If you’re searching for a new home to buy, you’ve probably noticed that buying a foreclosed home can be less expensive than investing in a home that is for sale by the owner. You may be tempted to buy a foreclosed home because of the low price.
However, there are risks to buying a foreclosed home, especially if you intend to live in the home once you purchase it. Buying a foreclosure could help you save on your home purchase, but it may involve additional investments to make the home livable. If you’re considering it, here’s how to buy a foreclosed home while avoiding the common pitfalls that come with them.
What is a Foreclosed Home?
When someone takes out a mortgage to buy a home, they must make regular payments to their lender to remain in good standing. A mortgage is essentially a lien on a property, which makes it a secured loan with the house itself as collateral. If the homeowner fails to live up to their mortgage agreement, the lender may foreclose on the home, take ownership of the property and evict the residents.
The foreclosure process typically begins with missed payments, meaning the borrower can’t or won’t meet the terms of their loan by paying their mortgage on time. After months of missed payments, the lender will record a public notice with the local county recorder’s office that the borrower has defaulted on their mortgage. The borrower is also informed that they are in danger of losing rights to their home.
If the borrower can’t fix the default, the lender will put the home up for auction. The borrower may still try to come up with the cash. If they can’t, their home will be sold to the highest bidder. If no one buys the home at auction, the lender will become the highest bidder, and will then take ownership of the property and attempt to sell it on their own.
Of course, there are other reasons a house could be foreclosed upon, too.
“One thing to keep in mind is that the home itself might be the reason for the foreclosure,”John Donlon, co-founder of GoldCoast Mortgage in Beverly, Massachusetts, said. “Owners may abandon a property if they can’t fix problems that make it legally unlivable, such as contaminated well water, a broken septic system, non-conforming zoning, health issues such as mold or contamination from a leaky oil tank. If you buy the home as is at an auction, whatever problem caused the foreclosure — you now own that, too, which may include unfixable flaws in the title.”
How to Buy a Foreclosed Home
The process of buying a foreclosed home depends on what stage of the foreclosure the home is in. To begin with, the home will be sold at an auction.
Buying a home at an auction is the riskiest approach to buying a foreclosure.
“You’ll often need to come up with payment within 29 days of winning your bid at the auction. If you’re seeking financing to buy the home, you’ll need an appraisal, and gaining access to a property after auction can be difficult,” Donlon said.
If the home isn’t sold to a third party at auction, it will be repurchased by the foreclosing bank and become what’s known as a real estate owned (REO) property. It’s now owned by the lender, but the lender is likely trying to sell the home through a real estate agent instead of through another auction.
You can purchase the home at either of these junctures, but waiting until after the auction to buy is usually less risky.
“We recommend most of our clients wait until after the auction to buy the home from the bank,” Donlon said. “It’s a much cleaner, more civilized sales process, and you’re more likely to get a clean title. It’s better to leave auctions to the pros.”
Your first step should be to get preapproved for a mortgage if you aren’t buying in cash. Preapproval will give you an edge when competing with other buyers for a real estate-owned property or against bidders if you choose to buy at auction.
You should also work with a broker or real estate agent who specializes in foreclosures, especially if you’ve never purchased a foreclosed home before. They’ll charge a fee, but their experience will help you find a property that meets your needs and avoid common risks.
Next, you’ll need to either bid higher than other bidders at auction or negotiate to purchase an REO property with help from your real estate agent.
Tips for Buying a Foreclosure
Working with a real estate agent and inspecting the home yourself are two of the most important tips when buying a foreclosed home. These steps will help you avoid buying a property you can’t live in and can’t afford to fix.
Before buying the home, you should also estimate how much it will cost to make the home livable. Homes that are foreclosed upon don’t typically receive any renovation work, as the previous owner has essentially abandoned the property. If renovations are too expensive, buying the foreclosure may not be worth it if you intend to live in the home. Furthermore, you may have trouble obtaining financing if the foreclosed home isn’t habitable since you can’t expect the bank selling the home to invest in repairs.
If you intend to use the home as your primary residence, you could apply for a 203(k) loan from the United States Department of Housing and Urban Development if you qualify. If the home is owned by Fannie Mae, you could qualify for a HomePath renovation loan, which is available for second homes and investment properties.
Pros and Cons of Buying a Foreclosure
The biggest pro to buying a foreclosure is the opportunity to save money. Bank-foreclosed homes are almost always less expensive than homes in the same market that are for sale by the owner. If you purchase the home at an auction, you may be able to save even more if you get it for a low bid.
If you’re in the business of flipping houses — buying unlivable homes, renovating them and selling them for a profit — then foreclosures may be a good investment. However, buying a foreclosed home can be very risky for most home buyers. Even if the home’s listing looks nice, there could still be problems with the home. A leaky roof, hidden mold, insect infestations and code violations are all issues you may not know about until you conduct a thorough inspection of the home yourself. Moreover, when you buy a home “as is” at an auction, you have little to no recourse if something goes wrong.
Just because you get a good deal on the house doesn’t mean you will be saving money in the long run.
“Even if you bought a foreclosure for twenty percent under market value, you’d still be taking a loss because of the risk and the non-disclosed expenses,” Donlon said. “You’d have to get a substantially good deal to make it worth your while, and you risk losing your auction deposit if you decide to back out.”
The Bottom Line
Buying a foreclosure is a risky investment. If you haven’t done it before, work with an experienced agent and conduct an independent inspection of the home before you buy it. You’ll likely need to put additional money into the home to make it livable. If you do your homework, though, you could get a good deal.