When a homeowner fails to make mortgage payments, the lender can foreclose on the property and sell it to recover the money they loaned. The foreclosure process has several steps and can last for months or years, depending on state laws. Homes can be sold at any stage of this process and are often sold at prices well below what they would cost on the open market.
Buying a foreclosed home can be an inexpensive way to purchase a residence or a rental property. There is competition for the quality properties, though, so you’ll have to know the system well enough to identify the opportunities and you’ll need to be ready to move quickly once you find them. There are also risks. Foreclosed properties may be in poor condition and there may be limited opportunities for inspection.
Understanding the foreclosure process and how foreclosed homes are sold can help you avoid the risks and exploit the opportunities.
What is Foreclosure?
A mortgage is a secured loan, with the home serving as collateral for the loan. When a mortgage holder fails to make payments, the lender can declare them in default, take the home back, and sell it. This process is called foreclosure.
Both the Federal government and many states have laws designed to protect homeowners from unreasonable foreclosure and give them a chance to catch up. The foreclosure process and the time it takes to complete can vary from state to state. If you’re considering buying a foreclosed home, it’s a good idea to get familiar with the basics of foreclosure law in your state.
Foreclosure has several steps that happen, in order, before the property is available for sale:
- Payment Default. Foreclosure begins with a series of missed payments. This process may be extended by negotiations and relief efforts. There are a number of programs available to assist distressed homeowners, and lenders generally prefer to avoid foreclosure.
- Notice of Default. After a period of missed payments, the lender records a public notice of default, usually with county authorities. Some states may have different names for this notice, and some may require that it be posted on the front door of the home.
- Pre-Foreclosure. After the Notice of Default, the homeowner has a mandatory grace period to settle the debt and maintain possession of the home. If the homeowner pays the arrears or reaches a satisfactory arrangement with the lender, the foreclosure process does not continue.
- Notice of Trustee’s Sale. If the borrower cannot or will not resolve the situation, the lender or a trustee representing the lender will issue a notice setting a date for the home’s sale at auction. The notice is usually delivered to the homeowner, registered with county authorities, and published in a newspaper.
- Auction. An auction of foreclosed properties may be called a “Trustee’s Sale” or “Sheriff’s Sale” in some states. Auctions can take place at a courthouse, in a trustee’s office, or at the property. The home is sold to the highest bidder able to make a cash payment. In many states, the homeowner still has the right to come up with the cash and stop the process up to the moment of the auction. This is called the Right of Redemption.
- Real Estate Owned. If the property is not sold at the auction, it reverts to the ownership and is considered a Real Estate Owned (REO) property. Lenders often post these properties on various listings and may be willing to negotiate the price.
Homes can be and often are sold at any stage in this process, but the sale process may be very different at each stage.
The Different Types of Foreclosure Sale
You can buy a foreclosed home at any stage in the process, but each stage has its own requirements.
- Pre-Foreclosure Sale. Many homeowners in the pre-foreclosure stage are willing to sell the home in order to prevent foreclosure. If they have built up enough equity and the home is worth more than the loan balance, they may get enough from the sale to pay their loan and put a down payment on a less expensive house.
When you buy a pre-foreclosure home you deal directly with the homeowner and the transaction is similar to a normal home purchase. The discount may not be as large as it would be later in the process, but you may be able to perform a full inspection of the home, which reduces risk. You may be able to get a better deal by offering to let the occupants stay in the home for a set period while they find a new place to live.
- Short Sale. If a home is worth less than the balance due on the loan, a lender may agree to accept whatever the home sells for as payment for the loan. This is called a short sale. You are still buying the house from the owner, not the lender, and the process is similar to that of a pre-foreclosure sale, except that the lender has to approve the sale.
