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Buying a Foreclosure: 4 Smart Rules

Let's get one thing out of the way: If you think that shopping foreclosure auctions is your ticket to a once-in-a-lifetime deal on a dream house, it's time to lower your expectations. Fully 45 percent of April's housing sales were foreclosed properties, and 33 percent of May's, so you'll have a lot of company at the fire sale. It's tough to be "below market" when you are such a big chunk of the market.

If anything, it’s the other way around: Foreclosures are creating opportunities by dragging down the prices of traditional sales.

That said, a motivated seller is a buyer’s best friend, and no seller is more motivated than a lender with a ton of properties to unload. Here are four things you need to know before jumping in to oblige.

1. Don’t Speculate

If you’re looking to buy and flip, think carefully. The one thing economists agree on is that home prices are going to continue to fall and inventory will continue to rise in the near term, so you may wind up underwater. And no one predicts a major turnaround in prices for some years. So depending on the local market (Florida, for example, or Phoenix), even a 20 percent savings in the purchase price may not be enough to cover future declines.

2. Focus on REOs

There are two kinds of auctions: Foreclosures and REOs (Real Estate Owned properties). The latter are houses that fail to sell in a foreclosure auction and become the property of the lender or trustee.

In a foreclosure sale, the minimum bid is the loan balance on the property plus all accrued interest, any expenses associated with the foreclosure process (including attorney fees), and any back taxes or liens, all of which could add up to more than the market value. You have to take the house “as is, where is,” so if the previous owner or his tenants still reside there, for example, it becomes your responsibility to evict them.

On the other hand, because banks are eager to rid their balance sheets of real estate, they are often willing to heavily discount the price of REOs and cover all outstanding liens. In some cases, there is no reserve price at all and the property will go for the highest bid, regardless of the lender’s investment in it.

3. Get a Check

Long before the bidding starts, check the auction company’s particular requirements online. For example, you likely will need a government-issued ID and a cashier’s check for $5,000 to $10,000 to use as a down payment on your deposit, which is usually 5 percent or 10 percent of the purchase price. You can usually pay the difference between your cashier’s check and the deposit with a personal check. In most cases, you can change your mind after making the deposit, but the time frame varies. Plus, you may have to close within a very tight window — too tight to get financing — so you might need cash for the total purchase price.

4. Don’t Feel Guilty

You are not a greedy vulture for benefiting from someone else’s misfortune. These sales are an important factor in stabilizing the market. The faster the foreclosed inventory is eaten up, the faster the real estate market will improve.

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