 less than the $305,000 list price and closed in six weeks. "It was a good opportunity to step in while the file was still warm," Tamayo says.
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If you can't find a HAFA property or an approved sale, at least try to find a short sale that involves as few parties and is as far along in the process as possible. Your agent should be able to tell you whether the transaction will involve getting approval from a second-mortgage lender or a mortgage insurer as well as the primary mortgage holder, for example, and whether the bank has already begun the paperwork required for a short sale. Both short sales and foreclosures will close faster if you're working with an agent who knows the routine and can speed the process by keeping in close communication with the seller's agent and lenders. Look for a broker who has special training, such as the National Association of Realtors' Short Sale and Foreclosure Certification Program, and who has sold at least a dozen short-sale or foreclosed properties.
Make sure a foreclosure can be financed
When you're shopping for a distressed property it's essential to be pre-approved before you make an offer, says Margaret Kelly, CEO of brokerage firm ReMax. The pre-approval not only will verify how much you can borrow but also indicate to the lender that you are serious about completing the deal. The twist with foreclosures: You'll probably be required to prove that the home is in good enough condition to be financed since lenders won't write a mortgage for a home deemed unlivable. Homeowners angry about foreclosure may have ripped out flooring, appliances, and copper pipes before abandoning the property. "Lenders want to see copies of all the inspections and maybe even ask for their own assessments," says Susan Kreyer, president of the New York Association of Mortgage Brokers. You may need to provide proof of repairs or set aside money for fix-ups in an escrow account before you can qualify for a mortgage. Or, get an additional construction loan. Federal programs such as FHA's 203(k), available through many lenders, wrap rehab costs and the purchase price into one loan.
Even before you make an offer on a foreclosure, spend $300 to $500 for a comprehensive inspection. (Find a qualified inspector through the American Society of Home Inspectors or the National Association of Home Inspectors). It's also a good idea to walk the home with a licensed contractor to get an idea of costs. "Make a list of everything that will need fixing, and if it's $8,000 worth of little things, factor that into the offer," says Fishers, Ind., agent Laura Musall. After your offer is accepted, it's worth spending another few hundred dollars for "specialty" inspections for mold, swimming pools, and underground septic systems. If you uncover problems that make the home unlivable -- such as mold -- the bank may still be willing to make fixes. If you don't mind putting in some work, however, a home that needs rehab can be a great deal. The Sykesville, Md., five-bedroom foreclosure that Celeste Stratton and her husband purchased last year for $268,000 needed new plumbing and a deck, plus major renovations to the bathroom and kitchen, and was riddled with rodent feces and dog urine.
The Strattons, who are doing the repair work themselves, will spend about $25,000 to make the place livable. That still put their total costs well below the $375,000 they would have spent for a typical nondistressed home in the area, says local realtor David McIlvene.
Don't finance a short sale too fast.
For financing a short sale, the biggest challenge is timing. You must be pre-approved, since the seller may need to show the lender that the buyer is qualified to purchase the home. But if the deal drags, it's likely that the bank will require additional rounds of documentation of income and credit; credit reports, for example, are good only for 90 days. It's best to wait until the bank has approved a price to finalize your mortgage paperwork, because short sales can take so long that your lock-in period can expire, says mortgage broker Kevin Goldman, president-elect of the Michigan Mortgage Professionals Association. Ask in advance whether your lender will extend the rate-lock period for a fee if the process should take longer than expected.
Get a contract that lets you out.
Once your bid is accepted on a foreclosure, make sure your contract specifies that you can walk away from the home if the property's condition turns out to be worse than expected, inspectors discover mold damage requiring more than $500 worth of work, or a title search uncovers additional judgments -- such as unpaid association fees or a city code violation -- above a certain amount. With a short sale, by law your paperwork must spell out that the deal depends on the bank's approval. Buyers can use this to specify deadlines for the seller's bank to respond; if you don't get the approval, you can cancel the deal. Laws can vary by state; in California, for example, lenders have 45 days to approve unless the contract says otherwise. "Most contracts have blank lines so you can pencil in as much protection as possible," says Dallas real estate lawyer Chris Christensen, who chairs an American Bar Association housing committee. Above all, keep in mind that persistence pays. Take the Moores, now living in their Long Island home. "We almost walked after all those months," says Chris. "But this is a really different house, not something that we could ever find again." And if a deal falls through, says Scottsdale agent Brian Gubernick, relax: "There are lots of properties, so if you don't get one, something else will come up," he says. Distressed properties like these typically sell at a discount to similar homes in their area.
Additional reporting by Beth Braverman and Veronica Crews contributed to this article.