Buying A House At Auction: What You Need To Know Before You Bid
Victoria Araj11-minute read
November 20, 2020
Everyone loves a bargain. Sometimes though, a bargain isn’t a bargain – it’s just a waste of money. And if you’re thinking of buying a house at auction, it’s imperative that you know the difference.
Why Are Some Houses Sold At Auction?
Most people are at least vaguely familiar with how to buy a house, even if they don’t know any of the details about how it works. There’s a For Sale sign, and a phone number to call. You visit the house and decide if it’s for you. If it is, you tell the agent, who prepares an offer and tells you what steps you need to take next. At some point, the sign is gone, and the house is yours.
But, there are other ways that homes are sold, and auctions are one way that foreclosed properties are sold. These homes are owned by mortgage borrowers who have either defaulted on their mortgage or failed to pay their property taxes, and they are now being seized by lenders and/or tax authorities.
How Do Auctions Work?
There are a variety of different auction houses, and every one of them has their own rules. Even within one auction house, there may be a variety of auctions being offered. They must also conform to the rules of the state and municipalities in which they are located. Make sure you understand the rules of the specific auction you’re interested in before you bid.
Types Of Auctions
Auctions, whether in person or online, will be organized in one of three ways, and any single auction may deploy one or all of these types, depending on the property owner’s preference.
In an absolute auction, the highest bidder wins, regardless of the amount of the bid. You might bid $1 and win a house.
Absolute auctions attract the most bidders because there is no minimum. This is also the preferred method of most lenders and government agencies. All sales are final, meaning there is no room for the seller to back out in the face of a too-low bid.
Minimum Bid Auction
In this type of auction, there is a minimum bid amount on a property. The minimum bid is published in advance, and if you’re bidding in person (more on that below), the auctioneer will announce the minimum bid amount before opening bidding on the property. The minimum bid is generally the balance owed on the mortgage in the case of foreclosure, or taxes owed in the case of a tax lien. All sales at the minimum bid or higher are final.
In a reserve auction, bids are treated more like offers in that the seller can accept or reject the bid (but not counteroffer, as they may in the typical real estate transaction.) In these cases, the seller usually has a minimum bid in mind, but doesn’t want to share the amount, in the hopes they’ll get more at auction. If you’re bid is lower than the minimum amount the seller is looking for, they may simply reject the offer.
Types Of Bids
Sellers choose the bidding arrangements they want to try and increase the sale price.
In an open auction, bidders know the amount of any other bids that have been made. Bidders like open bids, because they can see what the competition is doing and raise their bid gradually, as needed. If there is no competition, a lowball bid might just win. On the other hand, open bidding can result in bidding wars, and sometimes sellers reap a windfall.
Sellers generally prefer blind bids, even if it reduces competition. This process is more like bidding on a job. You’ll have to make a bid without knowing how others are bidding. Motivated buyers need to make a bold bid upfront instead of taking a wait-and-see approach.
If you’re an investor, you’ll have a good sense of how much to bid; if you’re looking to buy a home for your family, you might overbid because you lack experience or are too swayed by emotion.
In Person Or Online?
The world of auctions is rich and vast, and if you’ve never been to one, you should check one out in your area.
Attending an in-person auction can feel like taking a step back in time. It might take place right outside on the courthouse steps. There are the numbered cards, lifted almost imperceptibly and yet always seen and noted by the fast-talking auctioneer. The bidders wear sunglasses and hats, like high-stakes poker players, to hide any “tells” that might convey emotional responses.
If you’re a first-time auction attendee, you might not have a clue about what’s going on. Your best bet is to start attending auctions well before you plan to bid. Collect any sales materials being offered and read up on the rules. Much of this information can also be found on the auctioneer’s website. Get to auctions early or plan to stay after and ask questions of some of the auction house’s employees or other bidders. Pretty soon, you’ll develop an understanding and a feel for the process.
More and more frequently, the auction process is moving online.
This is a boon to first-time bidders, as it is easier to get all the information you need, ask questions, and simply watch and learn. Make sure you study the rules, as each auction site operates according to its own procedures. On most real estate auction websites, you’ll have to preregister and prove that you are a serious, prequalified bidder, so leave time to complete that process well before the house you’re eyeing comes up for bid.
