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Buying a Foreclosed Home: The What and How

TLDR

What You Need To Know

  • Foreclosure is a legal process where a lender repossesses a home because the borrower has defaulted (stopped making mortgage payments) on their mortgage loan
  • The primary benefit of buying a foreclosed home is that your dollar can go further than if you purchased a standard retail property
  • Home buyers can purchase a foreclosure in many ways, including during preforeclosure, as a short sale, in an auction, through a real estate agent or from a federal agency

Contents

Buying a foreclosed home is a great way to purchase a property below market value. Whether you want to take advantage of an investment opportunity or buy a new home to live in, foreclosed properties can offer more bang for your buck.

But foreclosures do come with some risks. 

If you’re curious about foreclosure homes, consider the advantages and disadvantages before getting in too deep. 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. 

Defining Foreclosure

Foreclosure is a legal process where a lender repossesses a home because the borrower has defaulted (stopped making mortgage payments) on their mortgage loan. 

Once a loan is in default status, the lender has the right to take the property to recover as much of the remaining loan balance as possible. 

How To Find Foreclosed Homes 

Home buyers can purchase a foreclosure in many ways, including during preforeclosure, as a short sale, in an auction, through a real estate agent or from a federal agency. 

If you want to find foreclosure properties for sale, you have to know where to look. Sometimes, it may not be clear which homes are foreclosure properties. 

The best ways to find foreclosure homes for sale are to consult a real estate agent who has experience with foreclosed properties or visit the “Homes for Sale” page on the U.S. Department of Housing and Urban Development (HUD) website.

Different Types of Foreclosure Sales

You can buy a foreclosed home during a few stages in the foreclosure 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.

Preforeclosure

When a homeowner is in the preforeclosure stage (they have received a notice of default from their lender), they can opt to sell their home. If the homeowner can sell the property, they may be able to avoid foreclosure, including its negative impact on their finances and credit.

Look for preforeclosure homes by checking listings posted in city courthouses and county buildings. Many real estate websites like Zillow also list properties in the preforeclosure phase. 

Short sale

A short sale is when a lender agrees to sell the property at a price that’s lower than the remaining balance on the borrower’s mortgage. This helps the borrower and lender avoid the painful process of foreclosure.

Let’s say a borrower owes $200,000 on their mortgage, and they know that if they list it for $175,000, it’ll sell quickly. The homeowner could 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 or a certain price.)

You can find a home in short sale through conventional real estate listings. These listings might be labeled as short sales or include language like “pending bank approval.”

Sheriff’s sale/auction

Another way to buy a foreclosed home is through a sheriff’s sale (aka sheriff’s auction). An auction is appealing because prices are low and sales happen quickly.

But auctions do come with downsides. 

Buyers must have the cash up front, the property might have tax liens on it and you won’t have the opportunity to get a home inspection or appraisal before you buy the home. 

Real estate-owned properties (REOs)

A foreclosed home (aka real estate-owned or REO property) that doesn’t sell at auction gets listed for sale on the open market by the lender. 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 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 with buyers. 

How To Buy a Foreclosed Home

If you’re thinking about buying a foreclosed home, taking the right steps can help streamline the process and get you to the closing:

1. Find the right real estate agent

It’s important to get a REALTOR® or real estate agent to help you with the buying process. An experienced real estate agent with REO property knowledge 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. 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 home purchases, you may need to get a nontraditional mortgage for a foreclosure purchase. 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:

Once you have a loan in mind, you can move forward with the buying process. 

3. Get your foreclosed home inspected and appraised

Like any other home purchase, it’s important to get a foreclosed home inspected and appraised before you move forward in the buying process. (Remember, if you’re buying at an auction, you likely won’t have this option.)

After reviewing the inspection and appraisal reports, ask yourself if the noted repairs work for your budget and if it’s still worthwhile to buy the home. If everything looks good, double-check to make sure you have the funds to close on the home and make needed repairs. 

4. Secure your new property

Once the appraisal and inspection are complete and you’ve decided to buy, you’ll continue the closing process with your lender. How long does it take to close on a house? That depends on the situation, but you can expect a foreclosure to take a little longer than a typical sale.

Advantages and Risks of Buying a Foreclosed Home

Like any other home purchase, there are pros and cons to buying a foreclosed home:

PROS of Buying a Foreclosed Home 👍

Lower price tag

Foreclosure homes are usually sold below market value, which means you may be able to get a great deal. Most buyers of foreclosed homes will tell you the primary benefit of buying a foreclosed home is that your dollar can go further than if you purchased a standard retail property.

Multiple lending options

As long as you’re not buying at auction, you have options for financing the purchase of your foreclosed home. Those options might include:

  • Fannie Mae’s HomePath®
  • Freddie Mac’s HomeSteps®
  • FHA loans
  • Hard money loans

CONS of Buying a Foreclosed Home 👎

Property problems

When a property is in foreclosure, the previous owner may have neglected the home for months or years. If maintenance is deferred for too long, the home may be in dire need of repairs by the time you close, which can be very expensive. Foreclosure homes are sold as is, so brace yourself for potential problems.

Hidden issues

You might be able to see physical defects of a foreclosed house that wasn’t properly maintained. What you might not know about, until conducting a title search, are potential liens and back taxes. Hidden title issues can be costly, time-consuming challenges you might have to take on as the new owner.

High competition

Everyone wants a great deal on a home, which is why real estate investors often flock to foreclosure homes.

Competition among buyers looking at foreclosure homes can be fierce – especially in a tight housing market where sellers have the upper hand – so be ready to duke it out with other buyers.

Banks can be difficult to work with

Large financial institutions aren’t always the easiest to work with, and they’re certainly not known for moving quickly. Don’t be surprised if it takes days or even weeks to hear back from the lender if they want more information or documentation, which can cause the closing to get pushed.

Buy Low and Aim for Low Risk

If you can find a property in decent condition for a reasonable sale price, buying a foreclosed home can be a smart financial decision. Just make sure to take your time, exercise patience throughout the process and understand exactly what you’re getting yourself into.

ICYMI

In Case You Missed It

  1. When a property is in foreclosure, the previous owner may have neglected the home for months or even years, so the home may be in dire need of repairs

  2. The best ways to find foreclosure homes for sale are through a real estate agent and by visiting the HUD website

  3. To purchase a foreclosed property at an auction, you’ll need to have the cash upfront

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