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How much money do I need to purchase a home at a real estate auction?

September 29, 2009

gavelMy last blog post was about how illogical and financially nutty it is to attend a real estate auction and place bids on a piece of property you’ve never even seen in person. One of the reader comments I received asked me a really good question. I responded to the question, but I’ll now post my response as it just might help many other prospective auction buyers that are tossing around the idea of buying through a real estate auction.

REDC auctions used to require showing a $5,000 cashier’s check just to get in the door, but the market is changing and this door amount has been dropped to $2,500. I assume this change is an effort to attract more buyers/bidders. Quite frankly I don’t know the real reason. But the lowered amount has probably increased the number of people that will now consider buying at an auction.

Keep in mind the $2,500 is only to get in the door. No, they don’t take the $2,500 check from you at the door as some sort of cover charge, but they do want to see that you’re a real buyer and not wasting their time, money and limited seating. If you cannot come up with a $2,500 cashiers check you aren’t a good prospect for a real estate auction.

There are some upfront expenses. You have to pay the deposit payment on the property right then and there…or at least right after winning the bidding. So assume the winning bid is $100,000. The first cost that is added on is a 5% buyer’s premium, which goes straight to REDC to cover their expense of running the auction. So now the winning bid is $100,000 + $5,000 or a total of $105,000.

Your deposit payment is 5% of the $105,000 if this is your first property being bought at the auction on any one particular day. If it is your second home you have to give a larger deposit. I believe it is 10 – 15%, but I’d have to check on this. The point is there is an increased risk of you not performing and following through on the purchase when you buy more than one property. REDC knows this. So they require you to prove you’re serious by providing a larger deposit. And all deposits will be lost if you fail to perform.

I should add a few notes here. Auction houses, such as REDC, take a risk when they stop the bidding on a house and declare the winning person as the buyer. The property is pulled out of the auction. Nobody else can buy it. If you fail to perform you will in essence have caused them some significant troubles. Once the auction is over it’s over. If you don’t close, for whatever reason, REDC will have to wait till the next auction to try to sell it again. This could be months. Of course, the listing agents can try to sell the property through more traditional means, but clearly the auction house is not going to be happy if the closing doesn’t materialize. As a result of the risk REDC assumes you have to demonstrate to them that you are buying with good faith. You intend to perform. You’re willing to put your money where your mouth is. If you don’t close you lose money. It is that simple. So when you buy at an auction you should approach the whole process very seriously. There is nothing gray in the bidding and closing process with auction properties. If you raise your hand be ready to buy.

Back to my scenario…

So your deposit payment would be $105,000 x 5% = $5,250. When you sit down at the contract signing table you’ll hand the notary that is doing the contract signing your check for $2,500 (the cashier’s check you used to get into the auction) and then write a personal check for the balance due, which in this case would be $2,750. This $2,750 can be a personal check.

If the winning bid is not “subject to lender approval” you’ll be closing in 30 days from the date of the auction. No, you cannot extend the closing date and even thinking about doing so can be a breach of contract. If you don’t close on time you could lose your deposit and home, unless the delay is no fault of your own.

Most homes have a “reserve” similar to how a reserve on eBay works. If your winning bid is lower than the lenders reserve (their secret bottom line) your contract will be stamped as “Subject To,” and the lender must make a decision on whether or not to accept your bid. If they accept your bid you will close within 30 days.

I hope this helps. If anyone has any further questions don’t hesitate to post them here. Thank you!

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