Of course, this increased accessibility means that there will be more bidders, so be prepared to face steeper competition.
What Are The Advantages Of Buying A House At Auction?
There have been countless books written and real estate workshops offered that extol the virtues of buying properties through the auction process, because it is possible to get a tremendous bargain.
Why? Because in the auction process, the lender is looking to cut their losses by recouping the balance due on the mortgage and their costs to foreclose. At auction, lenders are not interested in enriching the seller. The same is true for municipalities with a tax lien in place. Their interest is in coming as close as possible to having the tax bill paid and their costs recouped.
What Are The Disadvantages Of Buying A House At Auction?
There are several reasons why buying a house at auction is usually in the real estate investor’s wheelhouse and is an atypical way of buying a home to live in yourself. The reason the house is a bargain is because the buyer is taking on a lot of risk.
Houses Are Sold As Is
Homes at auction are sold as-is. That’s not so unusual, as many government-held foreclosures are sold in the same way. However, in most cases, it is highly unlikely that you will be able to even get inside a home sold at auction, let alone get a home inspection. It’s possible that the house is still home to the defaulting homeowners, tenants, or squatters have taken up residence there. In this case, “as-is” is closer to “sight unseen.”
You can drive by a house, but trespassing on the property, much less looking in the windows or entering the home, is illegal and unsafe – even if you did see them do it on a house-flipping reality TV show. If you are very experienced in-home improvement matters, you might be able to get clues to the condition of the property from the street or sidewalk. If you’re not, you’ll have no clear idea what you’re taking on when you bid on a home.
You Must Have Cash To Make The Purchase
Most auctions have very strict rules about how you can pay for your purchase, and they almost always involve cashier’s checks or cash. You can’t finance auctioned properties. There are loans available, and we will discuss them later, but in order to bid, you’ll have to prequalify by showing that you have cash available to complete the purchase, often on the same day as the auction.
That’s why most purchasers of auctioned-off properties are real estate investors. They generally have the financial backing of investors, or they have set up their businesses to allow for high cash reserves.
You’ll Forego Common Protections
In the vast majority of real estate transactions, home buyers are legally offered consumer protections, lenders are required to make disclosures, and real estate agents must advise you as they would advise themselves. In the auction situation, none of that applies.
In addition to having little or no access to the home you wish to buy before you bid, you are responsible for doing your due diligence to make sure the title is held free and clear. Of course, the mortgage lender, and probably the taxing authority, have liens in place, but you have to make sure there are no other liens, as in the case of a home equity loan in default or unpaid homeowners’ association fees. If there are, you will be responsible for paying those liens off when you acquire the title to the property.
After You Win At Auction, The Property Could Revert To The Previous Owners
Even if you win at auction, you can still lose the house. If the owner is suddenly able to bring their mortgage current, work out a forbearance plan with the lender, or negotiate a short sale, you will walk away empty handed. Until you receive the title with your name on it, which usually takes about 10 days after the auction ends, you have no guarantees.
How Much Should I Bid?
Here’s where your knowledge of the local real estate market and home renovation costs will make or break you as a bargain hunter.
As a general rule, you’ll want to know the value of a well-maintained home in the area where you are looking to buy.
Let’s assume that you are looking for a 3-bedroom house in an area where well-maintained homes with 3 bedrooms sell for $250,000. Let’s also assume that repairs to bring it up to the well-maintained standard will cost no more than $50,000. Finally, let’s assume that there are no liens aside from the primary mortgage. Note that these are all huge assumptions, made for the purpose of this example only, that you should not make in the real world.
If you can buy that house at $200,000 (in cash), you’ll break even, because after the repairs, you could sell it for $250,000, assuming, and it’s a risky assumption, that the market doesn’t take a downturn in the interim. Keep in mind, that with $200,000 in cash at your disposal, you have several other, less risky options available to you.
