Buying foreclosed homes can be a great option for finding real estate deals. But, before closing on a great deal, investors need to know how to pay for that deal. And, most new investors don’t have a ton of their own cash sitting around for deals. As such, people frequently ask me how to buy foreclosed homes with no money.
Investors can purchase either pre-foreclosure or foreclosed homes. I prefer the former, as you can usually get better deals. Once you find a deal, hard money loans often let you buy a home with no money. If you need extra cash beyond the hard money loan, some great gap financing strategies exist.
In the rest of the article, I’ll dive into strategies for buying foreclosed homes with no money. Specifically, I’ll cover the following topics:
- An Overview of the Foreclosure Process
- Buying Pre-Foreclosure Homes
- Buying Foreclosed Homes
- Using a Hard Money Lender to Buy Properties with No Money Down
- Gap Financing Strategies
- Final Thoughts
An Overview of the Foreclosure Process
Before discussing foreclosure purchases, I need to explain the foreclosure process, in general. Understanding this process provides insight into how investors can purchase these homes with no money.
When you take out a mortgage loan, the home you purchase acts as collateral for that loan. Whether primary residence or investment property loan, the property itself serves as a collateral. And, the fact that home mortgages are secured loans (that is, loans backed by collateral) plays a huge role in why borrowers can get such low interest rates.
Simply put, collateral reduces risk to lenders, because if the borrower stops paying – or defaults on the loan – the bank can seize the collateral. They can then sell it on the open market and recoup all or a portion of the outstanding loan balance. On the other hand, take a look at the interest rate your credit card offers on a cash advance. This is a form of unsecured loan (that is, not backed by collateral). And, you’ll likely see double digit interest rates due to the increased risk for lenders in providing these loans.
Banks call this process of seizing the collateral of a borrower who has stopped paying foreclosure. And, it typically follows these steps:
Initial Late Fees and Notice
When a borrower misses a mortgage payment, the bank will assess late fees. Then, banks will send multiple notices that the borrower owes payments. How many letters the bank sends depends on internal policy. But, generally speaking, the bank will move onto the next step after 90 days of missed payments.
Notice of Default
This serves as the formal, public notice that a borrower has defaulted on a loan. Lenders will prominently place one notice on the property door, and they’ll file one with the local courthouse. For many investors, this court filing offers the first opportunity to hear about a potential foreclosure.
Notice of Trustee’s Sale
Following notice of default, lenders generally provide borrowers an additional 90 days to pay their loan balance. If they fail to do so, the lender files a notice of trustee’s sale (commonly referred to as a “notice of sale”). This notice must be published somewhere (e.g. a local newspaper), and it lets potential buyers know that the property has been foreclosed upon and will be available at auction.
Trustee’s Sale: This is the technical name for a foreclosure auction. Banks conduct an analysis of the property’s pricing. They account for the outstanding loan balance, any liens, unpaid taxes, and the costs of the sale. Using this information, they’ll determine an opening bid for the auction. Potential buyers then bid on the property. Once sold, the buyer owns the property and is allowed to immediately take possession.
How to Buy Foreclosed Homes with No Money
Now that I’ve provided an overview of the foreclosure process, I’ll use the next two sections to explain how to purchase these homes. Once investors understand the general procedures for buying a pre-foreclosure or foreclosed home, doing so without money just becomes a question of financing.
As stated above, I prefer buying homes before foreclosure. First, pre-foreclosure homes generally face less competition, as they haven’t been sent to auction. Second, once a bank assigns a real estate agent to list and sell its foreclosed properties, that agent will inevitably increase the asking price. So, instead of waiting until the actual foreclosure, I approach owners with an offer to buy once it becomes clear that they’re on the path to having their home seized by a bank. But, how, as an investor, can you tell that a home is in the pre-foreclosure stages? Several indicators exist, which I’ve listed sequentially:
Owner Gets Behind on Mortgage Payments
This is the first step into pre-foreclosure. Once homeowners fall behind on loan payments, they’ve begun the path to foreclosure. And, unfortunately, when homeowners fall behind on mortgage payments, climbing out of that hole can be extremely challenging. However, from an investor’s perspective, there’s nothing public record about a homeowner falling behind on payments. This reality prevents you from identifying owners in this situation and extending purchase offers.
