Yes. You can buy a house in foreclosure. However, there are many factors involved. When buyers arm themselves with the proper knowledge, they’re more likely to get a smashing deal.
Buying foreclosed homes can be an excellent investment.
Putting the right real estate agent in your corner, learning the process, and researching your target are essential steps. Navigating the four main stages of foreclosure and understanding how to strike when the iron is hot could change your financial future.
In this article, we’re going to detail the what, when, why, and how of real estate foreclosures so you can start bidding right away.
What Is Real Estate Foreclosure?
Foreclosure happens when a borrower fails to make payments on a mortgage loan. The lender legally seizes the property and attempts to receive the borrower’s outstanding loan balance—sometimes by forcing the sale of the home.
There are many stages in the foreclosure process; all involve recouping the loan from the borrower.
The Four Stages of Foreclosure
There are a few stages of foreclosure as well as options homeowners have to settle their loans. See the following chart below:
Preforeclosure
This is the first step in the foreclosure process. At this stage, the borrower can still pay the amount due to stay in their home. The lender has taken legal action by sending a notice of default to the homeowner, outlining foreclosure circumstances. Defaulting on a loan after receiving notice usually comes with a grace period between three to six months—as lenders typically try to avoid this costly outcome.
Zillow and similar homebuying sites list homes under preforeclosure. It’s important to remember that these homes are still the property of the owner, not the lender. The owner could be working out a deal and paying off the amount owed to stay in the home. Therefore, they’re not technically for sale.
Pros:
- You’ll have bargaining power with the seller—especially if they urgently need to sell the home.
- The seller disclosures still apply in the preforeclosure phase, meaning you’ll have access to the property’s history.
- Buyers can use traditional financing options.
Cons:
- The price may not be as sweet as other options on this list.
- One could infer that somebody who doesn’t pay their bills doesn’t keep up on routine maintenance—but that’s not always the case.
- Sales tend to drag out due to unforeseen circumstances. The seller could regain their financial footing, have trouble finding a new home, or you could have difficulty securing a loan for a home in preforeclosure.
- See “Additional Considerations” below.
Real Estate Short Sale
Short sales occur when homeowners sell their property for less than the amount they owe. They’re optional for homeowners behind on mortgage payments or underwater—meaning they owe more than the home is worth. These sales happen before the lender puts the home up for auction or seizes the property.
The homeowner must gain lender approval before orchestrating a short sale, as the proceeds from a sale will not cover the outstanding loan amount. These sales are often used to bail out the homeowner in a sticky situation. Sometimes lenders will forgive the difference, but at other times, the homeowner may divest themselves of the home, but still owe the remaining balance on the home loan.
The pros and cons of real estate short sales fall into the “preforeclosure” category.
Sheriff’s Sale (Public Auction)
A sheriff’s sale is an auction, usually arranged by local law enforcement, of a repossessed home. These home auctions occur when the homeowner receives a notice of default and neglects to pay the balance within the grace period. The public is welcome to bid on the home, and the proceeds go towards settling the debt owed. The homes sold at these auctions are often sold “as-is.”
Pros:
- Auctions tend to give buyers an excellent price.
- The transaction closes immediately.
- Cash bids can reduce competition for homes.
Cons:
- The lack of financing options makes it difficult to participate in the auction—you’ll need cash.
- What you bid on is what you get; homes are sold in “as-is” condition.
- See “Additional Considerations” below.
Real Estate Owned (REO)
The term is used when a lender takes over ownership of a specific property because:
1. A notice of default was issued to the borrower.
2. The borrower fails to pay the amount by the contractual grace period.
3. The home doesn’t sell before or during the sheriff’s auction.
When the property fails to sell, the lender possesses it. The lender will use real estate agents and listings to sell the property—typically at a discount. However, these houses are often in disrepair and sold “as-is.”
Pros:
- Lenders will offer great deals on REO properties.
- Lenders pay your real estate agent’s commission.
