10 Essential Tips for Purchasing Distressed Properties

A distressed property refers to a property where the owner is behind on their mortgage payments. Sales of these distressed homes became widespread in the late 2000s, with one-third of home sales between 2008 and 2011 classified as distressed sales [source: [Gibbs]]. The availability of distressed properties varies by market conditions. Areas like California and Florida, where home prices have drastically fallen, tend to have a higher number of distressed homes, while regions with stable home prices generally have fewer [source: Gibbs].

In a short sale, the home's sale price is lower than the total amount owed on the mortgage, but the sale happens before the lender initiates a foreclosure. In contrast, a foreclosure occurs when a lender repossesses the property due to missed payments. Foreclosed homes are typically sold at auction or listed as REO (real estate owned) properties.

If you're looking to buy a home and want to find a good deal, distressed properties could be a viable option. Banks are eager to offload these homes to reduce their liability, which often results in lower listing prices [source: Re/Max]. However, there's a catch—competition for bargain-priced homes can lead to bidding wars among eager buyers [source: McQueen]. Distressed properties come with challenges, as they're sold 'as-is,' often require extensive repairs, and involve significant paperwork. Read on for tips to make the most of a distressed property purchase.

10: Get Preapproved for a Mortgage

When aiming to buy a distressed property, keep in mind that the banks reviewing your offer are looking for serious bids. Ensure you're preapproved for a mortgage before making an offer, as you'll be competing against investors. From house flippers fixing up homes to resell, to larger property management companies, investors are taking advantage of low property prices to profit. They often pay in cash, so you'll need to demonstrate you're a dependable buyer for the bank to accept your offer [source: Re/Max], [source: Gibbs].

There are a few challenges to be aware of when seeking mortgage preapproval. Lenders may refuse to finance a property if it's too damaged [source: Gibbs]. In such cases, you might need to provide extra funds or take out a second loan for repairs. If you struggle with preapproval, consider alternative lending options. Smaller banks and credit unions often offer more flexibility for borrowers with less-than-perfect credit than major banks [source: Gengler]. Additionally, FHA loans from the U.S. government require smaller down payments, which could be helpful [source: Re/Max].

9: Find an Agent Experienced with Distressed Sales

Distressed property transactions come with their own set of challenges. When selecting a real estate agent, it's crucial to choose someone with experience in handling these types of deals [source: Perkins]. Fortunately, there are certifications available for agents who have completed continuing education in distressed property sales. The National Association of Realtors introduced a Short Sale and Foreclosure Certification Program in 2009. To earn this certification, Realtors must undergo specific training and familiarize themselves with national and state laws surrounding short sales and foreclosures [source: Perkins]. Another valuable certification is the Certified Distressed Property Expert, offered by the Distressed Property Institute [source: Re/Max]. However, regardless of certification, ensure that your agent has a proven track record in closing distressed property transactions. Around a dozen short sales or foreclosures is a good benchmark to indicate sufficient experience for guiding you through the process [source: Gibbs].

8: Don't Invest in a Distressed Neighborhood

Purchasing a distressed property in a desirable neighborhood can offer significant savings. You may be able to buy a home you otherwise couldn't afford and build equity as property values rise. However, not every affordable distressed property is a smart investment. Avoid properties in areas with widespread economic decline. If an entire neighborhood is facing foreclosures, or if multiple units in a building are vacant, it's wise to look elsewhere [source: McCrea]. The future of such markets is unpredictable, and you may find yourself stuck in an area where property values continue to fall. In the worst-case scenario, you could end up owing more on your mortgage than your home is worth.

7: Get a Professional Home Inspection

Whenever you buy a home, it’s essential to get a detailed home inspection. This becomes even more crucial if you’re looking at a short sale or a foreclosure, as these sales are always 'as-is' [source: Max]. In a typical home sale, the seller usually addresses any damage, but with distressed properties, the buyer assumes responsibility for any repairs once the contract is signed. Banks generally won’t offer price reductions to cover repair costs, since distressed homes are often already listed below market value [source: McQueen]. The inspection will help you understand how much you might need to spend on repairs to make the home livable. Consider scheduling specialty inspections as well [source: Gibbs]. These inspectors will delve deeper into issues like mold, pests, and septic systems. If the seller or lender refuses to let you inspect the property, walk away from the deal immediately [source: Gengler].

6: Be Ready to Make Repairs

Homeowners facing foreclosure are often forced out of their homes, sometimes intentionally damaging them in the process. During the housing crisis in the late 2000s, some homeowners even took appliances, water fixtures, and lighting fixtures with them, either out of spite or in an attempt to salvage some value [source: Fulmer]. Once the home is empty, it can attract squatters and vandals who might further damage the property. Vacant foreclosures are also prime targets for thieves looking to steal valuable items like appliances, fixtures, and even copper piping. Copper can be sold for scrap, and thieves have been known to tear down walls to access it [source: McQueen].

