The Dangers of Buying Flipped Foreclosure Houses
Don't be lured by a fresh coat of paint, shiny new appliances, or slabs of granite on the counters. A foreclosure flipper home can have plenty of things wrong with it under the surface—things that you may not discover until it's too late to do anything about it.
When an investor picks up a bank-owned home, either by buying that home in a bulk purchase directly from the bank or by bidding on the home at an auction, the foremost thought in that investor's mind is making a profit. But when you see the home for sale, you're looking at its aesthetic value and how that home fits your parameters. Because of its emotional appeal, you might not notice construction defects that the seller is trying to slip by you.
Fixing Up a Foreclosure Flipper
That's not to say that all investors cut corners when they rehab a property. Many investors are conscientious and hire quality construction crews. But some investors—and you rarely know which ones they are by looking at them—hire the cheapest labor they can find and use the least expensive materials in an attempt to boost their profit margins. Here are some areas of concern:
- Mold: Some bank-owned homes sit empty, without heat or air conditioning, for months. If a pipe leak or moisture is present, mold may grow and spread. Mold remediation costs thousands of dollars. Would an investor paint over the mold? What do you think?
- Pest reports: Investors purchase bank-owned homes in "as is" condition. Banks rarely pay for pest work. Left untreated, termites or powder post beetles could be devouring the structural integrity of the home. The interior walls could be supported by rotting studs.
- Asbestos: A quick and easy solution for covering linoleum flooring that contains asbestos is to lay laminate or ceramic over it. If the underlayment is not securely fastened to the subfloor, it could break free over time. Ditto for the exterior siding. What's under the new siding?
- Building permits: Did the investor add or remove a room or make any type of improvement that required a permit? You might not know because it's unlikely that an investor will disclose every job performed. Some work could have required a permit while no permits were obtained.
- Substandard building materials: Unless the foreclosure flipper is a high-end home, it's likely that the investor purchased bottom-of-the-barrel appliances, low-end cabinets made from pressed board, and inexpensive plumbing fixtures or cheap dual pane windows, which may quickly wear out. You won't know if the contractor used half-inch or quarter-inch drywall unless you remove receptacle covers and measure.
- Unlicensed subcontractors: It is possible the investor's contractor may have hired undocumented or unlicensed workers below minimum wage to perform complex jobs for which the workers were untrained. Even a simple job such as hanging drywall, mudding, and sanding can be done incorrectly, and you won't know until the screws start popping out months down the road.
90-Day Flipping Rule
The 90-day flipping rule applies to the season of the title. Many lender guidelines and overlays require that the investor own the property for at least 90 days before the buyer's lender will make a loan to that buyer. The contract date must be at least 90 days after the recordation of the investor's deed.
Exact parameters will depend on the lender and loan type. FHA loans have a strict 90-day rule with a few exceptions, while many other situations will simply require that the flipped sale price be no more than 120% of the original sale price if it has been less than 90 days.
Ultimately, this law is designed to protect buyers from being ripped off with poorly done, quick flips. Be sure you know the sale history on the property before you sign an offer.
Mechanic's Liens on Foreclosure Flippers
Because flipping a home usually involves contractors doing improvement work, you should be wary of the possibility of a mechanic's lien against the property. These liens, also known as property liens or contractor's liens, can occur if contractors or subcontractors haven't received payment for their work. Time frames in which a contractor is allowed to file a lien vary by state.
In California, for example, subcontractors have 90 days to file a mechanic's lien for unpaid work. This means if a contractor did not pay a subcontractor or if materials were delivered without payment, a buyer could find that a lien was filed against the home after the home closes escrow.
The Bottom Line
Buying a flipped home can be a great way to get a property that's been freshly renovated and updated. And foreclosed homes can make for a great flipping opportunity. They also represent a risk, however, as they can be a tempting opportunity for dishonest investors to try to make a quick profit. Be sure you do your homework about any property before you buy.