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According to the National Association of Realtors, foreclosures sell for about a 20% discount compared to conventional sales. Many sell for much bigger discounts, and some sell for close to market value. Expect smaller discounts on homes that are in good condition and have not been on the market long.
Buying a foreclosed home comes with certain drawbacks and advantages. While you can buy a home at a discount, you may be purchasing a home that has considerable damage and neglect.
Making those needed repairs could significantly reduce the perceived discount you thought you were getting at the outset. Some foreclosed properties may have been stripped or vandalized by their departing owners to extract what value they can or out of anger over the foreclosure itself.
What is a Foreclosure?
A foreclosure home is a property a lender has seized due to the owner defaulting on mortgage payments. Every mortgage places a lien on a property, which acts as collateral.
This is known as a secured loan because the amount the borrower is loaned is protected by the prospect of losing the home if they don’t keep up with payments according to the prescribed schedule.
This should not be confused with a short sale. In a short sale, the owner still controls the property. Still, the possibility of foreclosure looms, and the seller is attempting to recoup some part of the equity they have in the home and avoid foreclosure proceedings, which are devastating for their credit for years to come.
Two Types of Foreclosure Purchases
There are two ways to purchase a foreclosure. Buyers can compete with others at an auction or buy from a lender if the house does not sell at auction.
Auctions, also known as a sheriff’s sale, are the quickest way to buy a foreclosed home because they eliminate negotiations with a bank or a seller looking for a short sale. Auctions may also be where the best discounted values are.
The trade-off is that most auctions only accept cash payments. There’s no title insurance on properties bought at a sheriff’s sale, and tax liens are a common problem with foreclosures.
In some cases, auctions will allow for mortgage financing, but you’ll need to have financing lined up in advance to keep up with a quick sale process. Ensure your initial approval is already lined up before participating in an auction.
Buying a home at auction means you also agree to buy it in ‘as is” condition without an appraisal or home inspection. You need to do your homework in advance on the local market conditions, and if you can, do what you can to learn about the property.
Most buyers at foreclosure auctions are experienced investors or real estate types who know how to spot the best deals and avoid potential title problems. It’s a risky place for neophytes to tread.
You can also purchase a property from a lender’s real estate owned (REO) inventory. Generally, these homes are already vacant, sold as is, and the bank has clear title before it goes into their inventory. However, you should be able to view the home and order an inspection before you close.
Banks usually don’t sell directly to buyers, so you’ll need to work with a real estate agent to help you complete the transaction. You can also get mortgage financing to buy an REO, though it probably won’t be through the same bank selling you the property.
The savings usually aren’t as great on an REO as buying at a foreclosure auction, but you can maximize your discount by looking for homes that have been listed for sale for a long time. Lenders usually offer minimal discounts when they first list an REO for sale, then mark it down further if it doesn’t move.
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A preforeclosure is a property in the early stages of foreclosure. These properties are flagged in property databases, so identifying them is not difficult with the help of an agent.
This designation means a property owner has received a notice of default from their lender, but no other official actions have taken place yet. Information on preforeclosures is limited in these databases, so you’ll need to do some digging to learn the particular circumstances of a property.
The benefit of this route is that you could find a highly motivated owner eager to work with you to sell the property. That gives you leverage and helps an owner, creating a win-win situation.
Not all short sale properties are in preforeclosure, but some are. If the homeowner still owns the home, you can work with their real estate agent, but the lender and not the homeowner must approve your offer.
Working with a REO Agent
Most lenders retain an REO agent to handle their foreclosed properties off to an REO agent. In turn, the REO agent works with traditional agents to find qualified buyers.
A qualified foreclosure agent can help you search for foreclosures, navigate your state’s REO buying process, handle negotiations, and make an offer on your behalf.
If you prefer, you can also do the legwork of finding properties independently. There are multiple online resources to help you with this task. Start with the Department of Housing and Urban Development (HUD), Fannie Mae HomePath, and Freddie Mac HomeSteps.
Special Programs for Buying Foreclosures
Most residential mortgages are guaranteed by Fannie Mae, Freddie Mac, the FHA, or VA. Not surprisingly, these agencies end up with a lot of foreclosures. As a result, all have special programs for selling these properties.
These programs may offer special financing, minimal down payments, or other perks for purchasers. Fannie Mae’s Homepath and the FHA’s 203(k) mortgage programs can provide additional loans for limited improvements and repairs to foreclosed properties.
Freddie Mac’s Homesteps offers a 2-year home warranty. The VA Home Loan Financing for Foreclosures is available to veterans and non-veterans. Many of these programs are also available to investors, second-home buyers, and those buying a home for a primary residence.
Financing a Foreclosure
Getting pre-approved for a mortgage is essential if you’re serious about buying a foreclosure. You may need to move quickly to close a sale, and not having financing lined up in advance can torpedo a great deal if you’re not ready to fully execute.
Preapproval lets you know how much you can borrow for a home loan and goes hand in hand with the more thorough prequalification process, which requires additional documentation to verify you’re a good candidate for a loan.
If a property isn’t being sold as a cash-only transaction at an auction, you may be able to get a loan to purchase a foreclosed home. You can get a conventional loan through a bank or a government-backed Department of Veterans Affairs (VA) loan, Federal Housing Administration (FHA) loan, or Department of Agriculture (USDA) loan if the home is in livable condition.
When financing is in play, you must get an inspection and appraisal. Lenders require appraisals to confirm they aren’t lending borrowers too much money.
It also confirms that you’re not overpaying for a property. Foreclosures often require a lot of repairs, so you’ll need a clear understanding of what that might cost before you buy a foreclosure.
Inspection and appraisal results are critical elements to help you decide if you’re getting a good deal or getting sucked into a lousy money pit transaction. Study these results and get your agent’s input before deciding whether to buy and at what price.
You can’t go back after the fact because foreclosures are almost always sold in “as is” condition.
Consider an Assumable Mortgage
A more attractive possibility may be to bypass the foreclosure process and try to reach an agreement with a homeowner before the property is foreclosed. If the loan is assumable, you only need to take over the payments from a homeowner facing foreclosure.
Invest with Partners
A smart option for first-time real estate investors is to consider taking on one or more partners in the venture. You can pool your resources to come up with a down payment, and it also minimizes your losses if the investment turns bad.
If you have friends or family members who are also interested in becoming first-time investors, this route allows all of you to make your first venture into real estate investing while minimizing your loss exposure, while also enabling you to learn the ins and outs of the business before taking on bigger commitments.
That is also a good route for one person actively managing the property, with one or more investors with a financial interest only.