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 important that you know the difference.
Most people are somewhat 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 of them. There are two main ways that a house ends up at auction: through foreclosure due to missed payments or defaulting on tax payments.
Foreclosed properties are sold at auction. These homes are seized by a mortgage lender after a borrower fails to make mortgage payments for a set period of time. This process begins after several months of missed payments. Before a servicer can proceed with the foreclosure process, the loan must be at least 120 days delinquent, with some exceptions. Servicers are required to make efforts to contact the borrower with alternatives to foreclosure to help them stay in their house if possible.
If the homeowner doesn’t pay the amount due or work out a repayment deal with their lender and has exhausted all options, the lender can put the home up for auction. The auction is then run by a trustee hired by the lender, a sheriff or the taxing authority.
Another way a house ends up at auction is when the owner doesn’t pay the house’s property taxes. In this case, the tax authorities seize the property rather than the lender. If a home has tax liens against it, it might be resolved one of two ways. There could be a tax lien sale, where the liens themselves are auctioned off to bidders. The highest bidder wins the right to collect on the liens from the homeowner. If the homeowner doesn’t pay, the lien holder can foreclose on the property.
There could also be a tax deed sale. In this case, a house with unpaid property taxes on the title can be sold outright at auction.
There are a variety of different auction companies, and every one of them has their own rules. Even within one auction company, 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.
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.
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 your bid is lower than the minimum amount the seller is looking for, they may simply reject the offer.
Sellers choose the bidding arrangements they want to try and increase the purchase 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.
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 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. 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.