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What You Need to Know
- A foreclosed home is a house that the lender or bank has reclaimed due to the owner’s inability to continue paying the mortgage.
- Foreclosed homes are typically purchased at auction or directly from the bank through a real estate agent.
- Some of the biggest benefits of buying a foreclosed home include low prices, opportunities for customization, and increased buyer leverage.
- There are several disadvantages to purchasing a foreclosed home. These homes may be in poor condition, are often sold sight unseen, may present challenges with obtaining financing, and could involve title complications.
Q: I’m in the market for a new home and found a foreclosed property in my price range. Should I buy a foreclosed home? What are the pros and cons?
A: Real estate owned (REO) homes, also known as bank-owned homes or foreclosures, attract potential homebuyers with the promise of a price well below market value. Buying a foreclosed property as a first home has the potential for significant cost savings compared with buying a home through traditional avenues or working with one of the best home builders. Foreclosed homes are also ideal for house flippers who make certain upgrades and repairs before reselling the home for a profit. Although foreclosed homes can offer significant savings, they also come with unique challenges that any prospective buyer will want to be aware of.
There are several things to know before buying a foreclosed home. The purchasing process for foreclosed properties is often more complex than for a standard real estate transaction, with additional paperwork, stricter timelines, and less flexibility in terms and negotiations. Any prospective buyer, especially a first-timer, will want to consult with a real estate professional who has a deep understanding of the foreclosure process to help guide them through their purchase.
How Buying a Foreclosed Home Works
A foreclosure occurs when the home owner is unable to make their payments and the bank or lender needs to reclaim ownership of the property. The process of buying a house in foreclosure works differently than traditional home purchases and varies depending on who owns the property and what stage of foreclosure the home is in.
The homes are generally sold “as is,” meaning the owner won’t make any repairs before closing. In cases where the property has already been repossessed by the bank or lender, there are two primary ways to buy:
- Purchasing at auction. Buying a home through an auction is often quicker than negotiating with a bank or seller and can offer significant savings below market value. Homes must typically be paid for in full up front. If mortgage financing is allowed, buyers must be preapproved, preferably with a verified approval. Auction purchases are often riskier because there is no opportunity for an inspection or appraisal before the deal is closed.
- Purchasing from a bank or lender’s REO inventory. Buying REO properties directly from a bank via a real estate agent is typically a “safer” process than buying a home at auction. Lenders typically ensure the title is clear and the property is vacant prior to a sale. Buyers may also have the opportunity to inspect the property before the deal is finalized (though they likely will not be able to see the property in person before making an offer).
If a home hasn’t officially been foreclosed yet, a preforeclosure sale (where the buyer “bails out” the current homeowner before the property is seized by the bank) may be an option. This type of sale, while still complex, may more closely resemble a standard real estate purchase.
Benefits of Buying a Foreclosed Home
Buying foreclosed homes can offer several advantages, especially for those on a budget or looking for a fixer-upper. Reduced price, the opportunity for customization, and increased leverage on the part of the buyer are all good reasons to search for homes for sale in foreclosure.
Foreclosed homes typically sell below market value.
Perhaps one of the most compelling reasons to consider purchasing a foreclosed home is the below-average market value. For buyers on a budget, shopping foreclosures may be a sneaky way to save money on a house. Because foreclosed homes are often priced under market value, homebuyers can take advantage of substantial savings to acquire properties they might not otherwise be able to afford in a conventional market setting. “You win by being the highest bidder, but that bid can potentially still be very low for what you would have paid if the property was bought through a listing,” explains Mark Severino, a Dallas-based real estate investor and owner of Best Texas House Buyers, LLC.
A reduced-price home means immediate savings and presents an opportunity to build up equity more quickly. As homeowners invest in improvements and the market appreciates, the gap between the property’s value and the amount owed on the mortgage can widen more rapidly than with higher-priced purchases. This accelerated equity growth can provide financial flexibility and a more substantial return on investment in the future when the home is listed for sale.
Foreclosed homes tend to be fixer-uppers, which may appeal to avid DIYers or those looking for homes to flip.
DIY enthusiasts and real estate investors who want to flip homes with no money often seek out houses in foreclosure that require anything from cosmetic updates to major structural overhauls. These properties provide an opportunity for homebuyers to implement their own designs and improvements, potentially increasing the home’s value significantly above the initial discounted purchase price. If the goal is to flip the house, foreclosed properties can be very profitable, especially in markets where real estate values are rising. “A foreclosure that you renovate can become a very attractive investment property, as you will begin to turn a profit much quicker,” says Brian Mollo, owner and CEO of Trusted House Buyers, a San Diego-based real estate buying company.
Alternatively, for those who will live in the home they buy, foreclosed homes may be a good target for complete customization. “This is your opportunity to create a space that is truly your own,” says Mollo. “The only real limits are your own creativity and budget.” Although it can be very tempting to purchase a home at a low price, buyers may want to assess the extent of renovations required. A thorough evaluation will help maximize the return on investment and avoid unexpected costs that can eat into profits.