- Auction. An auction is the fastest way to buy a foreclosed home: place the highest bid, and the home is yours. It’s not always that simple, though. Auctions typically require a cash purchase, and auctions for desirable properties may be dominated by professional investors or real estate companies who can make cash payments. Information on properties may not be complete, you may not be able to make more than a superficial inspection, and there may be tax arrears or other liens on the homes that are up for sale.
- REO Properties. REO properties can be purchased directly from the lender, usually a bank. These are properties that failed to sell at auction. They may be in poor condition or located in less desirable neighborhoods. These properties are often available at very low prices, but you’ll need to be careful.
- Government-Owned Properties. Government agencies like the Federal Housing Administration (FHA), Veterans Administration (VA), and Department of Agriculture (DA) insure home loans for qualified borrowers. If these borrowers default, the government agency takes possession of the home. Most of these defaults involve FHA loans, so these homes are often referred to as HUD homes, after the Department of Housing and Urban Development. These homes may be sold at auction or through listings. They are usually sold “as-is” and can be in poor condition, though the agency may make necessary structural repairs. You may not have the chance to inspect the home before buying it.
Each type of purchase has potential advantages and each also has potential risks and obstacles. You’ll have to decide which, if any, best suits your needs.
How to Buy a Foreclosed Home
Foreclosed homes can be great bargains, but it may be difficult to find the home you want, the purchase process can be complicated and there are significant risks. Here’s how it’s done.
- Be ready to pay. If you will finance your purchase you should get pre-approved by a lender. Pre-approval will tell you what your lender is willing to lend, which will help you set your budget, and will show prospective sellers that you’re ready to buy. Cash is king in the foreclosure sale market, but a pre-approval is the next best thing.
- Find a broker or agent. Look for someone with experience and expertise in handling foreclosure sales. It’s worth the cost. An experienced broker will know where to find homes in each stage of foreclosure, will be in a better position to estimate repair costs, and will know what neighborhoods have increasing or declining home values. The process of buying a foreclosed home can be complicated and you’ll need a pro to guide you through it.
- Decide what you’re looking for. Know your purpose: are you looking for a residence, an investment property, or a rental? Assess your budget and think about what neighborhoods, types of homes, and stages of foreclosure interest you. Your agent can help you with this.
- Look for homes that fit your criteria. Many online listing sites list homes in various stages of foreclosure. Your broker will know how to locate auctions and REO homes in your area.
- Assess and prioritize the homes on your list. You may not be able to perform detailed inspections but try to at least get a look at the exterior of the home. Remember that people may still be living in it. You may wish to have a contractor or home inspector look at the property. You may also wish to have a title inspector look for potential liens on the properties that interest you. Review this information and decide which homes on your list are most desirable.
- Make your offer. You may be dealing with the homeowner, bidding at an auction, or dealing with a bank or government office. In each case, you will make an offer. Know what you are willing and able to pay and don’t exceed it. Don’t get attached to a property or caught up in a bidding process and spend more than you think the property is worth. If you can’t make an acceptable deal on one property on your list, move on to the next.
- Close a deal. If the seller accepts your bid there may be some paperwork to complete, especially if you’re dealing with a government agency. Settle any final negotiations and set a closing date.
Each stage of this process can require rapid decisions, often on the basis of limited information. Getting guidance from an experienced professional will help you navigate the pitfalls.
How to Find a Foreclosed Home
Your best resource for finding a foreclosed home is an experienced broker, but if you want to look on your own, there are useful resources available.
- Local Real Estate Agents. A real estate agent in your area that specializes in foreclosed homes will be familiar with many listings and with many ways of locating listings. You may have to pay for the services but it’s often worth it.
- Online Listings. Many real estate-focused websites have listings of foreclosed homes. Search for listings in your area.
- Bank Websites. Some banks may list foreclosed properties on their websites, often with information about the property.
- Government Agencies. Some government agencies that hold foreclosed homes will sell directly to an individual; others require a bid from a licensed broker. Check agency websites for listings and required procedures.
