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5 mistakes that could cost you when buying a short sale

Lora Shinn
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A foreclosure or short sale home might tempt you with the promise of a great deal, but it's important to be aware of unexpected expenses that can arise after purchase.

Just ask Adam Melson of Philadelphia. Melson had looked at more than 2 dozen houses and he jumped at the chance to purchase a short sale home that seemed like a decent buy in a good neighborhood.

What is a short sale on a house?

A short sale happens when the homeowner sells the house for less than the amount owed, and the lender does not get all its money back. Typically, this happens when the home's value falls. A short sale occurs only with the lender's permission.

But $40,000 in renovations later, he feels differently.

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Melson's home inspector had said the short sale house was fine -- just a little termite damage in the basement. But when Melson tore up the linoleum to repair a soft spot in the kitchen floor, he found the damage went layers deep.

5 common buyers' mistakes

  1. Ignoring property problems.
  2. Skipping the home inspection.
  3. Ignoring legal and insurance information.
  4. Leaving too little time for closing.
  5. Falling hard for a bad home.

"The boards supporting the kitchen floor were entirely eaten by termites," he says. "I also learned at this time that the kitchen sink did not drain anywhere. It drained openly under the house."

Melson ended up replacing an entire wall of his house. That was before his roof started leaking and he discovered thick, smelly mold behind the entire shower unit. "With several other things I wasn't expecting, I wound up hauling over 10,000 pounds of my house to the dump in rented box trucks," he says.

Know what you're getting into before you buy a short sale or foreclosure property and be mindful of these 5 common mistakes:

1. Ignoring property problems

As homeowners are facing foreclosure, they don't want to leave their homes. And some take their anger out on the home or completely ignore structural and safety issues that should be addressed immediately.

"They'll often take that frustration out on the property," says J. Scott Steinhorn, a real estate investor with experience in foreclosures and short sales.

"I've seen a couple foreclosure properties where the previous owners clearly took a sledgehammer to the nice hardwood floors, the tiled showers and the cabinets, just to be spiteful," he says.

Empty foreclosure properties may suffer from issues that arise from neglect -- leaks, mold, termites, thieves, squatters and filth -- because the property sat vacant for weeks, months or years before purchase.

Two little-known loan programs -- the FHA 203(k) and Fannie Mae HomeStyle -- offer solutions to homebuyers who want to renovate.

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2. Skipping the home inspection

Tag along on your home inspection. "Most of what we do is education," says Kathleen Kuhn, president of New Jersey-based HouseMaster, one of the largest home-inspection franchisers in North America.

Ask for repair estimates when an inspector notes a problem, or do some research online later that night. "Every homeowner underestimates how much renovation costs," Kuhn says.

You may wish to call in specialized inspectors to look for expensive problems such as termites, mold and structural damage, particularly if it's a common problem in your area. Also make sure to choose an inspector that's highly rated. Ask for recommendations from friends, or weigh online user reviews heavily. Just as with any other industry, there are great, marginal and bad inspectors.

You are also allowed a certain period of time to inspect the home, known as an inspection period. While shortening an inspection period may get you leverage in a regular real estate situation when you're placing a bid, don't skimp or skip on the inspection period when you're about to purchase a foreclosed or short sale home. Use this time to make a decision.

3. Ignoring legal and insurance information

A typical disclosure statement would indicate if a house was in a flood plain or had any unpermitted renovation, Steinhorn says. Because bank-owned properties often sell as is without disclosure, buyers need to do a little extra research on the home's status.

Ensure that all renovations have been permitted and approved. "If not, and there is a problem, the city can cite you," says Brendon DeSimone, a San Francisco-based real estate agent.

4. Leaving too little time

Short sale and foreclosure homebuyers need to be aware that the sale won't necessarily close as quickly as it would for a traditional home. The short seller's lender must grant approval of either foreclosure terms or a short sale price that is less than the seller owes. Even so, troubled banks may be overwhelmed with foreclosures and slow to respond.

"They aren't just going to let the house go," says DeSimone.

It's not always possible or even desirable to get a home loan from the bank that has a mortgage on the short sale you're buying.

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5. Falling hard for a bad home

Don't assume you're getting a great deal, says Jim Randel, real estate investor and author of "The Skinny on the Housing Crisis." "Think of yourself as an investor," he says. Consider the house's condition, inspection, price and value dispassionately.

He suggests that you ask yourself these common sense questions:

  • If you were to buy this property, could you afford to rent it out for as much as, or less than, your mortgage payment? Use Bankrate's calculator to estimate your mortgage payment.
  • If the home's value drops another 20%, will you still feel satisfied with your purchase?
  • How much money will you have to pour into the property to make it habitable?

Kuhn says that sometimes HouseMaster inspectors provide bad news, but homebuyers just won't listen. She says buyers declare, "This is our house and we love this house," despite a broken sewer line, rats in the basement or a collapsed (and rotting) roof.

As long as you fully understand how foreclosures and short sales work, nothing should stop you from getting a good deal and finding the home of your dreams. Just be sure to carefully consider the home inspector's advice and report before making your decision.

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