How to Buy a Foreclosed Home
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Foreclosed homes are repossessed by lenders after homeowners fail to make mortgage payments and default on their loans. Buying this type of property can save you money, but you’ll likely have less leeway in negotiating the price or conditions of the purchase.
Before you hunt for one, it’s important to first understand how to buy a foreclosed home.
How to buy a foreclosed home
A mortgage foreclosure typically happens after a homeowner has been at least 120 days behind on their mortgage, but the time frame varies by state. Once the process begins, the lender files a lawsuit to sell the home and recoup their money. Then, the following key events usually take place:
- The lender notifies the homeowner of the lawsuit and gives them time to respond, such as 30 days.
- The court either decides to rule in favor of the lender or the homeowner.
- The lender attempts to sell the home — if the court grants permission — to recover the money they originally invested in the home purchase.
- The homeowner moves out or waits to get evicted.
Some states allow nonjudicial foreclosures, meaning lenders don’t have to go through the courts. Skipping the legal process also speeds up the foreclosure timeline.
Buying a foreclosure and purchasing a home the traditional way share some similarities, but there are notable differences, too. For example, instead of buying a home from an individual, you’re buying it from an entity — a bank or lender — that isn’t required to disclose details about the condition of the property, said Mindy Jensen, a Colorado-based real estate agent.
“They don’t know anything about the property so they can’t tell you that the plumbing’s broken or the electricity’s weird or anything like that,” she said.
Oftentimes, foreclosure properties are sold “as-is,” and the lender may be reluctant to make needed repairs or updates. This means you’ll need to go the extra mile to ensure you’re making a sound investment.
Below is a step-by-step list of tips on how to buy a foreclosed home:
Step 1: Determine how you’ll finance the home purchase.
Unless you’re planning to pay cash at a foreclosure auction, you probably need to finance your home purchase. Your loan options may include:
- Conventional loan. Fannie Mae’s HomeStyle® Renovation loan and Freddie Mac’s CHOICERenovation® loan are conventional mortgages that allow you to finance both a home purchase and the needed repairs. You’ll need at least a 620 credit score and a 3% down payment to qualify.
- FHA loan. An FHA 203(k) loan also provides financing for both buying and renovating a home. The credit score needed to make the minimum 3.5% down payment is 580.
- VA loan. The Department of Veterans Affairs insures loans for alterations or repairs for eligible military service members, veterans and surviving spouses. You typically need a 620 credit score to get a VA loan but a down payment isn’t required.
Step 2: Shop around and get a mortgage preapproval.
Once you’ve decided on a loan type, reach out to at least three to five mortgage lenders and apply for a mortgage preapproval. You’ll want a solid idea of the loan amount and interest rate a lender could offer you, based on a review of your credit history, existing debt and income.
Review each preapproval letter and select the lender that has the best deal for you.
Step 3: Find a real estate agent with experience in foreclosed properties.
Gather recommendations from family members, friends and colleagues to help you find a real estate agent. Working with a professional who has experience with foreclosed properties can make the process run more smoothly. Look for real estate agents with credentials specific to working with distressed properties, such as the Short Sales and Foreclosure Resource or Certified Distressed Property Expert designations.
Step 4: Find a home and make an offer.
Foreclosed homes are usually listed on the local Multiple Listing Service (MLS), Jensen said. From there, the listings are aggregated to popular online real estate search portals, some of which let you parse out foreclosures in your search.
When you’re ready to make an offer, keep in mind that the lender might not entertain a lowball offer right away, Jensen said. Be prepared to submit a competitive offer that is close to or above asking price, depending on the trends in your local market. Your real estate agent can provide more guidance.
Step 5: Get a home inspection and repair estimates.
Once the lender has accepted your offer and you’re under contract, schedule a home inspection. Buying a foreclosed home often means you’re buying it in an as-is condition, but it’s important to know what you’re getting into.
