With real estate prices rising, foreclosures and short sales, typically priced 5 to 15 percent below market value, may seem more attractive to frugal home shoppers.

Although the price reduction is an incentive to buy one of these properties, there are risks associated with them, and buyers should proceed with caution. Here’s how buyers can prepare to purchase a foreclosure or short sale.

Determine affordability

Even before buyers look for foreclosures or short sales, they must determine what they can afford. Calculate the monthly mortgage payment in addition to the insurance, taxes and home maintenance costs required with homeownership.

Buyers should also think about the initial out-of-pocket expenses they may incur such as fees for an appraisal or inspection, closing costs, earnest money — which is a deposit buyers often pay to show serious interest in a property — and down payment.

Once buyers have determined what they can afford, they should get preapproved for a mortgage from a bank and then follow the steps below. Remember that people buying foreclosures at an auction may have to pay cash for the property.

Understand the sale process and its risks

Typically, buyers of foreclosures and short sales have more hoops to jump through than buyers of traditional properties, and the purchase process takes longer.

Foreclosures:
When buying a foreclosure — sometimes called a real estate owned property — buyers are purchasing the property from the bank. Even though the bank owns the property, no one from the bank has lived in the property, and thus the bank does not have personal knowledge of the property’s condition.

This is why banks typically require buyers to sign documents stating that they are aware that the property is being sold “as is,” releasing the bank from liability.  “As is,” or flaws and all, means that a buyer could end up buying a property with major damages that the buyer would have to pay to fix.  

Short sales:
A short sale works a little differently. Because the seller is hoping to sell the property for less than the amount he or she owes on the mortgage loan, the bank must approve the sale. The bank’s approval can take months, and sometimes banks reject the short sale, leaving the buyer without a new home and having to start the house hunt over from scratch.

Hire a specialist

Because of the complexity of buying a short sale or foreclosure, buyers may want to work with a real estate agent who is familiar with the process. A foreclosure or short sale specialist can walk buyers through the extensive paperwork that often comes with these transactions and help determine how much to offer on a home.

Submit an offer

Once buyers find the short sales or foreclosed properties they want to buy, they submit their offers. To determine how much to offer, buyers must consider the “comps,” or comparable properties in the area, and the prices they sold for (the real estate agent can help).

Sometimes banks price properties really low and end up getting several offers above asking price, and sometimes the reverse happens. It’s essential to work with the real estate agent to figure out a reasonable offer price to increase the likelihood of an offer being accepted.  

Do a thorough background check on the property

Buyers must do an extensive background check to ensure they’re getting a property that has a clear title and is in good condition (this is particularly important with a property selling “as is”).

To do this, work with the real estate agent to search property records for past building permits, which should show any major or odd repairs that were planned for the home. Have the home inspected, and look through the home’s sales history for past contracts, which may contain previous inspection reports. Buyers may locate and contact the previous owners of the home to inquire about the condition of the property or ask neighbors about the property and its previous owners.

Typically this background check must be completed within the time frame specified in the contract.

Informed, patient buyers can benefit

In conclusion, as long as buyers are informed about the lengthy process and potential
pitfalls of purchasing a foreclosure or short sale property, then they aim to benefit financially from the lower home prices.

Jay Robert is a writer for Zillow and an associate with Kassoff, Robert & Lerner, LLP, focusing in the areas of elder law, real estate, special needs law and estates.