Lender Files a Notice of Default
After a certain number of missed loan payments, lenders file the notice of default. This notice is a public record, as it will be filed in the county recorder’s office. Savvy investors can go to the recorder’s office once a week or so to request lists of all notices filed for that week. And, armed with this information, you can offer to buy a home before the bank actually forecloses upon it. This path avoids a foreclosure on the owner’s record while potentially letting him or her convert some equity into cash.
Lender Files Notice of Sale
Following the notice of default, the lender will eventually issue the notice of sale. This, too, is public record and is typically published in local newspapers. This information provides investors two complementary opportunities. First, for owners hesitant to sell during the notice of default period, this sale notice may provide additional incentive to sell prior to foreclosure. Second, if you don’t want to spend time pulling reports at the county recorder’s office, these notices of sale still provide you an opportunity to make offers on homes before foreclosure.
NOTE: At Do Hard Money, we understand that approaching homeowners in these situations can intimidate new investors. As a result, we’ve developed a pre-foreclosure offer template letter. If you’d like a copy of this letter, we’d be happy to send it your way – for free! Just text your email address to 435-294-0433.
Buying Foreclosed Homes
While I prefer buying pre-foreclosure homes, opportunities still exist to buy homes once banks have foreclosed on them. More precisely, 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.
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.
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.
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.
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.
Using a Hard Money Lender to Buy Properties with No Money Down
After outlining the mechanics of how to buy both pre-foreclosure and foreclosed homes, the question becomes: how do I buy these properties with no money down?
Hard money lenders base their loans on the hard asset, that is, the property. As such, these lenders are far more concerned with the future value of that property than your financial picture (e.g. credit score, income, assets, etc.). In other words, if the property looks like a good deal, you can secure a hard money loan to buy and rehab it. And, if properly analyzed, investors can use hard money loans to 100% finance a home purchase – including pre-foreclosure and foreclosed homes.
Here’s how it works. Hard money lenders base loan amounts on the after-rehab value (ARV) of a distressed property. Based on your detailed contractor bids, renovation plans, and market comps, professional appraisers estimate what a home will be worth after the rehab. Then, lenders issue loans based on a percentage of that ARV. For instance, Do Hard Money will issue loans up to 70% ARV. So, if you find a pre-foreclosure home that, after a rehab, will have a $300,000 value, we’d lend you $210,000 ($300,000 ARV x 70% LTV).
If the acquisition/closing, rehab, holding, and transaction costs on this deal are $210,000 or less, the hard money loan will let you buy the foreclosed home with no money. But, it needs to be a really good deal for the hard money to cover 100% of your costs, which leads to the gap financing strategies in the next section.
Gap Financing Strategies
Most deals for pre-foreclosure or foreclosure properties require funds in excess of the hard money loan. Frankly, it’s extremely difficult to find the sort of awesome deal that a hard money loan will 100% cover. This reality means that most investors have other financing techniques to meet their budget needs above a hard money loan. While not a comprehensive list, investors can do the following to cover the gap between a hard money loan and foreclosure deal budget:
Credit Card Financing
Credit card companies want your money. As such, if you’re a responsible borrower, they’ll provide you pretty good personal loan options. Say you have a $25,000 limit on your credit card, but you only use $2,000 of it every month, always paying it off on time. There’s a good chance the card company will offer you a relatively low interest personal loan for the difference between the credit you regularly tap and your limit. This can be an outstanding gap financing strategy.
Alternatively, you can seek a business partner. Plenty of people A) want to invest in real estate, but B) don’t have the time or experience to do so. If someone has money to invest, you can potentially bring them on as a limited – or “money” – partner. These individuals provide funds, have no role in the day-to-day operations, and receive a return on their investment. Yes, you’ll need to sacrifice a portion of your returns. But, if it makes the difference between funding a deal or not, bringing on a partner can be a great option.
Home equity lines of credit, or HELOCs, are another great gap financing strategy. Typically, investors tap the equity in their primary residences. So, assume you have $50,000 in equity in your property. A lender may not extend a HELOC for that entire amount, but even if you secure a $25,000 HELOC, this gives you a tremendous amount of gap financing flexibility. And, with HELOCs, you only pay interest on the money you draw. Once you repay the outstanding balance, you don’t need to pay interest.
To buy a foreclosed property with no money, investors must first understand the ins and outs of the foreclosure process. Once you understand how to buy pre-foreclosure and foreclosed homes, buying them with no money just becomes a matter of finding a hard money lender willing to work with you. And, the Do Hard Money team would love to help! If interested in buying foreclosed homes with no money down, drop us a note to get started!