While the idea of significant damage might be daunting, if you're not afraid of hard work – or if you hire someone to handle it – you can save a lot on severely damaged, 'fixer-upper' homes. Since most distressed properties require some level of repairs, it’s a smart move to have a contractor inspect the property before you purchase [source: Gibbs]. This should be in addition to the home inspection. The contractor can provide an estimate for the repairs, allowing you to factor this into your offer price.

5: Be Patient

Buying a distressed property often involves facing numerous delays, bureaucratic hurdles, and frustrations. Unlike standard real estate transactions, where you primarily deal with the homeowner, purchasing a distressed property means working directly with the lender, who must approve the final sale. This can result in prolonged waiting periods, as you navigate through the bureaucratic maze of a large financial institution rather than an individual seller. Expect weeks or even months of waiting for the bank's response to your offer [source: McQueen]. However, if the property qualifies for the Home Affordable Foreclosure Alternatives (HAFA) program, you can expedite the process, as the bank is required to respond within 30 days [source: Gibbs].

Closing the deal may also be delayed if the seller has a second mortgage or has been refinancing. In these cases, the second lender will need to approve the sale as well [source: Re/Max]. Additionally, complications could arise if the loan has been securitized. In the years leading up to the 2008 housing crash, lenders sold their loans in bulk to investors, who then traded them as securities, similar to stocks. Any investment manager who now owns the securitized loan will also need to approve the deal, potentially adding multiple parties to the already crowded negotiation process [source: Gibbs].

4: Know Your State's Foreclosure Laws

The process of buying a foreclosure property can vary significantly depending on the state in which the property is located. Some states require a lengthy and complex judicial process for foreclosure, which can extend up to 12 months or longer, particularly in states like New York [source: Fulmer]. These states, known as "judicial states," have foreclosure procedures that are designed to offer additional protection for homeowners. On the other hand, non-judicial states have more streamlined foreclosure processes, allowing lenders to initiate foreclosure more quickly. For instance, in Texas, a foreclosure can be filed in just 60 days [source: Fulmer]. It's essential to understand how foreclosures are handled in your state and, once you find a property you're interested in, ask your agent to determine how far along the foreclosure process is. You may be facing a lengthy wait.

3: Have Cash on Hand

While money may not guarantee happiness, it certainly brings you closer to securing that dream home you've always wanted — especially if it's a distressed property. Having a substantial amount of cash available can streamline the process in several key ways. A larger down payment not only improves your financial standing but also increases the likelihood that the lender will take your offer seriously. Offering 20 to 25 percent of the home's asking price can convince the bank that you’re a reliable buyer [source: Gengler].

The unique aspects of buying a distressed property can come with significant costs. For instance, a thorough home inspection, which is essential, will typically cost around $350 [source: Gibbs]. Furthermore, if the property requires extensive repairs, you might think the loan will cover it. However, lenders may not approve loans for homes that need substantial work. In some cases, you may be asked to set up an escrow account to cover repairs, or even take out a second home improvement loan to assure the lender that the property will be habitable [source: Gibbs].

When purchasing bank-owned properties, the buyer assumes responsibility for many of the costs that would normally fall to the seller in a traditional sale. This often includes paying for closing costs, real estate transfer taxes, and addressing any liens on the property before the transaction is finalized [source: McCrea].

2: Be Ready to Make a (Serious) Offer

Making an offer on a distressed property can be more complicated than it may initially seem. You might assume that submitting a lowball offer will work, but that's not the case. While banks are willing to take a financial loss to offload a distressed home, they're not willing to take a huge hit [source: Re/Max]. Typically, the listing price of a foreclosed home reflects what the bank believes the property is worth, even in a challenging market [source: Gibbs]. The price is usually based on recent comparable sales in the area, just like with non-distressed properties [source: Gibbs]. So, if you're thinking about offering a lower price, be sure to back it up with examples of similar properties that have sold recently [source: Gibbs]. Banks aren't keen on long counteroffer negotiations, so don't start with an offer that's too low. If they think a higher offer is possible, they won't hesitate to reject you after just one or two attempts, or even on the first offer [source: Gibbs].

1: Use Your Lender's Appraisal Strategically

Purchasing a distressed home isn’t just about dealing with issues and frustration. In fact, you have some bargaining power when negotiating the price with the lender, especially if the property is in poor condition. If the bank is unwilling to lower the price on a home in significant disrepair, request that your lender conduct a full appraisal of the property. An appraisal, which is a detailed evaluation that helps lenders determine the loan amount, could come in lower than the asking price. If it does, you can use this information to persuade the bank to accept a more reasonable offer [source: Gibbs].