Want to Buy a Foreclosure? Here’s What You Need to Know

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Foreclosures are up in 26 of the 50 largest metro areas in the country, according to a quarterly report released by foreclosure site RealtyTrac.com. At the top of the list is Pittsburgh, where foreclosures are up 49% from the previous quarter, followed by Indianapolis, which had a 37% increase. The top five are rounded out by Philadelphia, New York City and Raleigh.

An increase in foreclosure activity might sound like bad news, but it’s actually a good sign for these markets because it means the logjam that’s been keeping housing in the doldrums is finally starting to break up. It’s also good news for bargain hunters and intrepid home buyers who want to get a cheap house. If you’re planning to buy a foreclosed home, though, there are some things you need to know before taking the plunge. Forget Auctions

First of all, if you’re new to the foreclosure market, don’t even think about buying a property at a foreclosure auction, says RealtyTrac vice president Daren Blomquist. The process has risks that can snag even seasoned bidders, he says. Prospective buyers can’t inspect the home to determine if there’s any damage — highly likely if the house has been vacant for a while — or find out if there are any senior liens (such as outstanding taxes owed on the property). A purchase could turn into a Pandora’s box of expensive repairs or payments to creditors.

Beware the Current Owner

If the homeowner who defaulted is still living in the home when the auction takes place, the buyer has two potential headaches to worry about: evicting the former owner, and the potential for vandalism. Blomquist says it’s not unheard-of for resentful owners to trash the house before being evicted. Plus, buyers have to pay in cash, which isn’t an option for many people.

Buy from a Bank

A better bet is to look for homes that are owned by the bank or “REO” — real-estate owned — in industry lingo. The bank is required to pay off senior liens like back taxes, you won’t have to kick out anyone living there and you’ll be able to inspect the homes for damage and figure out how much you’ll need to set aside for any repairs.

(MORE: Foreclosures Are at a 4-Year Low, But That’s Not Necessarily Good News)

Beat the Crowds

Many buyers go through real estate agents who specialize in foreclosures, but if there’s a particular property you have an eye on, Blomquist says you can approach the lender directly after the foreclosure but before it’s listed for sale. Especially if the institution holding the title is a local or community bank that doesn’t have a big infrastructure for processing foreclosure sales, they might be happy to get it off their hands.

Get Pre-qualified

Blomquist recommends getting a letter of prequalification from a lender before you start house-hunting. The foreclosure market is fast-moving and surprisingly competitive, since so many people are looking for bargain-basement prices. A seller is going to prefer working with a buyer who’s already secured financing rather than wait around for one who needs to get loan approval and take the risk that it won’t pan out. Don’t expect the bank selling the home to provide you with financing (they’re trying to get rid of the house, after all).

(MORE: Mixed Bag of Housing Data Shows Recovery — Except in Areas with High Foreclosures)

Expect a Low Appraisal

Even with financing secured, getting the foreclosed house of your dreams isn’t a guarantee. As with any home purchase, the amount for which a foreclosure is appraised is the determining factor for the size of the loan you can get. Foreclosures tend to appraise lower than other properties with similar features, because neglect or vandalism may have contributed to damage. If you’re seeking to purchase a foreclosure with an FHA loan, Blomquist says the requirements pertaining to the condition of the property are stricter.

Prepare to Spend Extra on Maintenance

Factor the cost of any necessary repairs into your budget, since foreclosures are generally sold “as-is.” “Be aware with these REO or bank-owned properties that a lot of them are in pretty poor condition,” Blomquist says. The bank that owns the title isn’t going to make needed repairs for you before the sale, and it’s unlikely to lower the price to compensate you for repair expenses you’ll incur. Of course, you can try to negotiate the price down, especially if the house has been on the market for a long time and hasn’t budged, but since the bank is already selling at a loss, your clout is limited.