Persistent high home prices and soaring mortgage rates have led to a crisis in home affordability: many people simply cannot afford to buy a home at these prices. If you know how to buy a foreclosed home you may have a way out of the affordability trap.
Knowing how to buy a foreclosed home can save you money, but that doesn’t mean it’s easy. You’ll need to be prepared for the different processes, legalities, and financing options involved with buying a foreclosed home, as well as the need to make improvements and repairs.
Before you begin exploring buying a foreclosure property, make sure you understand what foreclosure is, how the process works, and how to go about finding, financing, and closing a deal on a foreclosure purchase.
What Is Foreclosure?
A mortgage or deed of trust on a home is a secured loan that’s used to finance the purchase of that property. A secured loan is one that’s backed up by something tangible that a lender can then claim and sell if the loan isn’t paid. The property “secures” the money that was loaned to the purchaser.
Foreclosure is a legal process by which a mortgage lender takes back all rights to a piece of property when the borrower fails to pay the mortgage on the property. Once the lender has secured those rights according to the state’s requirements, it can then sell the property to recoup its losses. Smart real estate investors can take advantage of those sales to acquire property at discount prices.
The Foreclosure Process Explained
In the U.S., the legal process of foreclosing on a piece of property is determined by state law, and so the specifics of the foreclosure procedure vary from state to state. These procedures may be categorized as judicial, non-judicial, or some mix of both, and are guided by varying deadlines and timeframes.
Generally, foreclosure involves five separate stages, although they may be called by different names:
1. Late or Missing Payments
The process begins when the lender fails to receive timely payment for one or more months. The lender sends out an informal notice to the borrower requesting payment. If the borrower then misses another payment, the lender may issue a more formal (but still personal) notice called a demand letter.
During this time, the lender usually will work with the borrower to catch up on late or missing payments, in hopes of avoiding the expense and effort of filing a foreclosure action.
2. Legal Notice
When the borrower’s delinquency extends to anywhere from three to six months (depending on the lender’s policies), the lender will file a formal legal notice in the designated public office for the county in which the property is situated. This notice might be termed a lis pendens or a Notice of Default, depending on the state’s customary practice. The purpose of the notice is to let the public and more specifically the borrower know that the property is at risk of being reclaimed through a foreclosure action.
3. Pre-Foreclosure
After the lender issues the legally required notice, the borrower is given a grace period, usually between one to six months. Pre-foreclosure is an extension of time during which the borrower and lender are free to negotiate a settlement. That settlement can be based on a short sale or making catch-up payments to pay off the delinquency in full. Failing that, the foreclosure process will continue to the next phase.
4. Auction
Before the auction takes place, the lender must post a public notice on the property and also in a newspaper, typically, as well as give notice to the borrower of the time and date of the auction. In some states, the borrower has the right to redeem the property and save it from being sold by paying the full amount owed before the auction begins. Qualified buyers must come up with the full sales price in cash. Alternatively, the lender may allow the borrower to surrender the property through a deed in lieu of foreclosure.
5. Post-Foreclosure
If the property doesn’t sell at auction, the lender retains title to it and it’s thereafter known as “bank-owned” or “real-estate owned (REO)” property. In order to recoup their losses, post-foreclosure lenders may list the home for sale, possibly using a site such as Zillow, or sell the property through a liquidation sale or auction.
The Benefits of Buying a Foreclosed Home
One of the biggest benefits of shopping for a home that’s somewhere in the foreclosure process is the bargain pricing that usually accompanies such a listing. In many cases, a foreclosed home is priced significantly lower than its nearby “comps”, or comparable homes. Because most foreclosed homes are sold “as-is,” the sales price is somewhat discounted to account for the lack of repairs to any existing damage. The costs compared to renting might prove very attractive.
This is true for homes in many stages of the foreclosure process. In the pre-foreclosure phase, you are often negotiating with homeowners who are pressed for time and need to sell the home before more drastic legal and financial consequences occur.
If the property has already been claimed or seized, you may save even more, assuming you have the funds ready to pay the price to redeem the property. Most of the parties involved in attempting to unload foreclosed homes that have already been seized have no desire or interest in prolonging their involvement, so purchasers can benefit from that advantage.
Risks of Purchasing Properties in Foreclosure
While the potential savings of buying a foreclosed property is undoubtedly a highly attractive draw, there are some risks as well. It’s important to understand what those risks and potential drawbacks are before you commit to carrying through with a purchase.
- Property repairs: That as-is discount often means maintenance and repair issues that you’ll have to fix at your expense.
- Angry (soon-to-be) former owners: Losing one’s home to foreclosure is understandably a highly emotional event for homeowners, some of whom may let their anger show by damaging the home or removing appliances.
- Heavy competition: Foreclosure properties are popular, and you’ll face competition for quality homes. Bidding wars are not uncommon, which can quickly eat up any savings you might have anticipated.
- Professional competition: Many foreclosed homes are bought by investors or by companies looking for rental units. They search for properties systematically and make cash offers. They can be difficult to beat.
- Long legal processes: In some cases, slow response times and exacting legal requirements can make a foreclosure sale drag on for weeks and weeks.
