In periods of limited supply, real estate investors try to find quality deals wherever they can. And, many look to property auctions as a potential opportunity. But, this brings up a common question people ask me about this approach: Ryan, do I need cash to buy a house at auction?
Yes, you will need cash to buy a house at auction. But, the amount you need depends on what type of auction. At public auctions, you’ll likely need $5,000 – $10,000 as soon as you win the bid—and the whole amount within 24 hours. Private auctions generally only require $500 – $1,000 immediately.
I’ll dive into the details of cash requirements for buying houses at auction in this article. Specifically, I’ll cover the following topics:
- What’s a Real Estate Auction?
- Cash Requirements at a Public Auction
- Cash Requirements at a Private Auction
What’s a Real Estate Auction?
In simple terms, people or organizations use real estate auctions to publicly sell a property. And, homeowners, builders, governments, and banks can all host auctions. But, in this article, I’ll focus specifically on auctions held by banks, as these typically provide the most opportunities to real estate investors.
For banks, real estate auctions serve as a way to clear properties from the books. During the foreclosure process, banks seize homes from borrowers who default on their loans. With a mortgage, the associated home serves as collateral. That way, if the borrower stops repaying the loan (that is, defaults), the bank can seize the home and sell it to pay off the outstanding loan balance.
Due to this foreclosure process, banks often end up owning properties. But, holding these houses comes with significant costs, and it ties up capital that banks would prefer to A) lend and earn interest on, or B) use to meet required reserve ratios. Rather than continue holding these houses, banks choose to sell them. And, they frequently use auctions to make these sales.
Broadly speaking, two types of bank auctions exist—public and private. I’ll discuss both of these in detail in the following sections.
Cash Requirements at a Public Auction
Before bank-owned properties end up at a private auction, they go through a public one. Public auctions exist as an integral part of the foreclosure process. While I touched on it above, I need to cover this process in more detail here.
When borrowers stop making mortgage payments, banks send late notices. Each lender has a different policy, but they typically send these out until the 90-day late mark. At this point, lenders file a notice of default. This is a public declaration that a borrower has stopped making mortgage payments. Lenders typically publish them in a local newspaper while also filing them with the local courthouse.
Following the notice of default, borrowers generally receive another 90-day window to pay their outstanding loan balance. If they fail to do so, banks file a notice of sale—another public notice. This one announces the date, time, and location that the bank will auction off the foreclosed property. This constitutes a public auction, one that directly results from the notice of sale step in the foreclosure process.
Most public auctions are held at a local courthouse, often on the front steps or a corner of the lobby. A representative of the lender—usually the bank’s attorney—organizes some paperwork on a desk, states that an auction has begun for Properties X, Y, and Z, and announces the opening bid.
These auctions tend to have tiered bid systems. This lets banks set an opening bid while also allowing them to bid up to what they’re owed. With this system, banks can choose to accept less than what they’re owed, but they don’t need to accept a lower bid. However, if the final bid comes in over the owed amount, this becomes the winning bid.
If you have the winning bid, you’ll immediately need to pay a non-refundable deposit to the bank’s representative at the auction. This deposit generally ranges between $5,000 and $10,000. To pay this deposit, investors should arrive at an auction with a cashier’s check made out to themselves. Then, if they receive the winning bid, they just need to endorse it over to the bank’s representative, who will deposit it on their behalf.
While non-refundable, this deposit also applies to the final purchase price. And, in a public auction, buyers usually have 24 hours to pay this entire amount. For instance, say you make a $100,000 winning bid on a property. Immediately after the auction, you’ll pay $5,000 as a deposit (or whatever the lender requires). The next day, you’ll need to come up with a check for $95,000—the difference between the winning bid and the deposit.
On the one hand, public auctions provide investors an opportunity to quickly purchase properties. But, a couple serious drawbacks exist, too. First, bidders cannot access the properties. Before the auction, they’ll either be locked up by the bank, or they’ll be occupied by the people in foreclosure. This means you have no idea the shape of the place. Additionally, you cannot get title insurance for these properties, meaning you may end up purchasing a foreclosed property without clean title. For these reasons, I don’t recommend public auctions for new investors. Unfortunately, too many risks exist with this strategy.
Cash Requirements at a Private Auction
Sometimes, a property won’t sell during its public auction—generally because bidders don’t meet the bank’s minimum threshold. When this happens, the foreclosure process continues, but the bank takes possession of the property. These become known as real estate owned, or REO, properties.
As discussed, holding properties imposes significant operating costs on banks. To help, private auction companies offer to hold private auctions for banks. Say a bank has 20 REO properties on its books. An auction company will offer—for a fee—to auction these properties off to investors over a short period of time, often a weekend.
Over the course of the auction, investors and bank plants will both bid up these houses, with the final bid becoming the winning bid. However, with a private auction—unlike a public one—the winning bidder won’t necessarily get the property. Instead, lenders have a two-week period following the private auction to review each offer, accepting or rejecting them.
While this two-week period injects some uncertainty in the process, it also provides investors two key advantages. First, they can use that period to inspect the property. Second, they can get full title insurance, protecting themselves in case of bad title. These two advantages generally more than outweigh the associated drawback of a two-week delay.
At private auctions, the winning bidder also needs to pay a deposit. But, unlike public auctions, private ones require much smaller deposits, frequently in the $500 to $1,000 range. And, due to the two-week review period, investors then have more time to come up with the rest of the purchase funds.
In theory, private auctions provide great buying opportunities for investors. In reality, there just aren’t that many REO properties right now. Due to COVID-19’s impact on the economy, the federal government has imposed a foreclosure moratorium on government-backed mortgages. This has created an environment of little to no REO supply in most markets. But, in the future, this moratorium will eventually lift, and private auctions may become another solid buying opportunity for investors.