While the lender won’t likely agree to make repairs, they might drop the price to compensate for major issues found during the inspection.
“They aren’t going to go get it fixed, but they’ll give you money off the purchase price so that you can go get it fixed,” Jensen said.
However, your negotiating power depends on how competitive the local housing market is and how many offers the lender receives.
Step 6: Close on the purchase and start repairs.
After your financing is in place and you’ve agreed on the purchase terms with the lender selling the home, you’ll prepare for your mortgage closing day. The closing process works similarly to a traditional home purchase; you’ll sign documents and provide the funds to cover your down payment and closing costs. Once you get the keys, you’ll either move into your new home or start on repairs to make your home move-in ready.
3 types of foreclosed properties
As a buyer looking at foreclosed homes, you may find properties in one of three stages of foreclosure: preforeclosure, auction or real-estate owned (REO).
A home in preforeclosure is in the beginning stages of the foreclosure process. The homeowner is no longer making payments but hasn’t lost the home yet, and the lender has sent them a notice of default demanding they pay the past-due amount within a certain number of days of the notice date. During this stage, either the homeowner gets current on their mortgage payments or reaches out to their lender for permission to sell the home and repay the loan.
If a homeowner isn’t able to catch up on payments or sell their home, and the bank is ready to foreclose on the home, it may go up for auction on the local courthouse steps or at a similar public venue. At this point, it’s possible to compete against other buyers for a foreclosure, but you’ll likely have to pay cash if you win a bid.
Buying a foreclosed property could also mean pursuing a home that already belongs to a lender. If the property went through the preforeclosure and auction processes but didn’t sell, then the lender owns it. These types of homes are also referred to as real estate-owned properties, meaning that you’ll negotiate directly with the lender or a real estate agent representing them.
An example of an REO property is a HUD home, which is owned by the U.S. Department of Housing and Urban Development (HUD). HUD oversees the Federal Housing Administration (FHA) and can foreclose on properties when borrowers with FHA loans default on their mortgage payments.
What’s the difference between a mortgage foreclosure and a short sale?
Buying a foreclosure shouldn’t be confused with buying a short sale, another type of distressed property. A short sale is the sale of a home that’s priced for less than the outstanding mortgage balance. It may also be referred to as a preforeclosure sale, especially if the seller is behind on their mortgage payments.
The lender must agree to a short sale and accept a sales price that may not cover the outstanding loan balance. In some cases, the seller may not have to repay the difference between the final sales price and what’s still owed on the mortgage.
On the other hand, a mortgage foreclosure means the lender has repossessed a home and plans to sell it and recover the money it lent to the homeowner to buy it.
Pros and cons of buying a foreclosure
|You can snag a good deal. Foreclosures usually have lower prices than owner-occupied homes.||You could wind up with a bad investment. If the sales price isn’t discounted enough and the property requires significant work, you might pay more than you would for a move-in ready home.|
|You can get a mortgage. If you’re not buying a foreclosure at an auction, you may be eligible to get a home loan to purchase and repair the property.||You might not have much room for negotiation. Foreclosures are usually sold as-is, so don’t expect lenders to make repairs on your behalf or be too flexible on purchase terms.|
|You may not have to make many repairs. Depending on how long the house was vacant and how well the previous owners maintained it, there’s a chance the property is move-in ready once you get the keys.||You could wind up with a title dispute. If there’s a lien against the property, which is a claim from a creditor for unpaid money, the title isn’t clear and the home can’t be sold until the lien is paid.|
Questions to ask before buying a house in foreclosure
Answer the following questions honestly before buying a foreclosure:
- Do I have the right financing lined up?
- How much time do I have to put into remodeling or renovating this house?
- How much experience do I have with home repairs?
- Do I have a good network of local contractors?
- Do I have a budget to fix this house and make the appropriate repairs?
- Do I have enough of a cash cushion if issues come up that I don’t yet know about?
- Can I wait long enough for repairs to be completed, or do I need to move right away?