3 Key Ways to Buy Foreclosed Properties

It's not as easy as the infomercials make it look.

A for sale sign is seen in front of a foreclosed home October15, 2007 in Antioch, California.
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More than a million foreclosed and "distressed" properties are expected to hit the market this year, from two-bedroom starter homes to 20-room mansions. But while the banks that own many of them are now preparing to sell them en masse at auction, most of the best properties will be sold long before the gavel comes down.

Homeowners unable to refinance—but still with plenty of equity—can simply put their houses on the market, while those underwater can plead with their banks to let them "short-sell" for less than they owe on the mortgage.

Those who can't sell before they're foreclosed on will be evicted and their houses auctioned off. Whether on the steps of the local courthouse or through private sales, bidding typically starts at or just below what's still outstanding on the mortgage, plus fees and court costs—which isn't a deal if the property's market value has sunk below that.

More often than not, the bank takes back the house and hires a real estate agent to sell it, sometimes at far less than what was owed on it. So which stage offers the best opportunity to buy on the cheap?

Here are the upsides and downsides of each:

Pre-foreclosures. This entry point offers both the best and worst of the often messy business of investing in foreclosed property. On the one hand, if you can contact a distressed homeowner as soon as or even before his troubles become public knowledge (usually in the form of a "notice of default" listing in the newspaper), you're ahead of the competition and in position to work out a deal. On the other hand, you're approaching the hapless homeowner when he's at his lowest, or even worse, still in denial of the reality he faces. Already on edge, many facing foreclosure are warned to be wary of strangers approaching them with quick fixes, and with good reason. "That's when the vultures show up," says real estate attorney Oliver Frascona, who notes that fraudsters posing as so-called foreclosure consultants often try to get involved at this stage in the process.

Anyone with misgivings about profiting from someone else's misery has plenty of reason to steer clear. The irony, however, is that this is the point when a would-be can actually do some good, helping an owner avoid the all but permanent taint of a foreclosure. Although involuntarily selling one's house is sure to be heart-wrenching, a fair offer can at the very least create a path to financial recovery. That said, foreclosure experts warn buyers to avoid getting entangled in the seller's personal affairs. "A reasonable offer is all you owe them," says real estate broker Ralph Roberts, author of the book Foreclosure Investing for Dummies.

Those who want to avoid direct contact with a distressed seller have another option: the short sale. Such homes, which are often put on the market with the help of a real estate agent, are priced below what the owner owes on the mortgage and must be approved by the bank. The advantage, of course, is that you have every opportunity to do your due diligence and make an offer without having to engage the seller directly. The disadvantage is that once the house is on the market, you're competing with everyone looking for a deal. Meanwhile, even if your offer is accepted, it could take weeks, even months, for the bank to respond.

To increase your chances of getting a thumbs up, be sure to do your homework, including a thorough market analysis of what comparable homes have sold for, and submit your research along with your offer. "If you come in with all the statistics and can make the case that yours is a fair price, they're more likely to take it," says Pat Lashinsky, chief executive of real estate brokerage ZipRealty. And whatever you do, "don't try to low-ball the bank because they won't go for it."

Public auctions. The very idea is irresistible. Find your dream house, head for the courthouse steps, and bid whatever you think the place is worth. Unfortunately, the public auction stage of the foreclosure process rarely presents easy pickings. Although the exact method of disposition varies widely by both state and county, the general process is that the homeowner is sent a "notice of default" and given a certain amount of time—usually about 90 days—to "cure" the loan and bring payments up to date. If the homeowner doesn't, the bank then sues to repossess the house, which the court or a trustee then auctions off to the highest bidder.