Everything You Need to Know About Buying a Foreclosed Home

People in search of real estate bargains may find themselves considering foreclosures. Foreclosed homes have been seized by a lending bank after a homeowner has defaulted on their mortgage. Although not as common as during the real estate crisis of 2008, foreclosures still happen all over the country.

Buying a foreclosed home can be a good deal for a buyer who is willing to jump through some hoops and take on a bit of risk. But that still leaves a savvy investor with a big question:

Exactly how does buying a home in foreclosure work?

There is a step-by-step process for buying a foreclosed home. And while not rocket science, it is important to understand the process before deciding to buy a home that has been foreclosed on, especially since this process is slightly different than a traditional home purchase.

The main appeal of buying a foreclosed home is the price, which is typically about 5% below the market. There are a couple of reasons for the low price.

First, foreclosed homes are almost always sold “as-is.” Offers by potential buyers are made knowing that they will be responsible for any work that is needed on the home. Because the seller doesn’t need to make any repairs, they are ready to accept a lower price.

Second, banks are in the money business, not the real estate business. The longer they hold a house in their inventory, the more money they lose. Holding onto these properties means they are missing out on the collection of mortgage payments, plus they have to pay property taxes and insurance. Banks simply want to get foreclosed properties off their books, even if that means selling them at a significant discount.

Foreclosures are a popular investment opportunity for real estate investors and house “flippers.” Properties can be snatched up at low prices, renovated, and then sold for a profit. 

Some buyers may purchase a foreclosed home to live in themselves. For some, it can mean their best chance at first-time homeownership, or an opening into a desired neighborhood. Others may simply enjoy the challenge of a fixer-upper. If someone has the time and money to take on necessary repairs and renovations, and the flexibility and patience that the buying process requires, a foreclosure may check all the necessary boxes.  

The “as-is” nature of foreclosed home sales is something buyers must be prepared for. The house may have sat vacant for an extended period of time. Empty homes can fall into disrepair without anyone there to notice. Things like water damage from a leaky roof or pipes can cause damage. Or rodents, insects, or other critters might take up residence.

It’s also important to remember that if the previous owner neglected their mortgage payments, they may have neglected the upkeep of the house too. And it’s an unfortunate fact that some people may cause intentional damage if they are upset about losing their home.

Potential buyers are often not given the opportunity for an inspection before making an offer on a foreclosed house. They need to be ready to handle whatever problems may exist. Fixing problems may take substantial amounts of cash and a lot of time. A wise buyer will figure potential repairs into their budget. And if they are planning to occupy the home themselves, they will need an alternative place to stay in case the problems are serious enough to make the home unlivable.

Another thing to be ready for is competition. If you see potential in a certain home, you can bet others will too. And foreclosures are often snapped up by investors armed with cash. If you are looking for your family’s next home, you might not be able to compete.

The process of foreclosure has different stages. The buyer’s experience will differ slightly depending on the stage.

Pre-foreclosure. When keeping up with mortgage payments is becoming difficult, a homeowner may fear that foreclosure is in their future. In order to avoid the bank from taking the house, the owner may rush to sell it. They are motivated to take a low offer, provided it will get them out from under their mortgage. Because the homeowner, and not the bank, is still calling the shots, the buyer can negotiate things like repairs prior to making an offer.

Short Sale. Like a pre-foreclosure, the bank has not yet seized the home. In a short sale, the homeowner gets permission from their bank to accept less for the home than the amount they still owe on the mortgage. The reasoning is that a lender will prefer a reasonable offer, even if it comes up short, rather than dealing with a foreclosure. Short sales require a great deal of flexibility and patience in a buyer. There is no guarantee the bank will agree to the offer, and even if they do, it can take a considerable amount of time. 

Auction. The most common way for a bank to sell a home they’re in possession of due to foreclosure is with an auction. This can be a very fast way to buy a home, but there are some obstacles. First, buyers usually need to be able to pay cash. This alone will usually rule out a lot of potential buyers. Second, there could be stiff competition from other shoppers. It is probably best left for properties meant to be investments, rather than for a home you hope to move into.

REO. REO, or “real estate owned” homes are actually owned by the bank. In some cases, they are still unsold after an auction. They are houses that the lending bank is selling on the open market through a real estate agent to recoup their losses.

The steps to buying a foreclosed home are not that different than any other home, but the order they occur is. 

1. Decide how much you can afford and get pre-approved for a mortgage. Better yet, get the cash together if possible. Depending on the details of the sale, some banks may be hesitant to lend for a foreclosed property. And if you are buying at auction, cash may be required. While the bank selling the property may offer some incentives, it is not necessary to finance the purchase through them. A buyer should opt for whatever lending institution best suits their needs and offers the best rate.
2. Find a real estate agent that has experience with foreclosures. This is not the time to try negotiating a sale on your own to save on closing costs. Experienced agents like those at Berkshire Hathaway HomeServices Select Properties will be able to track down foreclosed properties that meet your wish list and walk you through the process from start to finish.
3. Submit your offer or place your bid at auction. Make sure that your offer isn’t at the top end of your budget. You will want to make sure you have money left for inspections, closing costs, insurance, property taxes, and repairs and renovations.
4. Be patient. Buying a foreclosed home can take a considerable amount of time. 
5. When the offer is accepted, arrange for a home inspection. Unlike most purchases, the inspection happens after the fact, so you can’t use its information as a tool to negotiate your offer. Instead, it will give you information about what the property needs. In some cases, there may be certain contingencies written into the agreement that will allow the buyer to back out of the purchase if the inspection reveals specific problems.
6. Repair, renovate, and move in. Or rent or resell the property if investment was the goal. 

Buying a home under any circumstances can be frustrating and stressful. Dream homes are lost to higher bidders every day. A lender’s slow decision-making process can make buying a foreclosure even more uncertain. Completing a successful purchase can be done but might require a lot of patience on the buyer’s part. Not to mention the willingness to start over if the first attempt falls through.