Before the 2007-2009 mortgage crisis, buying a foreclosed house was challenging. You had to travel to courthouse auctions or read through hundreds of pages of court records. But in the course of the mortgage crisis, things got even worse. The massive surge of foreclosures clogged the system and led to changes in how foreclosure homes are sold.
Today, buying a foreclosed home is pretty much the same as buying any other home. And while foreclosure rates are nowhere near their highs from the late 2000s, there are still plenty of bargains. Here’s how to buy foreclosure homes in 5 steps.
What Is A Foreclosure Home?
When you sign a mortgage, the bank puts a lien on your property, and this lien entitles them to take possession of your home if you stop making your monthly payments.
When a person falls behind on their mortgage, the bank initiates a process called foreclosure. Foreclosure is a legal process where a court orders the homeowner to leave the property, and the bank takes ownership. The bank can then sell the property to make good on its losses.
A foreclosed home can be an excellent bargain. Banks are often willing to sell below market price just to unload the property quickly. The longer they hang onto it, the longer they’re responsible for repairs, maintenance, and taxes. That said, buying a foreclosed home also presents its own challenges and pitfalls.
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How Does Foreclosure Work?
As we discussed, foreclosure is a legal process that operates through a series of defined steps. Here’s how the process works.
Notice of default: When a homeowner misses a payment, they go into payment default. After a series of missed payments, the entire mortgage goes into default. This usually happens after 90 days. At this point, the lender will send a formal letter called a “notice of default.” This officially informs the homeowner that they’re in default and that they are in danger of foreclosure. Depending on the terms of the mortgage – and state law – the homeowner will have a certain period to catch up or work out a payment plan. If they’re unable to do so, the foreclosure proceeds.
Notice of trustee’s sale: To take possession of the home, the bank must publish an official notice in the newspaper. They also need to make a record with the county. The notice and the public record provide an opportunity to find out about the sale. But these days, the easiest way to find a listing is on the internet.
Trustee’s sale and subsequent listing: At a specified date and time, the bank will try to sell the property at a public auction. If there are no buyers, the bank will list the property with a real estate agent. This is the point where most homebuyers will make their purchase.
How To Buy A Foreclosed Home In 5 Steps
So, you want to buy a foreclosed home but are unsure how to go about it. It might seem intimidating at first. But it’s actually not that different from buying a new house the usual way.
That said, it always helps to know what you’re getting into. Let’s talk about the process.
1. Research Purchase Methods
First things first, you need to do your research. There are many ways to purchase a foreclosure, and not all of them are right for everybody. Here are the most common methods.
Purchasing a short sale
When homeowners know that foreclosure is imminent, they may opt to sell the house instead. That way, they can pay back the bank, and there won’t be any foreclosure on their credit history.
Technically, this isn’t a foreclosure sale since the bank hasn’t foreclosed on the house yet. That said, the homeowner will still need to get permission from the bank. The sale also happens on an accelerated timeline since the bank won’t be willing to wait for months on end for the sale to close.
Because the timeline is accelerated, the home typically sells for well below market value. The bank may even agree to allow a sale at a loss to avoid the hassle of foreclosure. For example, a homeowner may owe $200,000 on a house, but the bank allows a sale at $185,000 to wrap things up.
Purchasing at auction
Traditionally, buyers have purchased foreclosed homes at an auction. Depending on the scenario, the auction may be held by a bank, a third-party trustee, or even the county courthouse. Auctions offer the best prices, and you can walk out the same day with a title in hand.
That said, there are some definite drawbacks. To begin with, there might still be a lien on the title. For example, if the previous owner fell into tax debt, the government may have a tax lien. In that case, you’d have to pay the back taxes to obtain full ownership.
Auctions also require you to have cash in hand. And you won’t have the opportunity to have a proper appraisal done, so you’ll be working with limited information.
Purchasing from the bank
To find bank-owned foreclosures, look through listings for a marking that says “REO,” which is short for “real estate owned.” These are foreclosures that failed to sell at auction and are now owned by the bank. REO properties cost more than auction properties but have a few key benefits.
For one thing, you’ll have time to perform a proper inspection. For another thing, the bank will have paid any liens and evicted the homeowner. This tremendously simplifies the buying process.
Purchasing from the government
Buying from the government is similar to buying a property from the bank. The difference is that the properties are owned by the U.S. Department of Housing and Urban Development.
HUD foreclosures are cheap, but they’re sold as-is. Rarely will the government agree to perform any pre-sale repairs.
