Fixer-uppers and Forclosures

Fixers, foreclosures and other bargain properties come with their own set of risks. Know what you're getting into before you sign on the dotted line and pick up a hammer

One persistent myth in real estate is that anyone can make money buying a fixer-upper or foreclosure property for a pittance, doing the renovation work themselves, and then reselling the house at a profit. While many experienced contractors and career renovators do just that, first-time buyers can get caught in a web of cost overruns, contractor disputes and resale problems. Does this mean you should avoid your dream house in the rough like the plague? No, for many first-time buyers a fixer is the only and best option. But there are some basic rules of thumb to consider before buying fixer-uppers, foreclosure properties or other real estate "bargains":

Fixer-uppers that pencil out the best are those that can be improved within the existing walls: Exterior additions or major defect repairs can be costly. Fixers that only have cosmetic problems, like ancient shag carpeting and hundreds of square feet of bad wallpaper, are ideal for first-time buyers. Cosmetic repairs can be relatively inexpensive; some fixer-uppers will pay back double their cost. But the expense of correcting major structural defects might not add a penny to the house's market value and could run a project into the red. Always have a fixer-upper carefully inspected before you buy.
Never pay too much, especially if you intend to resell quickly: If you do, you could suffer a loss rather than a profit when you sell. The best time to buy a fixer-upper in terms of investment potential is when the market has bottomed out and is turning around. The worst time to buy is when the market has peaked and starting to decline. Research the potential market for the fixer-upper once it is restored. Make sure that your plans for the house do not result in an over-improvement for the neighborhood
Forecast renovation costs accurately before you buy: If you miscalculate, your profit will dwindle. Have the property inspected as a condition of the purchase, particularly if you are buying it in "as is" condition. This way, you reduce the chance of having to pay to fix unanticipated defects.
Evaluate the floor plan: Sounds simple, but a with a good basic layout but a hideous decor is an ideal fixer-upper. A house with a maze of rooms may have a defective floor plan that no amount of paint and paper will remedy.
Renovate wisely: In planning a remodel of a fixer-upper, keep resale value in mind even if you are going to live in the hose for some time. Kitchens, bathrooms and storage spaces are important to today's buyers. Curb appeal sells houses, so concentrate on improving landscaping and the front entry. Stick to neutral color schemes.

Creative fixer-upper financing: Nailing down the money to remodel

FHA Title 1 Loan: Short-term, fixed-rate loans; allows buyers to borrow up to $25,000 to make specific home improvements to a house except for such projects as adding a swimming pool.
U.S. Department of Housing and Urban Development 203(K) loan: Short-term, fixed-rate loans; allows buyers to purchase a fixer-upper property "as is" and rehabilitate it.
Seller financing: Loan terms negotiable; seller might pay for some or all of the work before closing or carry a second loan for repairs or home improvements.
Assumable adjustable rate mortgage: Long-term flexible loans; allows loan to be included with house when it is resold; ideal for remodeling buyers who want to do the work, then turn around and resell again.
Combination loan/equity line: Long-term, fixed-rate loan combined with short-term line of credit; allows seller to take out an equity line of credit to pay for renovations after closing (loan may be paid off by refinancing on higher appraised value). Example: $200,000 property is purchased "as is" with 20 percent down and $160,000 first mortgage but needs about $40,000 in renovations. Property refinanced at higher loan value; equity line is paid off from that.

TIP: Another way to get a seller to pick up all or part of the cost of home improvements is to negotiate for them as repairs required after a home inspection. Many sellers prefer to lower their asking price and sell the property “as is” instead of financing the repairs. This presents fewer problems for the sellers and the buyers can close the deal easily.

Other bargains: A short course

Some real estate investors make careers out of buying and selling foreclosure, probate and short-sale properties. Most experts would agree that buying such properties is not for the inexperienced or the faint of heart. If you are a first-time buyer, consider working with an agent or lawyer with experience in such properties.

Foreclosures

When a buyer can't keep up with loan payments, a lender will foreclose on the mortgage and the property goes up for auction. If the auction fails to produce a buyer, the property reverts to the lender, which then offers it for sale. Other foreclosure properties can be purchased through the Federal Housing Administration or the Department of Veterans Affairs. To find the foreclosure properties, check local legal ads and, in the case of FHA and VA properties, the Internet.

Cautions: You may have to agree to an all-cash deal with no contingencies and the property sold "as is." Always get an inspection to avoid buying a house with a major defect. You also may have to deal with eviction proceedings if the owner has not vacated the property.

Probate sales

A probate property is one being sold in order to settle the estate of a deceased owner. Often such a property is listed with an agent, though some sales take place at a court hearing. Because the sale is coordinated by the estate's executor or a court administrator, you may or may not get a bargain price. Their interest, after all, is to get the best price they can.

Cautions: If the heirs are disputing each other over who has the legal right to the property, the property might not be saleable until the estate matters are settled. Always get an inspection to avoid buying a house with a major defect.

Short sales

When a lender reduces the amount of the loan payoff on a home, which can happen with a seller who can't cover the mortgage due and closing costs in order to sell, that is a short sale. Many lenders prefer to clear such a loan from their books, even at a loss, in order to avoid the cost of foreclosure or have the house in their inventory of property. This can make for an attractive deal for a bargain-hunting buyer.

Cautions: Make sure the purchase contract includes a time frame (30 days) for the sellers to obtain written permission from the lender to conduct a short sale. Prepare for a tough negotiation. And always get an inspection to avoid buying a house with a major defect.

Defective economics

If you have to cut corners to make a fixer-upper financially worthwhile, it is probably not worth doing. Most buyers have properties inspected before they buy and require that any defective work be repaired as a condition of the sale. If you have to repair the defects, it could put your project into the red.

Place your bets

The best time to buy a fixer-upper, if your intention is to turn the house around for immediate profit, is when home prices are climbing. If your real estate market is hot, avoid getting caught up in the rush to buy; you could end up overpaying for the house and that will cut into your profit margin. It is much less risky buying a fixer-upper if you are able to live in the house for several years while you fix it up.