Buying a foreclosed home can be a great opportunity when it’s done correctly. You could end up with a great home that you purchased at a bargain, meaning you have equity right from the get-go.
However, the process is a little more involved than simply browsing real estate marketplaces and throwing out an offer online. We’re here to give you the facts about buying a foreclosed home and help you make an informed decision that best suits your financial goals.
What is Foreclosure?
Foreclosure is a legal process by which a mortgage lender or servicer takes action against a delinquent borrower. It is typically a three-step process that begins when the lender or the servicer notifies the borrower that they have defaulted on the loan. From there, a notice of sale informing the borrower of the auction date is provided, followed by the auction of the property.
Lenders will typically want to work with the borrower by offering to reamortize the loan to include the missed monthly mortgage payment before the process begins. This is because the process of foreclosing a home can be lengthy and costly. It can take up to six months depending on the level of cooperation from the borrower and the motivation of the lender.
How Do Home Foreclosures Work?
The three-step process of foreclosing a home starts with a borrower defaulting on their loan, meaning they miss their monthly payments. A borrower usually has anywhere from twenty to thirty days to submit their late payment, but if additional missed payments follow the original one, or if there is no attempt to remedy the default, the lender will send a notice of sale.
The notice of sale is a letter informing the borrower in default that the property will be auctioned at a certain date, though that date is usually the first Tuesday of the following month. The foreclosure process is considered complete once the auction takes place and the property is sold to the highest bidder.
It is also worth noting that there are three avenues of foreclosure, including the auction, the short sale, and the bank-owned properties. We talked about the auction in the previous section, but as a reminder, the auction is where a foreclosed home is sold as is to the highest bidder.
A short sale is a voluntary step by which the homeowner and the lender will agree to sell the property for less than what is worth. This means that the homeowner will be responsible for covering the difference between the remaining mortgage value and the sale price of the home.
The final avenue of foreclosure is when the bank takes full ownership of the property and the homebuyer purchases directly through them. This route extends the process and makes it even more time-consuming as an appraisal and an inspection are typically required.
Buying a Foreclosed Home
Now that you are familiar with the foreclosure process, we should discuss some of the advantages and drawbacks of buying a foreclosed home. There are always risks associated with a large transaction of any type, especially from an unknown party, but add a complex legal process on top of that and mistakes can become really expensive really fast.
Luckily for you, we have already listed some of the most common pros and cons of buying a foreclosed home so that you’ll know what to look for and be aware of before buying a home that has been foreclosed.
- You can use your home to generate equity immediately. This is especially the case if you manage to secure a purchase price that is less than what the property is actually worth. That equity can be stored until you are ready to sell the home at a future date, or you can use the equity as collateral in a home equity line of credit (HELOC).
- You can get more for less. Banks and lenders tend to avoid real estate as an asset because they don’t want to hold on to property like that, so they look to offload properties fairly quickly. This is great for you because you can often get a larger or higher quality home at a discount.
- You are buying a property as-is, meaning you don’t really have any negotiating power. Warranties and other contingencies are not in place to protect you, so you must be wary of your lack of negotiating power and have a substantial financial cushion in case any issues arise after you purchase the home.
- You are competing heavily with other buyers for a deal. Everyone wants a discount on a home, meaning people will be willing to bid up to the current home value and even beyond. The numbers have to make sense or else a foreclosure can quickly exceed your budget and become more expensive in the long run.
Things to Consider When Buying
You don’t know what you don’t know, but luckily for you, we have already done some research for you in terms of what to consider when buying a foreclosed home. Here are the top three pieces of advice that we can offer to make your foreclosure purchase a better experience for you.
Hire a Real Estate Agent to Help You
Unless you are a seasoned foreclosure investor, it is highly advisable to hire a real estate agent who has the know-how when it comes to navigating the buying process of foreclosed homes. Purchasing a home that has been foreclosed can be costly, especially with lost earnest money and negative marks on your credit score that can arise when done incorrectly. The amount of money you spend on commission for a worthwhile and effective agent will more than pay for itself because they can help you secure a good deal, saving you a lot of money overall.
Get Preapproved for a Loan Within Your Budget
If you’re thinking of financing a foreclosed home, it is highly recommended to get pre-approved well in advance to the auction date. There is no worse feeling than thinking you have secured a home and the mortgage loan can’t close.
It is also important to review if the pre-approved terms and conditions of the loan are in line with your monthly payments, repayment period, and fixed rates goals. Lenders can often approve you for more than what you had anticipated your credit limit would be but that doesn’t necessarily mean you should borrow the entire amount.
Any installment liabilities that begin to creep up past 25% of your monthly take home pay can start to feel a little overwhelming on your finances.
What Type of Financing Options Will Work for Me?
There are so many avenues available to home buyers whether the purchase is for personal or investment use. It may seem daunting to hear about bidding against all cash buyers but you can still remain competitive with some creative financing.
A home equity line of credit or HELOC, is essentially a draw against the equity in your own home. Homeowners with paid for properties can utilize the cash they have accumulated from the home. Home equity loans also tend to have better variable rates and draw periods than personal loans or personal lines of credit.
Another alternative to a 30 year home loan is using other people’s money. This is typically done via an investor and a hard money lender when the property is purchased to be renovated and flipped. Always thoroughly research any financial product and be sure to fully understand the impacts of pursuing that particular financing route.
Common Questions About Buying a Foreclosed Home
The foreclosure process can be complicated and really test your real estate know-how, not to mention your patience. Luckily for you, we have compiled a list of some of the most common questions surrounding a foreclosed home purchase.
Do I Have to Buy a Foreclosed Home With Cash?
It is possible to purchase a foreclosed home with the help of various financing options. However, it is better to be preapproved before the auction takes place because lenders require the collateral to be a value equal to or greater than the amount borrowed.
Short sales are typically sold for less than what the property is worth, meaning a solid relationship with a credit union or other local lender is your best bet when bidding against cash buyers. So, you don’t have to buy a foreclosed home with cash, but make sure you have been preapproved if cash is not your preference.
Will I Get to Inspect a Foreclosed Home Before I Purchase It?
Foreclosed homes are typically sold as is, meaning that there is little to no time to inspect the home beyond a visual inspection. As such, buyers of foreclosed homes are taking a gamble when buying these properties as they could require a little TLC to fix it up.
The property in question might even require some serious foundational work that can push the repair costs far beyond the purchase price, meaning you’ll be putting more money into the house than it was sold for. Doing research ahead of time can give you, as a buyer, an edge over other bidders and protect yourself in the process.
What Types of Liens are Placed on Foreclosed Homes?
Typically, property tax liens on foreclosed homes will be settled during the purchase process. Some other details to be aware of include secondary or tertiary mortgages, an unpaid home equity line of credit, and liens from contractors who have claims against the property. These aspects might not even show up on the property disclosure document, so it is important to conduct research ahead of time and verify the title while checking for claims against the deed.
Is a Foreclosed Home Right For Me?
When it comes to home buying options, the foreclosed home route is often overlooked, but it shouldn’t be! Buying a foreclosed home is a great opportunity to create some equity right from the start, especially when done correctly and with the help of thorough research.
Every homebuyer is in a different situation regarding their preferences, needs, and wants. A good real estate agent, a strong grasp on your personal finances, and an appetite for moderate risk are the three major components of making a successful foreclosure purchase.
Remember to do your research ahead of time. That way, you’ll fully understand everything that you’re agreeing to before you sign any documents!
This page last updated: March 21, 2022