Being aware of these risks will help you evaluate a potential purchase more closely and make the best decision for you.
5 Different Kinds of Foreclosure Purchases
There are five different types of foreclosure property purchases that you can pursue. Each kind of purchase takes place in a slightly different context and may be governed by differing procedures and rules.
1. Pre-Foreclosure
During the pre-foreclosure phase, the homeowner has a high degree of motivation to sell the property and avoid the negative impact of foreclosure proceedings. If you can purchase the property at this stage, you can avoid some of the risks stated above, since legal proceedings have not yet been initiated.
2. Short Sale
A short sale of a property means that the mortgage lender will accept a lower price for the property than the full amount owed on that mortgage. Buying a home in a short sale is similar to any regular property purchase, with the exception that the seller’s lender must approve the terms. This can lead to a long response time, stretching out the timeframe for the closing.
3. Sheriff’s Sale
Once the property has been formally placed into foreclosure proceedings, the sheriff of the county in which the property is located may include it at a courthouse auction. The highest bidder on the property wins the auction and is contractually bound to carry out the purchase.
4. Bank-Owned
If the sheriff’s auction does not successfully sell the foreclosed home, the lender then holds the title to the property. Bank-owned properties are then marketed and sold by real estate specialists employed by the lender, who typically list them for sale on their own and other real-estate websites.
5. Government-Owned
If a home was financed through federally-guaranteed loans (such as the Federal Housing Administration, or FHA, or the Department of Veterans Affairs, or VA), then the U.S. government becomes the title holder after foreclosure. These properties are sold by registered brokers, and if you want to purchase one of these homes you’ll have to work through one of them. You can find them listed on the Department of Housing and Urban Development (HUD) website.
Types of Loans You Can Use to Buy a Foreclosed Home
When purchasing a foreclosure home it’s important to make sure you’ve either got sufficient cash on hand or a firm offer of financing for the property in place before you officially place a bid. That’s especially true at sheriff’s auctions but securing financing beforehand will also help speed up the process of closing on a foreclosed property no matter what stage of proceedings the property’s currently in.
To finance a foreclosed home, you have a few options to consider beyond private banks and mortgage lenders, who may not like the idea of extending financing for a property that’s about to be seized or is already in foreclosure.
FHA’s 203(k)
To help encourage banks to finance foreclosure properties, the FHA created the 203(k) loan program, which guarantees those loans and charges the borrower a premium via mortgage insurance to offset that guarantee. The advantage of the 203(k) is that it allows a purchaser to request additional funds for necessary repairs in one mortgage product.
USDA
Buyers and investors can also use a USDA Mortgage Program loan to finance the purchase of foreclosure properties. These loans do not generally require the purchaser to make a down payment, which can offset the funds you’ll need to make necessary repairs. You’ll need to provide documentation and proof that the property meets the agency’s minimum guidelines as well as make sure you complete repairs before closing.
VA
VA home loans may also finance a foreclosure purchase. You must meet the agency’s minimum property requirements, including a roof with no major defects, the residential nature of the property, termite- and fungus-free, and other rules that help ensure the property is safe and habitable. If you or a qualifying family member are a veteran of the U.S. armed forces, this might be a worthwhile financing option to explore.
HomeSteps
The Federal Home Loan Mortgage Corporation, or Freddie Mac, purchases loans from lending institutions, packages them together as securities and then sells them to investors. The HomeSteps program it offers provides financing for individuals who want to purchase one of its owned properties.
This program is currently available only in a few states: Alabama, Florida, Georgia, Illinois, Kentucky, North Carolina, South Carolina, Tennessee, Texas, and Virginia. Qualifying purchasers in these states can skip purchasing mortgage insurance, which makes the HomeSteps loan cheaper on the whole than a 203(k).
Where to Locate a Foreclosed Home to Buy
In order to find the right foreclosed property to buy, you’ll need to know where to look. That can pose a bit of a challenge for those new to foreclosure properties. Look for these types of properties with the following resources (and for the widest list of candidate homes, use as many of these resources as possible):
- Websites include real estate sites such as Zillow, Foreclosure.com, and HomePath by Fannie MaeTM, as well as bank and lender websites.
- Print publications such as specialized real estate magazines and circulars or local newspapers.
- MLS (multiple listing service) listings may not spotlight the foreclosure status of the property, so also look at the listing’s copy, including its extended property description.
- Local real estate agents are increasingly retained by lenders seeking to offload distressed homes and often have the inside track on foreclosure listings that may not be otherwise available.
If you’re looking for a foreclosed home a capable real estate agent with expertise in your target area will probably be your best ally.
Get In Early on the Deal
Sometimes it’s easiest to find out about nearby foreclosed homes through informal channels. Let your colleagues, relatives, and friends know that you’re interested in buying a foreclosed home. Often, people who aren’t involved in the process are among the first to learn of distressed properties, even before the foreclosure proceedings begin.
Foreclosed homes have one huge advantage: they are usually much more affordable than other homes in the same area. To gain that advantage you will have to navigate the sometimes complex process of finding and financing a foreclosed home and closing a deal.
It isn’t easy and you may have to try for several homes, but if you can pull it off the savings can be worth the effort!
