After the mortgage crash of 2008, buying foreclosed homes has become a more common practice. Foreclosed homes can be just as easy to come across as any other listing on the multiple listing service (MLS).
Buying a foreclosed home can be a savvy way to buy a property priced under market value. It can also be a great way to get into a good area for a low price. It’s a chance to save money, and it’s a cost-effective investment opportunity.
Selling points aside, foreclosed homes do come with some risks.
Foreclosure-curious buyers should fully consider all the advantages and disadvantages of the foreclosure buying process. That means understanding what happens during a foreclosure, learning how the buying process is different and knowing how to buy a foreclosed home (including any possible risks).
What Is Foreclosure?
Foreclosure is a legal process where a lender repossesses a home because the borrower has defaulted (think: stopped paying) on their mortgage loan.
When a borrower signs a mortgage contract, their home is the collateral. The contract specifies what types of violations will put the loan into default, including the number of missed, consecutive payments.
Once a loan is in default status, the lender has the right to take the property to recover as much of the remaining balance of the loan as possible.
Typically, the foreclosure process can start after 3 – 6 months of missed payments. But foreclosures can happen for other reasons, like unpaid property taxes.
The foreclosure process and timeline depend on who’s running the show. Whether it’s judicial or nonjudicial, a look at state and federal laws and the homeowner’s specific mortgage contract will all come into play.
How Does Foreclosure Work?
A foreclosure can be a complicated, long process, and there are multiple opportunities for buyers to step in and purchase a property.
Here are the usual steps of a foreclosure:
- First homeowner violation: The homeowner makes their first violation of their mortgage contract. This date triggers the countdown to default unless the homeowner catches up on missed payments.
- Notice of default: After several months of missed payments, the homeowner is officially notified that their loan is in default (aka preforeclosure). How long a homeowner has before going into default varies depending on the specific contract. The notice of default includes instructions on how to contact the lender and start a payment plan to get out of preforeclosure.
- Notices of trustee sale: If the homeowner fails to take action, the lender can move into the process of a trustee sale. The lender must record the upcoming sale with the county and publish it in a local newspaper. Aspiring home buyers who are interested in buying a foreclosed home should keep their eye out on these newspaper listings. If you’ve never touched a physical newspaper in your life, you can add an alert to your online listings.
- Trustee’s sale/auction: The post-foreclosure stage is when the lender tries to sell the property. The house is usually put up for sale at a public auction. If the property doesn’t sell at auction, the lender becomes the owner. At this point, it’s considered “real estate ownership,” and the lender will try to sell the house through open houses, real estate websites, etc.
If you’re a homeowner and you’re in loan default status, there still might be a chance to recover. Talk to your lender to see what your options are.
How To Find Foreclosed Homes
Wondering how to buy a foreclosed home? Here are some common ways homes typically become available for you to purchase during the foreclosure process:
When a homeowner is in the preforeclosure stage (they’ve received a notice of default from their lender), they can opt to sell their home. If the homeowner can sell the home, they could potentially avoid foreclosure, including its negative impact on their finances and credit.
Keep an eye out for preforeclosure homes by checking listings posted in city courthouses and county buildings. Many real estate websites also list properties in the preforeclosure phase.
A short sale is when a lender agrees to take a loss on the home if it means it’s sold, and foreclosure can be avoided.
Let’s say a homeowner owes $200,000 on their mortgage, and they know that if they list it for $175,000 it’ll sell quickly. The homeowner could then suggest a short sale to their mortgage lender and ask if they’d be willing to take the loss. (FYI: Lenders don’t always agree to a short sale.)
A homeowner can also suggest a short sale when their loan isn’t in default.
If a homeowner can prove that they are facing a financial hardship (a job loss, a sudden spike in medical bills, etc.) that could lead to a loan default, they may be approved.
After a short sale, it will take a while before sellers can buy another home. Lenders usually require a waiting period of at least 2 years before sellers can apply for a new mortgage, with most requiring 4 years.
Buyers can find a home in short sale through conventional real estate listings. These listings come with “pending bank approval” language in the listing.
Another way to buy a foreclosed home is through an auction. An auction is appealing because the prices are low and the sale can be fast.
But auctions do come with some downsides.
Buyers must have the cash upfront, the property might have tax liens on it, and you can’t get an appraisal on the home before you buy it.
Real estate purchased properties
Foreclosed homes that don’t sell at auction end up for sale as a real estate listing by the lender (aka a real-estate owned or REO property). You typically have to work with an agent to access these listings.
