Key Takeaways
- Foreclosed homes can seem like a great opportunity to save money on a home purchase, but be sure to investigate so you understand the risks.
- There are a few different ways to purchase a foreclosed home including a short sale, at auction, buying from the bank or buying from the government.
- Buying a foreclosed home is risky since you’re purchasing the home “as is,” and that can entail additional costs down the line.
According to U.S. Foreclosure Market Reports, foreclosures are steadily increasing and are nearing pre-pandemic levels. But they’re still historically low, says Lawrence Yun, chief economist and senior vice president of research for the National Association of Realtors. “It’s very unlike 2008 through 2012, when a massive foreclosure wave was depressing home values.”
Still, because foreclosed homes are often sold for less than their market value, that discount could bring a home within reach for some buyers – especially with mortgage interest rates higher than they’ve been in recent years. However, financing and the home’s condition could present challenges. Before you start bidding, learn more about how to buy a foreclosure and understand the risks.
What Is a Foreclosed Home?
A foreclosed home is a property that has been repossessed and is being sold by the mortgage lender. A home goes into foreclosure, which is a legal process, after the homeowner misses multiple payments – usually three months. Once the homeowner is notified that the mortgage is in default and is not able to reinstate the loan by catching up on payments, the ownership shifts back to the lender, which will then try to sell the property.
What Are the Different Ways to Buy a Foreclosed Home?
According to David Reiss, law professor and research director of the Center for Urban Business Entrepreneurship at Brooklyn Law School, there are multiple paths to buying a foreclosed home – including directly from the homeowner, via an auction or directly from the bank. “It is very important to realize that each of those types of sellers has very different incentives,” Reiss says.
Here’s a closer look at the different options for buying foreclosed property:
- Buying a foreclosed home directly from the homeowner as a short sale or pre-foreclosure. Short sales can be great purchases, as the owner is still the seller and the lender hasn’t foreclosed yet. A short sale means that the lender agrees to accept less than what is owed on the property, which can mean big savings for buyers. The process could take up to 120 days or more, however.
- Buying at auction. With this option, you buy the home “as is,” which can be risky. You may also end up purchasing a property that has other liens that need to be paid or has additional expenses. If going this route, plan to have some cash on hand to make an immediate down payment.
- Buying from the bank. When a property cannot sell at auction, interested buyers will work directly with the bank. If you’re buying a bank-owned foreclosure, applying for a loan from the same bank may simplify matters, assuming you can get a competitive interest rate. Fair warning: Some banks will not want to finance foreclosures or will require large down payments because they can be risky investments.
- Buying from the government. This is usually the safest way to buy a foreclosure since most government agencies offer incentives and protections for buyers. Government-backed loan programs from the Department of Veterans Affairs or the Federal Housing Administration may offer financing options, but the property will need to meet standards for approval. Then you have programs like Fannie Mae’s HomePath, which help homebuyers purchase properties the government-sponsored mortgage buyer has foreclosed on, Reiss says. The program even provides up to 3% in closing cost assistance for first-time buyers who complete a homeowner education course.
Pros and Cons of Buying a Foreclosure
Pros
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You could find a property at a steep discount. The main draw of buying a foreclosure is that the price is typically much less than similar homes on the market.
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You’ll have some bargaining power. The homeowners are facing a financial crisis and often aren’t in a position to negotiate with you. For homes already taken over by a bank, those lenders may be eager to sell quickly and willing to make concessions.
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The home value should increase substantially. If you’re someone who is handy or interested in “home flipping,” a foreclosed property could be a good investment.
Cons
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Supply is scarce. “Both real estate investors and first-time buyers are out looking for distressed properties, so expect competition,” says Yun.
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Buying “as is” could be risky. “The big, scary thing is that with a number of foreclosures, you can’t actually inspect the property before you actually bid,” Reiss says. “That’s in part why the prices are below the market.”
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Extra costs often come with the territory. Especially if a home was neglected for a period of time, it may require substantial repair in order to make it livable. Other times, the home might have liens attached to it.
Preparing to Buy
The process of buying a foreclosed home can vary depending on the circumstances, but this is generally how it will work.
- Determine your budget. Just as with any home purchase, you want to crunch the numbers to see what you can afford. For a foreclosure, you might need to put down a larger down payment depending on how you’re buying.
- Check your credit score. If you are seeking financing, your credit will help determine if you’ll be approved and what your interest rate will be.
- Do some market research. Buyers can find foreclosures at auctions, on home search sites like Zillow and from traditional real estate agents, as well as government sources like HomePath from FannieMae and Freddie Mac’s HomeSteps.
