Many people have been considering investing in a foreclosed home because it sounds simple enough - buy a foreclosure at pennies on the dollar, cover the mortgage by renting the property to tenants, and then sell it at a tidy profit when the economy recovers. As with many things in life, however, foreclosures are not as simple as they seem at first blush. The following tips can help you make a more informed and less risky decision:
- Remember that while you're investing in a home, you're also investing in the community too. The neighborhood in which the foreclosure is located will ultimately determine its long-term appreciation. Before being lured in by a low price, do your homework. Is the town investing in new infrastructure, roads, schools, libraries and public parks? Is the downtown area thriving or declining? Bottom line: if the local government or businesses are not investing in the town for the long-term, neither should you.
- A "Real Estate Owned" (REO) property is a much safer way to purchase a foreclosure. Unlike a home sold at auction or purchased during pre-foreclosure, its title is held by a bank or lender; there are no other liens against the property. While an REO's price discount is typically less than a foreclosure sold at auction, there is also less financial risk. Inspections are allowed. No evictions are required. Plus, the bank will see that the property is cleaned out before you take ownership, saving you potentially thousands of dollars in labor cost and dumpster rentals.
- It's important that potential investors know that homes sold at public auctions are the leftovers of an inventory picked over by professionals and it's never a good idea to buy one sight unseen.
- The more bedrooms, garages, basements, and bathrooms (at least one-and-half) a home has will all allow you to charge higher rents. Additionally it's generally a good idea to choose brick over wood frame homes.
- Know when to walk away. There are hard fast rules as to when to pass up on a foreclosure. For example, if total repair work is more than $30,000, it is unlikely an individual investor will recoup their money. Damage to the foundation is another serious red flag, as is mold infestation or extensive plumbing repairs that will require breaking open floors and walls. It is crucial that you hire an experienced home inspector before making a bid. Otherwise, a foreclosure that seemed like a good deal could end up costing you more money than the home is worth.
- Use the one percent rule for rents which means investors charge a monthly rent of approximately one percent of the value of the home (for example, $1,500 rent for a home valued at $150,000). While there are exceptions to this rule, collecting one percent per month should cover mortgage, insurance and taxes, plus provide a small profit that he recommends be held as a reserve for home repairs or other emergencies.
- Don't quit your day job. Plan to hold your foreclosed properties from ten to fifteen years, just as you would a mutual fund or other retirement vehicle.
- Consider a passive investment: Buying a foreclosure on your own is a major commitment. If you are not ready to become a landlord, consider using a management company whcih, for a small fee, will run and maintain the property for you.
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