VA or FHA purchased
When homeowners default on a government-backed mortgage, like a Department of Veterans Affairs (VA) loan or a Federal Housing Administration (FHA) loan, the property is returned to the associated government agency. Brokers who work for the agency help negotiate the sale of these properties.
How To Buy a Foreclosed Home
Many people are interested in foreclosed homes because of their low prices. The reduced prices mostly stem from the lender’s desire to get a quick sale, but other factors may be at play, like extensive repairs on the property.
If you’re thinking about buying a foreclosed home, taking the right steps can help make the purchase a reality.
1. Get your REO agent
It’s important to get a real estate agent to help you with the buying process. An experienced real estate agent can assist you by:
- Knowing the market and confirming when a foreclosure is priced well
- Knowing the state rules and regulations around foreclosures
- Having insight into foreclosures before they go on the market
2. Find foreclosed homes
You can buy a foreclosed home during a few stages in the process: preforeclosure, short sale, foreclosure auction, bank and government options. You’ll have to determine what works best for you so you can focus on finding foreclosed homes in your stage of choice. You can start the search by looking at home listing sites.
3. Get mortgage preapproval from a lender that works with foreclosed homes
Unless you buy a foreclosed home through an auction, you’ll probably have to apply for a mortgage to fund your purchase.
Unlike most other home purchases, you may need to get a nontraditional mortgage. Private lenders tend to be more cautious about financing foreclosed homes because they can be riskier investments.
Financing options for government-backed foreclosed homes
There are many government-backed options for financing a home, including:
- FHA 203(k) loans
- Fannie Mae HomePath® ReadyBuyer program
- Freddie Mac HomeSteps® program
Once you have a loan in mind, you can move forward in the buying process.
4. Get your foreclosed home inspected and appraised
Like you would with any other home purchase, get the foreclosed house inspected and appraised before you move too far into the buying process. (Remember, if you’re buying at an auction, you likely won’t have this option.)
After the appraisal and inspection, review the reports. Ask yourself if the noted repairs work for your budget and if the home is still a worthwhile purchase. Make sure you have the funds you’ll need to buy the home and make any needed repairs.
5. Secure your new property
Once the appraisal and inspection are completed and you’ve decided to buy, you’ll continue the closing process with your lender.
Reasons To Buy a Foreclosed Home
Besides the low price tag, there are some other big benefits to buying a foreclosed home:
- A foreclosure might be the only way someone can afford to enter the home buying market. After making some improvements, homeowners can sell for a profit and upgrade homes.
- As long as you’re not purchasing at an auction, you have many loan options for a mortgage on a foreclosure. Your choices include a conventional or government-backed loan (VA loan, FHA loan and U.S. Department of Agriculture (USDA) loan). All of these loan options require that the home is in a livable condition.
Make sure you know what the risks are before you buy a foreclosed home. A savvy buyer, such as yourself, should understand aspects of the process before making a final decision.
What To Consider Before Buying a Foreclosed Home
Because of the extra risk involved for buyers, you should keep these factors in mind:
- Maintenance and repairs: If a homeowner is in default for a few months and knows a foreclosure is likely, they’ll have zero incentive to care for the home. This means you might be buying a property that hasn’t been maintained for months.
- As-is condition: Most foreclosed homes are sold as-is. This means the buyer is responsible for all repairs. As a buyer, you should make room in your budget to tackle needed repairs.
- Competition: There may be many investors looking for foreclosure opportunities. This often leads to bidding wars.
- Required Cash: If you want to buy a foreclosed home through an auction, you’ll need to have the cash upfront.
Buy Low and Aim for Low Risk
If you can find a property in good condition for a reasonable price, buying a foreclosed home can be a savvy financial decision. Make sure you don’t rush the process, and you understand what you’re getting into.
U.S. Department of Housing and Urban Development. “FORECLOSURE PROCESS.” Retrieved November 2021 from https://www.hud.gov/topics/avoiding_foreclosure/foreclosureprocess
U.S. Department of Housing and Urban Development. “ARE YOU AT RISK OF FORECLOSURE AND LOSING YOUR HOME?” Retrieved November 2021 from https://www.hud.gov/topics/avoiding_foreclosure/fctimeline
Fannie Mae. “B3-5.3-07, Significant Derogatory Credit Events — Waiting Periods and Re-establishing Credit.” Retrieved November 2021 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-5-Credit-Assessment/Section-B3-5-3-Traditional-Credit-History/1032994681/B3-5-3-07-Significant-Derogatory-Credit-Events-Waiting-Periods-