How to Buy a Foreclosed Home in 2020
Although foreclosures aren’t as common today as they were a decade ago, it’s still possible to find foreclosed homes in your local housing market. A foreclosure is a home that’s repossessed by a lender after a homeowner fails to make mortgage payments and defaults on their home loan.
Here, we discuss the steps to buy a foreclosed home and score a good deal in the process.
- What is a foreclosed home?
- Understanding 3 types of foreclosed homes
- What’s the difference between a foreclosure and a short sale?
- How to buy a foreclosed home
- Pros and cons of buying a foreclosed home
- Questions to ask before buying a foreclosed home
What is a foreclosed home?
A foreclosed home is a property that a lender has repossessed after the homeowner defaults on mortgage payments for an extended period of time. The lender evicts the homeowner and attempts to sell the home to recover the money they originally invested in the home purchase.
A mortgage foreclosure typically happens after a homeowner has been at least 120 days behind on their mortgage, but this time frame varies by state.
Understanding 3 types of foreclosed homes
The foreclosure process is lengthy and can take several months. 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 one that’s in the beginning stages of foreclosure. 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 that they pay the past-due amount within a certain amount of days after 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, and the bank is ready to foreclose on the home, it may go up for auction on the local courthouse steps or 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 in 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 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 oversees the Federal Housing Administration and can foreclose on properties when FHA borrowers default on their mortgage payments.
What’s the difference between a foreclosure and a short sale?
Buying a foreclosure isn’t the same thing as buying a short sale, another type of distressed property. A short sale means a home is being sold 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 full loan amount. In some cases, the seller may not have to repay the difference between what the home sold for and what’s still owed on their mortgage.
A mortgage foreclosure means the lender has repossessed a home and plans to sell it to recover the money the homeowner borrowed to buy it.
How to buy a foreclosed home
While there are similarities between buying a foreclosed home and a standard home purchase, there are some notable differences. For example, instead of buying a home from a person, 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. This means you’ll need to go the extra mile on your due diligence.
Here’s a breakdown of 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 eligible spouses. You typically need a 620 credit score to get a VA loan but a down payment isn’t required.
Step 2: Get a mortgage preapproval and shop around.
Once you’ve decided on a loan type, reach out to at least three to five 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 creditworthiness, existing debt and income.
Review each preapproval letter and move forward with 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.
When you’re ready to make an offer, keep in mind that the lender might not entertain a lowball offer right away. If you’re looking to snag a good deal, you’ll have to wait patiently for the listing price to drop.
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 as is condition, but it’s important to know what you’re getting into before you buy.
While the lender won’t likely agree to make repairs, they could 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.
Step 6: Close on the property and start repairs.
After your financing is in place and you’ve agreed on purchase terms with the lender, you’ll eventually move forward to your closing day. Once you get the keys, you’ll start on repairs to make your home move-in ready.
Pros and cons of buying a foreclosed home
If you find a good deal and everything goes smoothly, a foreclosure can help you save money on a property you plan to live in. Still, it’s important to note the benefits and drawbacks of purchasing a foreclosed home.
- You can snag a good deal. Foreclosures usually have lower prices than owner-occupied homes.
- 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 buy and repair the property.
- You can customize your home. Since you’ll likely need to make extensive repairs, you get the chance to incorporate your style preferences right away, rather than waiting until you’ve built equity to later borrow a home improvement loan.
- Not all foreclosures are a good deal. 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.
- There may not be much room for negotiation. Foreclosures are usually sold as is, so don’t expect lenders to make repairs.
- There may be liens against the property. If there’s a lien against the property, you may have to pay for them to get a clear title.
Questions to ask before buying a foreclosed home
Before buying a foreclosure, answer the following questions honestly:
- How much time do I have to put into remodeling or fixing 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 appropriate repairs?
- Do I have enough cash savings if issues come up that I don’t yet know about?
- Do I have the right financing lined up?
- What is my risk tolerance for the renovation process?