2. Determine How Much Home You Can Afford
As with any major purchase, it’s important to budget for your foreclosure. Don’t get sucked in by internet myths, either. Yes, you can find some properties that cost $1. But they’ll come with several years of property tax debt and require tens or even hundreds of thousands of dollars worth of repairs.
Instead, look at your monthly income and current debt payments. Mortgage providers tend to approve borrowers only if their monthly debt payments amount to 43% or less of their income. Plan your mortgage budget accordingly.
3. Hire A Real Estate Agent
Most foreclosed properties are managed by a real estate owned (REO) agent. REO agents don’t work like regular real estate agents and generally prefer not to deal with homebuyers directly.
Instead, it’s best to find a real estate agent who’s experienced in working with REO agents. If possible, look for an agent specializing in foreclosed homes. They’ll be best qualified to carry you through the process without any significant hitches.
4. Get Preapproved
Getting preapproval is wise whether you’re buying a foreclosure or a more traditional home. During this process, the bank will check your credit history, verify your income, and give you a preliminary mortgage offer. At that point, you’ll know exactly how much house you’ll be able to afford.
Being preapproved also makes you stand out as a buyer. The bank doesn’t have to worry about whether or not you can qualify for a mortgage. Since they know you can get a loan, they’ll be willing to move forward faster.
This is especially true for foreclosures since the bank is already taking a loss. The last thing they want to do is sell the home to another buyer who can’t afford to pay.
5. Conduct A Home Inspection
Before making an official offer, you must know what you’re buying. That’s not possible at an auction sale. But when you’re buying an REO or government property, it makes sense to order an inspection.
A home inspection will let you know if anything is wrong with the property. A qualified inspector will come to the house and make note of anything that needs to be repaired or replaced.
An appraisal is a less in-depth inspection required by your lender. The appraiser will evaluate the property to confirm its value. After all, your lender doesn’t want to pay more for the property than it’s actually worth.
6. Make An Offer
How you make an offer will depend on how you’re buying the home. If it’s a short sale, your real estate agent will have to take the offer to the homeowner, who will then have to get approval from their bank.
For an REO property, your agent will take your offer to the REO agent. The REO agent will deliver that offer to the bank, along with any other offers. The bank will then decide on the best offer and let your agent know if yours was accepted.
7. Purchase Your New Home
Go over your appraisal and inspection reports and decide whether or not you really want to move forward. If the home is up to your lender’s standards, you’ll be ready to close. If not, you’ll have to complete repairs before they will sign off on the loan. Your real estate agent can walk you through the process, and you’ll be sleeping in your new home in no time.
Pros Of Buying A Foreclosed Home
So, why would you want to buy a foreclosed home instead of buy one in the traditional way? There are a few good reasons, including the following:
Better prices: Foreclosed homes are almost always more affordable than similar homes in the same area. This is because the bank is not in the business of owning real estate. For them, a house is just an ongoing expense they want to unload as soon as possible.
Standardized loan options: While the buying process for a foreclosed home is a bit different, the financing options are the same. Unless you’re paying cash at an auction, you can get an FHA, VA, or USDA loan. These loans carry far lower costs than a run-of-the-mill mortgage. Just be aware that because they’re government-backed, the home will need to meet minimum requirements. If it’s not in livable condition, the government will require repairs before they approve a loan.
Cons Of Buying A Foreclosed Home
Just as foreclosed homes have some benefits, they also have their share of downsides. Here are some reasons you might want to stick with a traditional home purchase:
Surprise expenses: When someone is in financial distress and about to lose their home, basic repairs are the last thing on their mind. Foreclosed homes can have all kinds of maintenance issues that you won’t find in most houses. So while you’ll save money on the initial purchase, you may end up with unexpected repair costs on the back end.
Squatters: If a home has been in foreclosure for a while, someone may have moved in. But just because they’re not there legally doesn’t mean they’re easy to get rid of. Evicting a squatter can cost thousands of dollars in legal fees, and the court process can take months.
The home is sold “as-is”: During a normal home purchase, there’s a back-and-forth process. You can ask the existing owner to make repairs before you agree to buy, or haggle them down because of existing damage to the property. Banks have a “take it or leave it” approach. Then again, that’s part of why you’re getting a discount.
As you can see, foreclosed homes aren’t the best deal for everybody. You’re making an as-is purchase, and the lender will want to close the deal in a hurry. But learning how to buy foreclosure homes can also get you the title to a house you otherwise wouldn’t be able to afford.
Maybe it will be a fixer-upper. But it will be your fixer-upper.
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