- Auction Companies. Some large auction houses may hold periodic auctions of foreclosed properties. These auctions are often attended by investors or real estate investment companies and may require cash purchases.
- Multiple Listing Service. The Multiple Listing Service or MLS is usually accessible only to brokers, but if you have a broker, they can use it to identify potential purchases in your area.
- Public Records. Several stages of the foreclosure process require public notice. County offices may have records of Notices of Default or Notices of Sale. The search may be tedious, but you may be able to identify properties that are not yet listed for sale, especially if you’re interested in pre-foreclosure properties.
If you’re considering buying a foreclosed home, you may wish to explore all or some of these sources to get a sense of the market in your area.
Remember the Risks
Foreclosed homes are often available at well below market value, but it’s not always easy to find one and buy it. There are also things that can go wrong. Be aware of the risks before you start and stay alert for them as you move through the process.
- Competition. Many foreclosed homes are bought by professional investors or investment companies that have established broker networks and make cash offers. These professional buyers have the resources to locate desirable properties and make cash bids. It may be difficult to compete with them.
- Hidden Costs. Foreclosed properties may have back taxes and liens that go with the property. You may not have the opportunity to do a thorough search, especially if you’re bidding at an auction.
- Property Condition. Many foreclosed homes are in poor condition, and you may not be able to perform a complete inspection. Many foreclosed homes are poorly maintained. Some homeowners who lose homes to foreclosure may remove wiring, plumbing, or other fixtures and some may even vandalize the property.
- Paperwork. The process of buying a foreclosed home may involve more red tape than a regular sale would. Be prepared for a slow process and some hurdles.
- Eviction. In many states, residents don’t have to leave a home until the sale is complete. The process of eviction may be complicated in some states and ex-owners may take advantage of laws designed to protect against abusive evictions.
- Right of Redemption. In some states, the prior homeowner has the right to buy the property back for a set price for a set time. This right may extend up to the point of sale and in some states even beyond. Check the laws in your state.
You may encounter more than one of these issues during the purchase process, and any of them can derail your search for a foreclosed home. Be aware and be ready.
How to Get a Good Deal on a Foreclosed Home
Most foreclosed homes sell at a discount, but that doesn’t mean they are all good deals. There are ways to raise your chances of getting a bargain and minimizing risks.
- Know the home’s current market value. You won’t be paying the full market value – that’s the whole point of buying a foreclosed home – but a good estimate of current market value is an essential starting point for deciding what you’re willing to offer.
- Know the market trend in the home’s neighborhood. Home values in a given neighborhood may be rising, stable, or falling. That’s an important part of your calculations, especially if you’re buying a foreclosed home as an investment.
- Know the rental market. If you’re planning to rent the home, know the home’s rental value, choose neighborhoods that are desirable to renters, and know the responsibilities and risks that go with your role as a landlord.
- Learn about title searches, potential liens, and home inspections. Make contact with title searchers, home inspectors, and contractors before you need them.
- Assess potential repair costs as well as you can. Get help from a contractor or home inspector if you need it.
- Don’t base your offer on a guess. You need a methodical system for deciding what you’re prepared to spend on a given property. Some experts suggest this formula: 80% of market value – estimated repair cost = bid price.
- Don’t get lured into competitive bidding. A bidding frenzy is a good way to end up paying more than you want to pay. If you can’t get the price you wanted, look for another property.
- Attend auctions first. If you’re considering buying at auction, attend some auctions first to observe and get familiar with the process.
- Always read the fine print. Review every word of every document and get help if you see something you don’t understand.
Foreclosed homes can be a bargain and can be a great way to get a residence or an investment property at a bargain price. That’s an opportunity, but there are also risks. To take advantage of the opportunity and avoid the risk you’ll need to understand the foreclosure process and the different types of foreclosure purchases, know the risks, gain expertise, enlist expert help, and buy carefully. It’s a significant challenge and it’s not something you’ll want to take on casually, but if you do it right there can be real rewards.