Most people are interested in purchasing a foreclosed home because they can get a good price. But is that the end of the story? Far from it. If you’re considering buying a property in foreclosure, there’s a lot to consider, and a lot you need to know.
What is foreclosure?
Foreclosure happens when a homeowner isn’t able to pay his or her mortgage payments and/or property taxes and homeowners association fees, and a lender is forced to repossess the home. Once a home is foreclosed, the lender sells it to help make up for money lost from the loan default.
Foreclosures can save you money, plain and simple.
Unfortunately, no one agrees to a home loan planning to skip out on payments, so foreclosures are often the result of sad circumstances like natural disasters, job loss, a medical emergency, or other events with economic ramifications. As someone interested in purchasing a foreclosed home, it’s helpful to remember these types of causal factors as you move forward and encounter potential problems like a poor interior condition or liens against the property.
Stages of Foreclosure
Foreclosure happens in three stages: pre-foreclosure, auction, and bank-owned. During pre-foreclosure, a homeowner can still sell the property quickly in order to avoid the penalties of foreclosure—and they may be willing to sell below market value (this is usually called a short sale). Once foreclosure has occurred, the lender will often attempt to sell the home at auction. You can find a low price here too, but don’t expect to get a loan: Auctions are usually cash-only.
The bigger the risk, the bigger the reward, as the old adage goes.
You may also see the term “REO” when searching for foreclosed homes. This means “real estate owned” or bank-owned and refers to the fact that a bank or lender owns the property rather than a private owner. At the bank-owned stage, you’ll have better luck getting a loan. According to Wells Fargo, 60 percent of foreclosed home purchases are financed.
The Pros and Cons of Buying a Foreclosed Home
Let’s start with the big one. Foreclosures can save you money, plain and simple. According to mortgage experts HSH, you could save as much as 15% on a home. While this might not sound like much for a smaller purchase, tens of thousands of dollars are at stake when it comes to buying a home. For example, if your neighbors paid $300,000 for a home and you paid 15% less, that’s a savings of $45,000. Such drastic savings may have added benefits too, like being able to live in a neighborhood you couldn’t otherwise afford.
However, HSH cautions that such big savings are potential, not guaranteed. Their vice president said in an interview that it all depends on how determined a bank is to get a property off of their hands. He calls it the “desperation factor.” Remember: A bank is never going to just give an REO away, no matter the condition it’s in. But depending on that desperation factor, the bank may be willing to negotiate on price, escrow, and closing.
Traditional homebuyers and first-time homebuyers, in particular, may be dissuaded from purchasing a foreclosed home, regardless of the potential savings. In historically competitive areas like cities, you may find that a foreclosure also presents less competition. While bidding wars can happen at auction, once a property becomes an REO, you may encounter fewer buyers interested in the property.
Increased ROI Potential
The bigger the risk, the bigger the reward, as the old adage goes. While a foreclosed home may present a lot of work (more on that below), it could mean a big payday down the road when you decide to sell, particularly if you purchase in an established neighborhood.
If you’re purchasing a foreclosure at auction, you won’t have a chance to tour or inspect it, compared with a short sale or REO. Still, no matter what stage of foreclosure a property is in, you can expect problems, sometimes major. Homes in severe disrepair or even infested with rodents have all been reported with foreclosures (just watch an episode of HGTV’s “Flip or Flop” to see what we mean). Repairs can add up fast, and many times a foreclosed home’s overall condition isn’t for the faint of heart.
Particularly if a property has a lien against it (see below), it must be settled before the closing process can be completed. If you’re working with a strict deadline, a foreclosure might not be the right move—pun intended!
While an "as is" condition is a certainty, potential liens are simply a possibility. Still, it’s worth knowing that a property doesn’t have a lien against it.
A lien refers to the right of another party to keep possession of the home until a debt is paid—common liens in foreclosures might be from a contractor to whom the homeowner owes money, a divorce-decree lien resulting in one spouse not paying alimony or child support, or a lien from the IRS for failure to pay taxes. Liens are messy, and you’ll want to get them cleared up right away. Liens usually only apply to pre-foreclosure and auction properties, as a lender will always pay off any liens before reselling the home as an REO.