Foreclosures can be a goldmine of potential for real estate investors who are looking for low-hanging fruit in the marketplace. By dealing directly with banks instead of homeowners, investors can remove emotion from the valuation process and instead come to a fair price that makes everyone happy. But before you start seriously looking into foreclosures, you should know what’s behind the asking price. So how do banks price foreclosures?
There are several factors a bank must consider when pricing a foreclosure. Things like the property’s condition, how hot the market is, and whether it’s more profitable to sell the home as-is or spend money fixing up the property and flip it for a higher profit are all considered. Interestingly, the loss the bank has taken on the original mortgage is rarely a factor.
But we’ll get into all of that in a moment. Let’s talk about what a foreclosure process looks like, what variables a bank will use to create their asking price, and when you can expect to start seeing price reductions.
What is a Foreclosure?
Before we get into the nuances of the pricing formula a bank uses, let’s talk about why a bank would own a property in the first place.
Foreclosure is often portrayed like a singular event where a family is suddenly forced out of their home by a sheriff, able to take only what they can carry in their arms. While a foreclosure can be as heartbreaking as depicted in the media, the actual way a foreclosure works is much different.
A foreclosure is both an event and a process. The catalyst for this process is that the homeowner has begun to fall behind on their mortgage payments. Rarely is it one or two payments behind. The homeowner is so far behind it’s gotten to the point that the bank has lost confidence in their ability to pay at all.
Once the bank has lost confidence, they’ll issue a Notice of Default which notifies the owner that times up, the mortgage is now in default. The bank is now taking over control of the home and is no longer interested in waiting for the current owner to get the mortgage back into good standing.
After the Notice of Default, the next step is a Notice of Sale. This document states that the home will be sold and gives the details of where and when the sale will occur.
Then comes the auction, which is the foreclosure “event.” The home is put up for auction by the bank and begins to accept bids for the property. The interesting thing is, not only will the bank be auctioning off the home, but they may also be one of the bidders. The bank will also submit bids to officially receive full ownership of the property and potentially reduce their total losses.
Once the auction is over, the foreclosure is considered complete, and the title is transferred to the highest bidder.
How Do Banks Price Foreclosures?
Let’s say the bank ends up taking ownership of the property after the auction and is preparing to list it on the MLS. How do they know at what price they should list the property?
First, the bank will hire one or two agents to assess property during the foreclosure process. These agents calculate a few different rates:
- What the property is worth as-is.
- What the property would be worth after repairs.
- An estimate of what those repairs would cost.
Next, the bank uses these calculations to find the best way to recoup its losses. While many foreclosed properties are sold as-is, if the bank feels they’ll make more of a profit by fixing up the home, then they will do so. It all comes down to which method will net them more profits and how hot the marketplace is.
What’s interesting is that the loss they’ve taken on the original mortgage is rarely factored into these calculations. Banks will build a certain amount of loss into their financial projections, so the amount the original owner owes is more of an afterthought than a primary factor for what they’ll ask for on the market.
If the bank actually nets more than enough to cover their costs, lawyer fees, and so on, the profits might actually be sent back to the original owner. This is extremely rare and is state-dependent, but it is still a little fun fact I like to mention.
When Will the Bank Lower the Asking Price on a Foreclosed Property?
The bank’s goal of selling a foreclosed property is to recoup their costs as quickly as possible, as there are usually multiple foreclosed properties they’re dealing with. Because of this, banks are less emotional about the value of a home than a homeowner would be and will often begin reducing the asking price.
Once a month, the listing agent will send a feedback report to the bank from buyer agents who have shown the property to potential buyers. This feedback report will often list how many times the property has been shown, the interest levels of the buyers, and why they may have chosen not to submit an offer.
From there, it’s dependent on the way the bank operates. Some banks are aggressive and will make price reductions monthly until they get a bite. Other banks will be more conservative and wait 3-6 months; it’s just dependent on how quickly they want to get rid of the property.
I’d estimate that a bank will average about a 3% reduction in price every month if they’re not getting a lot of interest, but talk to your agent about what a reasonable estimate for your area might be.
Things that Will Affect the Asking Price on a Foreclosure
The feedback report from their listing agent provides a lot of good data the bank will use to decide if they’re in the right ballpark with their asking price or not.
If the feedback report states that the home isn’t being shown a lot, this tells the bank that it’s most likely overpriced, and so they will either fix up the property to meet the asking price or lower it.
If the report shows that people are seeing the home but not submitting offers, the bank knows it’s most likely due to the home’s condition or other mitigating factors.
A good example I like to use is if the property is on a busy street. If the bank sees that the home is getting interest but is not receiving any offers, they can assume it has to do with the house’s value versus the annoyance of living on a busy road. The bank may then decide to lower their asking price to compensate a buyer and make it worthwhile for them to live on that street.
Many factors go into what a bank will calculate to be a fair asking price on a foreclosed home. At the end of the day, though, it all comes down to what it will take for them to net the most profit in the current marketplace. Sometimes that means they can offload the property quickly by selling it as-is for a lower price. Other times, it means that they’re willing to sit on the home while they pay to fix it up and net a more significant profit down the line.
Keep an eye out for potential properties that have been on the market for a few months and see if there’s any movement on the price. Use these tips as a guideline to understand what goes into the process of valuing a foreclosed home and how you can use that information to your advantage.