- Seek help from a pro. Look for a real estate agent experienced in distressed properties; some agents even have a short sales and foreclosure resource certification from the National Association of Realtors. Someone with experience in these types of sales can help guide you through processes unique to purchasing a foreclosed home.
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Financing a Foreclosure
You can finance or use cash to pay for a foreclosed home, but the former can be tricky. “In the current environment – with inventory shortage of all sorts, including foreclosures – cash will be king,” says Yun. “There will be many potential buyers fighting over every piece of inventory.”
If you plan to finance a foreclosure purchase, you will want to obtain a preapproval from a mortgage lender. You might also consider specific loan programs designed for foreclosure purchases such as the FHA 203(k) loan, which allows borrowers to take extra funds to finance repairs and renovations.
Once you find a property and determine how you’ll pay for it, make an offer. The process for doing this will depend on how you’re purchasing the foreclosed property. For example, if you’re trying to buy at auction, there may be specific rules to follow. For other types of foreclosures, your real estate agent can help you come up with a number that is likely to be accepted.
Just be mindful that the price you pay is likely not the only cost. It will really depend on the condition of the home and the work involved to fix it up as necessary. “Some properties are in quite good shape with the prior owner just being unable to pay the mortgage,” says Yun. But that’s not always the case.
Mortgage rates inched higher across the board this week, according to the Mortgage Bankers Association. The 30-year fixed rate eclipsed 7% for the first time since December.
Mortgage interest rates are forecasted to decline somewhat throughout 2024, as the Federal Reserve projects rate cuts will begin sometime this year. Here are the current mortgage rates, as of Feb. 21:
- 30-year fixed: 7.06% with 0.66 points (previous week: 6.87% with 0.65 points).
- 15-year fixed: 6.61% with 0.77 points (previous week: 6.53% with 0.94 points).
- 5/1 ARM: 6.37% with 0.71 points (previous week: 6.3% with 0.6 points).
- 30-year jumbo loans: 7.16% with 0.45 points (previous week: 7% with 0.39 points).
- 30-year FHA loans: 6.91% with 1.03 points (previous week: 6.68% with 0.89 points).
Tips for Success
Buying a foreclosed property is always a gamble, but there are ways to mitigate some of the risk.
- Get an inspection. While banks will disclose any defects in the house, doing your own inspection can uncover any major issues that are not revealed so there are no surprises later.
- Check out public property records. If you aren’t allowed to inspect the property, you can check the county tax office, which may have records available online. Doing so can reveal information about sales, tax liens, changes to square footage and additions to the property.
- Do some informal due diligence. Do a “curbside inspection” of your own, including a look into the windows from the street if you can. Talk to neighbors to see if they have any insight to add about how long the previous owners lived in the house and how well they maintained it.
- Plan for potential additional expenses. Foreclosures are often in need of repair and renovation. “Often, the land value may be more than the property structure, so it’s worth considering whether to completely demolish and rebuild,” says Yun.
- Get some guidance. Working with a real estate agent or mortgage expert who has experience in dealing with foreclosures can help give you realistic expectations for how the process will go.
- Have patience. Depending on the situation, buying a foreclosed home could be a lengthy process. You may have to wait on the bank to respond to your offer, plus there’s the financing application process on your end. If there are any liens or other issues, those will have to be handled as well, resulting in more paperwork.
Is Buying a Foreclosure Right for You?
Buying a foreclosure may save you some cash, but it comes with risks. If you pursue a foreclosure, it helps to have a “stomach of steel,” says Reiss. That’s because there could be a lot more ups and downs than the typical homebuying process.
Despite the potential complications, the lure of savings can be irresistible. “It can be like a 15% discount on your neighboring houses,” Reiss says. “So, it can be significant.”
Of course, how much you save will depend on the local real estate market and the condition of the foreclosed home. Properties that need a lot of work sell for less than market value because of their condition and lower demand – but you’ll have repairs and renovations to deal with.
If you’re considering buying a foreclosure, just remember that not every foreclosed home is a great deal. The truth is the bank doesn’t want to “give away” a house, or sell it for less than it’s worth. It’s up to you to do your research and shop with caution.
- Minimum FICO Credit Score
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Not disclosed
- Minimum FICO Credit Score
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620
- Minimum FICO Credit Score
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580
- Minimum FICO Credit Score
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620
- Minimum FICO Credit Score
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620
- Minimum FICO Credit Score
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620
- Minimum FICO Credit Score
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620
- Minimum FICO Credit Score
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Not disclosed
- Minimum FICO Credit Score
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620
- Minimum FICO Credit Score
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Not disclosed
