We have all seen the late night infomercials featuring the guy who bought a foreclosure for $40,000 and sold it a week later for $75,000. These stories can certainly get people excited. Considering the costs involved and the associated risks, can you really make money buying foreclosures?

Let's take a closer look at buying foreclosures.

There's no doubt that this can be done, but it can be very challenging. As the housing market cools in many parts of the country and as nearly a trillion dollars in adjustable rate mortgages reset themselves, now may indeed be a great time to get started buying foreclosures.

But before you start getting greedy, let's consider the specifics. There are many ways you can go about buying foreclosures. You can deal directly with homeowners in delinquency, you can go to auctions, or you can work the short sale market (when a bank accepts a discounted or a lower payoff than the actual mortgage balance as payment in full). Each process has its own advantages and risks. Whatever approach you decide on, educate yourself about the property and don't overpay. You make your money in real estate on the buy.

There is no doubt that discounts can sometimes be substantial, but competition for deals can often be fierce. You may need to sort through dozens of potential deals to find one that makes economic sense. And just when you think you have the perfect deal, the costs to rehab the property is far greater than expected. In addition, in today's environment, lenders are more flexible than they were many years back. Many of them believe that it's better to offer some leniency to a troubled borrower rather than to take back a property.

But the question still remains ? is buying foreclosures a good way to make money?

Well let's consider a study conducted by the Office of Federal Housing Enterprise & Oversight on buying foreclosures. The study attempted to answer this very question.

Using data on over 12,000 foreclosed single-family property sales, the value of foreclosed property was found to be substantially less than the value of other similar property. The average price appreciation rate for foreclosed properties was 22 percentage points lower than for typical homes.

The study also found that while foreclosed properties are responsive to local area house prices, they do not capture all of the area wide appreciation. In addition, when local area house prices are dropping, the discount increased. Borrowers who are identified at application as higher risks also tend to own homes that sell at an even higher discount than typical foreclosed property.

State level foreclosure laws can also have impacts on the appreciation of foreclosed property. For instance, if a loan is foreclosed in a state that allows the borrower the right to redeem the property after paying the foreclosure expenses for up to a year after the foreclosure date, the discount increases. But the impact of buying foreclosures is different for each type of law. For instance, if a state requires that the foreclosure proceed through the judicial system - the discount also increases, but the discount is smaller in states that allow the lender to recoup any losses from other assets beyond just housing.

Well this sounds great, but what does all this mean to the investor who is considering buying foreclosures? The simple fact is that if a borrower is in default, it indicates that the property will generally be sold at a discount relative to similar properties. In addition, foreclosed properties tend to follow the movement of house prices in the area, but in a muted fashion.

Investors who understand the risks associated with buying foreclosures can certainly exploit the opportunities in the current market. However, with a soft market in many parts of the U.S., it will be a challenge to find a property with enough equity. In fact, many foreclosures have no equity at all.

So before you take the plunge, realize that making money buying foreclosures is not a simple process. Assuming you have the time and the temperament, there is money to be made. It certainly is not as easy as the infomercials would have you believe.

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