Buying a foreclosed home can be a good way to score a deal while hunting for real estate. A foreclosure is a house whose owners were unable to pay the mortgage or sell the property. As a result, the real estate lender assumed ownership and is now trying to sell it to recoup some of its costs.
Buying a foreclosed home
While foreclosure isn’t as common today as it was during the height of the real estate crisis in 2008, it does still happen. Currently, according to RealtyTrac, 1 in 13,000 homes ends up in foreclosure. In states with the highest foreclosure frequency, such as Maryland and New Jersey, that ratio is 1 in about 550 homes. That’s a lot of foreclosed homes.
While foreclosure is hardly a pretty story for the home’s previous owners, it can be a bargain bonanza for buyers. Since banks are often eager to unload these foreclosure properties, they aim to break even with an asking price that’s typically the sum of the remaining mortgage note plus interest, lawyer fees, and penalties. On average, this ends up totaling about 15% below the home’s actual value—and if you want to buy a foreclosure, you’ll find it often sells for less than asking price.
But buying a foreclosed home does come with risks, so buyers should proceed with caution to see if the gamble is worth it.
How does foreclosure work?
Foreclosure isn’t something any homeowner wants to go through. Unfortunately it affects hundreds of thousands of Americans every year. So how does the foreclosure process work?
Homeowners have to first default on their mortgage, failing to pay their required monthly payments. And it’s rare for lenders to begin foreclosure after just one late mortgage payment. Lenders usually offer alternatives during this period, including different payment plans to help the homeowners get back on track, keep their home, and keep paying their monthly mortgage bill.
If a borrower can’t come up with the funds to pay what he or she owes, a lender will issue a notice of default. This form will be sent to the mortgagee via a certified letter, and it typically gives a homeowner 90 days to pay off the most recent bill. This is the beginning of the formal process.
If the homeowner hasn’t come up with the money within 90 days of the notice of default, the lender may proceed with the foreclosure. Next comes a notice of sale, which will state that the trustee (the lender) will sell the home at auction within 21 days.
The home will be sold at a public auction to the highest bidder, who will have to pay the full amount of the bid immediately. This buyer will receive a trustee’s deed once the sale is complete, at which point he becomes the official owner.
What are REO properties?
Real estate owned properties, or REO properties, are houses that have been seized by banks or other lenders from people who are unable to pay their mortgages. Essentially, it’s a foreclosure that has been seized by the bank. When real estate lenders offer mortgage loans, they see them as an investment, because they will earn money from the interest on the loan. So to salvage their investment, banks foreclose on homes with unpaid mortgages and sell the properties at a foreclosure auction. If a home doesn’t sell at auction, it becomes an REO.
How to buy a foreclosed home
To find a foreclosed home, you can peruse listings of foreclosures on realtor.com®, which may also be marked as “bank owned” or “REO.” If you spot a home you like, contact the real estate agent on the listing as usual.
The biggest caveat when buying a foreclosed home is that it is typically sold as is, which means the bank is not going to fix any problems. And there may be plenty of them, considering that many foreclosures have been slowly crumbling into disrepair due to the previous owner’s financial strain. And unlike a traditional home sale, in which disclosure requirements force owners to reveal a home’s every flaw, there’s no such legal stipulation in a foreclosure. What you see (or don’t) is truly what you get.
That’s why foreclosed homes risk costing buyers a ton of money to renovate that could negate their supposed savings. This is why Eric Workman of the Chicago-based residential rehab lender Renovo Financial suggests that buyers take extra precautions such as the following before making an offer:
- Research how long the foreclosure sat vacant, whether it endured freeze and thaw seasons unattended, or experienced anything that may have caused significant structural damage. Homes in a dire state of disrepair won’t be eligible for a conventional mortgage.
- Hire a home inspector to thoroughly check out the foreclosed home for major problems. Have the inspector give you an estimate of how much money it will take to make repairs.
- You can try to add loan and inspection contingencies to your offer. That way, if you do encounter problems with the home or attaining a mortgage for it, you can back out of the deal without losing your deposit. Just keep in mind that asking for contingencies does not mean the bank will accept them; they’re not the norm when you buy a foreclosure.
- Hire a professional to conduct a title search, says Ben Niernberg, executive vice president at Northbrook, IL–based Proper Title. This may allow you to avoid all kinds of nightmare scenarios—sometimes the bank will clear the liens, but it isn’t required to do so. For instance, let’s say the IRS has a lien on the property for back taxes. That debt doesn’t follow the owner once he sells. Instead, the lien sticks with the property, making the new owner responsible for repayment.
If you find out the home has problems, you will want to carefully weigh whether it’s worth all the extra work. In some cases it will be; in others, it may be more prudent to walk.