If you’re looking for a home, you might be comfortable with breaking even. Maybe there were no other affordable homes aside from the foreclosure fixer-upper in that neighborhood, and it’s in the school district you want your kids to attend. And if you’re going to be living there, you aren’t going to be concerned if the market takes a downturn in the short run because you plan on living there for the foreseeable future. You won’t have a mortgage to worry about, in any case.
But if you’re an investor, you’ll be much more concerned about short-term real estate market risk. You’ll probably want to discount your bid to take into account a risk that the market will suffer a downturn. So, we’ll subtract 10% from the bid price to protect you from that risk, which would bring your bid down to $175,000. Moreover, no serious investor would ever assume that there was any kind of cap on the cost of repairs.
Investors will also want to make a profit, either by selling the home after it’s repaired or renting it out. That amount will also need to be subtracted from the amount investors might be willing to bid.
In short, you may overbid if you don’t understand how investors bid on auction properties.
How Can I Finance The Purchase Of A Home At Auction?
Even though auctions require cash, there are loans available that might help first-time investment buyers.
Hard Cash Loans
These are loans that are high interest and short term, and generally unsuitable for auction bidders who plan to live in the home. These loans make sense for property flippers, whose business it is to fix up and sell their auction buys as quickly as possible, paying off the loan, and pocketing their profits.
In a delayed financing loan, you pay for your home upfront, as in the case of an auction purchase, and then immediately refinance the home to take the equity back out, presumably to buy more houses. It could also work if you borrowed money from friends or family to make the initial purchase of an auction property and need to repay those loans.
Essentially, you will have to meet the appraisal and home inspection requirements, so a lot will depend on the condition of that home. It might be impossible to get that financing if the home turns out to be in worse shape than you imagined.
Tips And Tricks
Here is some advice that can help you navigate the auction process.
Know Your Limit
If you have figured out what you must pay for an auction property to make it worth your while, either as a homeowner or an investor, write that amount down somewhere and take a solemn vow not to exceed that price. It can be difficult to stick to, especially in the case of a bidding war, when emotions run high. But if you know exactly when to walk away, you will avoid overpaying for an auction property.
Do Your Research
Make sure you understand the market where you are bidding. Especially if you are moving from a high-cost real estate market to a lower-cost area, you might not understand the market or know what kinds of damage are unique to your new home.
All risks are on the buyer in the auction situation, so there is no one to look to for financial assistance should the problems in a home, or in its legal status, be greater than you thought they might be. Even the best-kept home can harbor serious problems within its walls.
Buying A House At Auction FAQs
Here are some common questions about buying a house at auction, but make sure you research the specific auction you are considering.
What If I Can Buy The Home I Want By Paying Off Second Liens?
If a homeowner has defaulted on a second lien, the first lien for the primary mortgage is probably not far behind. Your purchase will always be subordinate to the first lien, which could foreclose and wipe out all subordinate liens.
There are sophisticated investors who know how to make money in these situations, but unless you’re one of them, you are best off forgetting you ever saw the listing.
Can I Get Help From A Real Estate Agent?
You might, if you have a long-standing relationship with one. The problem is that real estate agents do not make commissions on auctioned properties. If you know an agent who is willing to help you anyway, they can pull comparables in the area, learn about the property’s history, and even help you get a preliminary title report.
What If I Find The Home I Bought At Auction Is Simply Not Worth Renovating?
It happens. Even the most experienced investors get burned at auctions. It’s simply not possible to know all that is wrong with a property before you purchase it, even if you’ve had the opportunity to conduct a thorough home inspection. If you purchased the property in your own name, as opposed to purchasing it as a business asset, you’ll be on the hook for upcoming property taxes, and refinancing won’t happen.
And that’s why real estate auctions are NOT a recommended way for inexperienced home buyers to purchase real estate.
Summary: Auctions Are Best Left To The Investor Set
I know how tempting a bargain is, but buying a home at auction is generally a pretty risky endeavor. The good news is that there are lots of other ways to buy foreclosure properties. Contact a real estate agent in your area and discuss what you’re looking for. They’ll be able to guide you away from pitfalls and into your new home.
In the meantime, learn more about buying your next home in our Learning Center.
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