Looking to purchase a foreclosed home could potentially be a good investment if you don’t have lots of capital but want to purchase a home. In other cases, you may want to flip it for a profit. However, in both, you are better off knowing why they are so cheap because offers of this kind usually come with a catch. Let’s find out if there are any.
Foreclosed homes are cheaper due to numerous reasons, including the bank or lender wanting to cut losses and sell it quickly, the home being appraised incorrectly, and being in poor condition. Another factor is due to it being sold for its market value instead of its intrinsic value.
This article will detail and go into depth on why foreclosed homes are so cheap and if this should be a concern if you are a potential homeowner or investor of sorts. We look at market value, appraisals, the home’s condition, and more to give you insight into what to expect.
Why Are Foreclosed Homes Cheaper?
These are the four primary reasons why foreclosed homes are cheaper than their comparable counterparts:
- Banks want to cut their losses
- Intrinsic value vs. market value
- Appraisal mistakes
- The home is in a poor condition
Mainly, however, foreclosed homes are cheaper because banks want to liquidate.
Typically, in the past, the holders of mortgages were banks because these were the primary (and sometimes only) lenders. Although today, a mortgage may have been sold to several lenders since it was first acquired. However, when a home goes through foreclosure, they typically end up sold by the bank.
When a home is foreclosed on, the bank is left with no owner to pay the mortgage, and due to their inexperience in the real estate business and wanting to liquidate the property and get it off their books quickly, they would offload the home at whatever price they could and cut their losses.
Foreclosed Home Intrinsic Value Vs. Market Value
In simple terms, the intrinsic value of a home is based on its actual financial performance (the home’s actual worth). A home’s market value can be thought of as what people at the time of its sale are willing to pay for it.
Consider that realtors determine the market value of a home by looking at three comparable sales of similar houses and ones in the same area. Once this information is known, then the foreclosed home is typically listed within the average of the three comparable sales.
However, there is a problem with this because it leads to situations of mispricing, effectively over-valuing homes in a “boom” and under-valuing them in a reception (crisis)
As such, there are times when a foreclosed home will be marketed and sold for a price way below its intrinsic value.
Foreclosed Homes Are Cheaper Due To Appraisal Mistakes
There are many instances where the bank holding the property deed has little to no market knowledge of the home’s value. This is similar to our first point yet different. In these instances, the bank does not need to liquidate quickly but rather does not get a BPO (broker price opinion) or an opinion from a knowledgeable local broker (also known as an REO broker).
A BPO is the estimated property value determined by a broker or real estate agent based on comparisons of other comparable homes on the market. Then an REO broker is a real estate agent working for a bank that sells foreclosed homes regularly and typically handles many inquiries.
In these instances, the homes are not assessed nor appraised adequately, resulting in homes sold for a price way below their intrinsic value.
Foreclosed Homes Are Cheaper Because Of Their Condition
Besides the other factors discussed, typically, a foreclosed home will be sold for a cheaper price due to much damage that it has sustained, and the bank does not want to invest in any refurbishments.
A foreclosed home may be damaged for multiple reasons. The first is that the previous owners could not keep up with its maintenance because it was too costly. Additionally, this could be why the home was foreclosed on in the first place (due to their inability to pay the mortgage).
In these situations, you can expect to find the home deteriorated, such as a leaking roof, build-up of mold, a broken HVAC unit, and such.
In other situations, the homeowner is upset at the bank and the foreclosure of their home, and they will deliberately cause damage to the property. In these circumstances, almost anything is possible, and it is not uncommon to find holes being smashed into drywall, windows being broken, cement being poured down sink drains, and electrical wires being cut.
As such, the bank will determine if the renovations and refurbishments are worth their time and money. If it is not, they will sell the home for below market value and for “as is.”.
Take note that you will be able to see the inside of a foreclosed home once it has been priced and put up for sale on the market by a realty company. This should not be confused with other types of home auctions.
What Determines The Price Of A Foreclosed Home?
Numerous factors can determine the price of a foreclosed home, and some of the points above can be included. These are namely;
- The properties condition
- The bank’s decision
- The property’s market value
- Its Intrinsic value
- The opinion of an REO broker
- A BPO
- The area
Are Foreclosed Homes Really That Cheap?
The price of a foreclosed home is less than other comparable homes doesn’t necessarily make them cheaper. The main reason is the fact that most foreclosed homes are in poor condition, and the bank will sell them as is.
The majority of people don’t know how much repair and renovations will be because not everyone is a broker, a real estate agent, or in the business of “flipping houses” (buying them cheap, fixing them, and selling them for a profit).
Natasha Doty, a broker for more than 15 years, says that out of all the REO houses she was involved in, there were only one or two that were in decent condition, and the amount of repair and renovation to get the others up to code cost more than a “move-in ready” home.
The next reason is that banks are smarter now due to the financial crisis of 2008. In essence, this is when there were too many foreclosures from REOs (real estate-owned property by the bank) and not nearly enough buyers.
Due to the rapidly growing number of foreclosures, the banks could not liquidate homes in their usual manner by smoothly putting properties back on the market and selling them for a lower price; instead, nobody could afford a home, resulting in all the foreclosures in the first place.
This meant banks had two options which were;
- Sell the properties at whatever price they could
- Don’t saturate the market and hold off on selling a property
Banks learned that it would be best to hold on to properties for longer and not flood the housing market. This meant that although they did not liquidate them straight away, they would, in fact, sell properties at a later date for a better market price.
Nowadays, this is common practice, and banks will typically hold off on selling a home at lower prices unless it is in some form of disarray and the investment to fix it is too large.
Is Buying A Foreclosed Home A Good Investment?
As we stated, in many cases, the cost of repairing the damage to a foreclosed home will often exceed a similar comparable home that is in good condition.
However, if you don’t have a lot of capital and are looking for a home to purchase for yourself and not flip it, then it could potentially be a good deal. Take note that property flippers usually have most of their capital tied up in a foreclosed home, meaning they need to fix and sell it quickly to recoup their money.
This is not the case for an individual or couple wanting to purchase a home for a long-term purpose. In that case, the renovations can be done “in time” when more money becomes available.
Additionally, it is not uncommon for buyers of foreclosed homes to get exceptional financing. This could be better interest rates, better payment plans, etc. This is due to the bank or lender wanting to get rid of the property as quickly as possible and is motivated to sell it.
Conclusion
We discovered that foreclosed homes are cheaper for numerous reasons, and we outlined four main points that will typically contribute toward this. In most instances, a foreclosed home will be cheaper because it is in poor condition, and the bank is not willing to repair or renovate it.
However, there are situations where you can find a foreclosed home in good condition, and this is due to the bank wanting to offload it quickly, it was not appraised correctly, or it was undervalued because of the current market value.