Buying a foreclosure home, also known as a distressed property, might seem like a less expensive way to get into your next place. These homes usually sell for about 15% below the home’s actual value. But buying a foreclosure property isn’t always what it seems. While it may look like a bargain, it could end up being more expensive (and more trouble) than it’s worth.
“On the surface, foreclosed homes can seem awfully appealing,” says Beatrice de Jong, consumer trends expert at Opendoor. “However, costs can be extremely unpredictable, and underlying damages could make a property undesirable.”
With big risks associated with foreclosures, a buyer could end up with a money pit, rather than an affordable new home. That’s why you should always budget for the worst-case scenario.
“It’s better to be pleasantly surprised than to not have the funds to solve the problem,” says Avery Boyce, a real estate agent with Compass Real Estate in Washington, DC.
Here are some of the hidden costs you need to look out for when considering a foreclosure home.
Foreclosures are likely to need some work—and the list of needed repairs and renovations can be long indeed. The worst part is, you might not even have a ballpark estimate of what repairs are needed until you receive the keys.
“The bank will be limited on the disclosures they can provide regarding the condition of the home and previous repairs done,” says de Jong.
In some cases, you can get a home inspection before finalizing the sale, but often, a foreclosed house is sold as is.
“Keep in mind that if the previous owners couldn’t make their mortgage payments, they likely also fell behind on regular maintenance,” de Jong says. “The home may have foundation problems, need a roof replacement, and require a heavy workload to bring the home up to code.”
The property could have also been sitting there, uncared for, for a while. You might have to factor in the additional costs from overgrown lawns, graffiti, weather damage, and more.
Paying too much in a bidding war
Buyers—especially those purchasing a home for the first time—should be careful to not get stuck in an expensive bidding war. Why? They could end up paying too much for a house that they can’t afford to fix.
There can be a lot of competition from other eager buyers, real estate developers, and flippers.
“For damaged homes that are priced well below market value, you will probably be competing with developers who plan to rip out everything anyway, and can afford to solve big unknown problems,” Boyce says.
Steer clear of a bidding war and avoid busting your budget on a home that needs more work than you can afford. Before making an offer, set your upper limit, and stick to that number. There will be other houses later on, and it’s often better to play it safe when it comes to foreclosures.
Challenges in getting funding
Even if you can get a great price on a foreclosure property, many buyers will still need a loan to help them purchase it. Before you make an offer on a foreclosure, don’t bank on being able to get a mortgage.
Some lenders simply won’t offer funding for foreclosure properties. The most common reason: The house is in such bad condition, it can’t pass an inspection.
“To get traditional financing, the home needs to be in really good shape,” Boyce explains. “All the utilities need to be on and testable, there can’t be holes in the drywall or floors, and there can’t be water inside the home.”
Plus, most banks favor all-cash offers on foreclosures because they have already lost money on the property and they don’t want to end up in the same situation again.
If you can’t do all cash upfront, it is likely to help to get pre-approved, and it also helps to be willing to put down 20% or more. This way, at least the bank knows you’re serious about buying the house and paying the mortgage.
No room for negotiation
When buying a home the traditional way, the seller may be willing to negotiate on the price. You submit an offer, the seller might counter, and in the end, you could end up paying less than the asking price.
“Dealing with the bank is a more formal and corporate process than dealing with a seller, so expect limited flexibility, if any, when negotiating on the offer price,” de Jong says. “Banks are not likely to budge on the price, since they are mostly concerned with recouping the costs from their investment.”
However, if you’d like to test the waters, Boyce suggests you ask your agent to search for past sales by the bank to see whether the sale price is lower than the list price.
“That will give you some insight into whether it’s worth submitting a lower offer,” she says.
Property tax increases
If, after learning about all these hidden fees, you’re still seriously considering a foreclosure, you’ll be aware that some properties will need to be overhauled. And while you might be ready to put some serious cash into the project, know that there’s an extra fee associated with a major home makeover: increased property tax. Fixing the house up will increase its value, and in most places, that means your property tax bill will go up.
This may seem like a no-brainer to some seasoned homeowners, but it’s important to remember this tax increase when budgeting for repairs. Don’t get stuck going all in on a home and finding yourself strapped for cash when it’s time to pay taxes.