- You have bargaining power on everything from price to escrow length.
Cons:
- The property is sold “as-is.”
- Buyers should be cautious; homes that have reached this final stage of the foreclosure process might be in serious disrepair.
- See “Additional Considerations” below.
Additional Considerations
Foreclosures can be tricky and vary from state to state. There are a few issues that can wreck a perfectly good foreclosure purchase. Namely, “squatters,” or homeowners refusing to vacate the property, can make the transaction difficult for the new homeowner. Some of these previous tenants will even have the right of redemption—a legal process—allowing homeowners to reclaim their property by paying the amount due within a state-mandated timeframe.
Other potential pitfalls include liens, additional mortgages, or back taxes. These extra expenses, in the case of a short sale, are the responsibility of the seller. However, sheriff sales put the burden of these fees on the purchaser. If you want to mitigate risk, you can search for the title before the auction and get title insurance after the auction closes.
How Can I Buy a Foreclosed Home?
The good news is that you can buy a home in foreclosure. However, you’ll need a different approach to the sale. As outlined previously, you can find homes in various stages of the foreclosure process; most will either be scheduled for auction or REO properties sold on behalf of the lender.
An excellent start to your foreclosure search is on specialized websites like Foreclosure, HomePath, and RealtyTrac. Other popular providers, including Zillow, offer filters you can use to seek out homes in preforeclosure and foreclosure. Specific sites like Auction.com and HomePath, local newspapers, and public records will give you up-to-date information about local foreclosure auctions. These auctions are often required to be listed by law and will show up using Google search.
Homebuyers on the hunt for foreclosure bargains should enlist the help of a real estate agent with experience in foreclosed properties. Others with a bit of real estate knowledge will try their luck at an auction. You’ll want to conduct due diligence and educate yourself on the pre-auction process because foreclosure sales, in most circumstances, are final and sold “as-is.”
How Do I Identify the Right Opportunity?
Picking the right property is tough enough with standard homes, but foreclosures take it to a whole new level of difficulty. Best practices include understanding your budget, finding and interviewing real estate agents with experience buying REO properties, looking at local auctions, and educating yourself on the factors that determine value in the first place.
The next step is to ensure your finances are airtight; often, buyers will get a letter of preapproval from a lender if they aren’t buying with cash. It’s worth mentioning that most auctions and lenders will require the funds upfront, which will prevent the use of many traditional financing options. Banks are skittish on these properties and are less likely to lend money because they are often in disrepair.
Special loan programs are offered from some organizations such as the Federal Housing Administration’s (FHA) 203(k) loan. These are designed for borrowers who want to borrow money upfront for both the home and repairs. FHA 203(k) loans often come with mortgage insurance premiums to insure the lender.
Make sure to research the house before heading to the auction. Drive by the property and take a look. Don’t invade the privacy of the current resident, as the house could still be occupied. And even if it’s not, going onto the lender’s property is trespassing.
Ask your real estate agent for a comparative market analysis (CMA) to give you an idea of what the property is worth. Stick to your price range at auction and try not to get emotionally involved when bidding.
Remember, finalizing the sale means accepting the home in “as-is” condition. If there’s something critically wrong with the property, you’ll end up footing the bill for repairs and other costs associated with foreclosed homes.
The Bottom Line
When a borrower fails to pay on his or her mortgage and the lender issues a notice of default, the foreclosure process begins. Each stage is contingent on the buyer’s ability or willingness to pay the owed amount, which can be tricky for interested homebuyers. You can buy properties directly from the homeowner, at auction, or from the lender. Getting up to snuff on the potential risks and opportunities of foreclosed properties can kickstart your purchase and hopefully land you a good deal.
Foreclosures can be lucrative with the proper real estate knowledge but detrimental to unknowing homebuyers. Choose the right real estate agent to advise you on best practices, be careful when bidding, and set “as-is” expectations regarding the property’s condition.