Sellers are often highly motivated to find a buyer for foreclosed homes, potentially giving buyers increased leverage.
Highly motivated sellers, like banks or other financial institutions, are eager to offload foreclosed properties quickly to recover outstanding loan amounts. The urgency can provide potential homebuyers with significant leverage in negotiations as sellers might make certain concessions in order to close the sale. In some cases it may be possible to negotiate an even lower purchase price or better financing terms. Additionally, buyers may also be able to ask that certain major repairs be done before the sale.
Risks of Buying a Foreclosed Home
Though buying a foreclosed home comes with several benefits, there are also risks to consider before bidding on one.
Foreclosed homes are likely to be poorly maintained or in significant disrepair.
Potential buyers must prepare for the reality that foreclosed homes may require extensive and potentially costly repairs to make them habitable and safe. Foreclosed homes are often in poor condition or significant disrepair, as the homeowners may not have had the financial means or ability to keep up with maintenance. Maintenance neglect can manifest in various forms, from minor cosmetic issues like peeling paint and overgrown yards to more severe problems such as roof damage, plumbing issues, and structural wear.
Most importantly, buyers will want to carefully assess their budgets and ensure they have plenty of cash flow for potential repairs. “The strategy is to buy with such a discount [that] anything found in inspection afterward is within budget to fix,” says Severino. “If you overpay, there are few things you can do to salvage the investment, [but] if you get a good deal that leaves room for the rehab budget, holding costs, and profit, you can win.”
Buyers often must purchase foreclosed homes sight unseen.
A significant challenge when buying a foreclosed home is that these purchases are often made sight unseen. This is particularly common in auction settings, as buyers will have limited or no access to the interior of the property before making a bid. Mollo notes that similar properties in the area can give prospective buyers a clue as to what they’re in for. “Look at other comparable homes for sale and the neighborhood, and find as much history on the property as you can,” he advises. “The more knowledge and planning, the more prepared you’ll be to purchase a foreclosed house.”
When possible, a thorough inspection can help in identifying the scope of work needed and estimating the total investment required for repairs. Unfortunately, in the case of foreclosure, sales inspections may not take place until after an offer is accepted. Some foreclosure contracts will allow buyers to “get out” of the purchase after inspection if they decide the property is too much of an undertaking. However, it’s still important to understand repair and maintenance costs, since they can significantly impact the overall affordability and feasibility of the purchase.
It may be difficult to procure financing for a foreclosed home.
Securing financing for a foreclosed home can be more challenging than obtaining a loan for a home under normal circumstances. Due to their sometimes poor condition, foreclosed homes often do not meet the basic conditions required by lenders for a standard mortgage. Traditional lenders may also perceive a higher risk in financing foreclosures due to the unpredictability of the property’s true market value and the potential for hidden costs. Prospective buyers will want to discuss their options with one of the best mortgage lenders (such as PNC Bank or Caliber Home Loans) before starting their search.
Buyers may also want to explore government-backed loans, many of which cater to foreclosed home purchases. One such loan is the Fannie Mae HomePath program, which helps first-time buyers purchase REO properties. Another option is the FHA 203(k) rehabilitation mortgage. Though not specific to foreclosed properties, this loan type allows buyers to finance both the purchase and the needed renovations through a single mortgage. Finally, those purchasing foreclosed homes as investment properties may be interested in researching the best loans for flipping houses.
Buyers may run into title complications such as liens.
Homebuyers must be vigilant about potential title complications, which can significantly impact their purchase transaction. Liens or other legal burdens can arise from unpaid debts by previous owners, such as property taxes, contractors’ fees, or other secured loans that were not cleared before the foreclosure. These issues can prevent the transfer of a clear title to the new owner.
A comprehensive title search will uncover any liens or outstanding claims on the property, providing an understanding of what needs to be resolved before proceeding. This can help prevent unexpected financial liabilities and legal hurdles after purchasing. Title insurance also offers protection against future claims that might not be identified during the initial title search.
FAQs
Prospective buyers are bound to have additional questions about buying a foreclosed house. Learning the answers to some common queries may help kick-start their research.
To get a free list of foreclosed homes in your area, visit housing websites like Zillow.com. These sites often provide up-to-date listings of foreclosed properties. Local government websites and county offices may offer free access to foreclosure listings. A real estate agent specializing in foreclosures can also help with access to comprehensive and current lists of bank-owned homes for sale.
Some of the best foreclosure sites include:
– Auction.com, which lists various properties available for auction.
– Equator is ideal for those interested in investment property opportunities.
– Foreclosure.com features a wide and varied portfolio of both government-owned and bank-owned foreclosure homes.
– The U.S. Housing and Urban Development (HUD) Home Store features HUD-approved listings with access to brokers to complete the sale.
