If you're-- and you're looking for a deal -- a foreclosure may be an enticing option. Foreclosed properties, which have been taken back by a lender after the homeowners defaulted on their loan, usually sell for significantly less than similar homes on the traditional market.
The lower price tag has a few strings attached, though. Buying any house can be complicated -- and a foreclosed house especially so, with its own unique set of risks and challenges. Learn more about how to buy a foreclosed home to decide if it's a good option for you.
What is a foreclosed home?
Foreclosures have been seized by the lender because the homeowner was no longer able to pay the mortgage. Most lenders will begin the foreclosure process when the owner falls three to six months behind.
Though the pathway to foreclosure varies by lender, state and the homeowner's specific situation, the ultimate outcome is largely the same: The lender seizes control of the property and looks to resell the home as quickly as possible to minimize or recoup any losses. To speed up this process, foreclosed homes usually come at a discount and are often sold "as is" -- which means that lenders may be reluctant to make repairs.
For a buyer, the primary difference between purchasing a foreclosure and a traditionally listed property is that you're buying from a lender and not the homeowner. This changes the dynamics of finding a home, making an offer and negotiating a contract.
How to buy a foreclosed home
Before you start looking for hot foreclosure deals, it's important to understand the process and what you should expect.
Know the methods for buying a foreclosed home
One tricky aspect of buying foreclosures is the number of ways you can buy them. These include:
- Short sales: With a short sale, a lender agrees to accept a sale price that's lower than what's owed on the loan. When a homeowner owes more on their mortgage than the equity they have in the home -- sometimes known as "being underwater," lenders may agree to this type of sale if they believe they'll recoup more from short-selling than a full-blown foreclosure. Short sales are listed openly on multiple listings services and are relatively easy to find.
- Auctions: If a foreclosure is inevitable, the bank may let the homeowner take their property to auction. Home auctions are typically administered by a county or municipality-level agency. Buyers at auction should be prepared to make a full-cash offer and be ready to stomach some risk; the property's condition and who holds the title may be uncertain.
- Direct from lender: Properties that have completed the foreclosure process and are released to the lender become bank-owned or real estate-owned homes. Banks tend to take their time with what are called real-estate owned homes in order to find the most profitable offer. As a result, buying an REO home can take a long time, depending on the number of foreclosures the bank is handling. Sometimes, it can take months for a bank just to respond to your offer.
- From the government: Agencies such as the US Department of Housing and Urban Development, the Department of Agriculture and the Department of Veterans Affairs also sell foreclosures on loans they guaranteed. You can find listings online at the various agency websites but must work with a real estate agent to make an offer.
- Preforeclosures: Homeowners in the preforeclosure stage have received notice from their bank that foreclosure is looming. They will have a specified period to catch up on payments and late fees but will often look for a buyer who will pay the right price for their home to save them the financial trouble of foreclosure. Preforeclosures can be harder to find since they're not officially on the market.
Find a knowledgeable foreclosure agent
If you're thinking about buying a foreclosed home, choose your real estate agent carefully.
"An agent who knows how the process of buying a foreclosed property works will be very helpful," says Santosh Bhatt, a broker at Greater Louisville Homes in Kentucky. "Understanding the process allows the agent to manage buyer expectations. An agent with a lack of foreclosure experience can make the transaction a bit challenging."
Look for agents in areas with high foreclosure rates or ask your lender if they partner with any REO agents. It can also be helpful to search for agents with Short Sales and Foreclosure Resource or Certified Distressed Property Expert certifications.
Securing your mortgage preapproval is an essential step for any prospective buyer, but it's critical when targeting foreclosures. The most successful foreclosure buyers make all-cash offers, which immediately gives them a leg up on anyone who still needs to secure financing. A preapproval letter proves that you can back up your offer and close the deal.
You may also want to investigate alternative loan options that work well for foreclosures. The FHA 203(k) loan, for instance, lets you finance up to $35,000 in repairs or upgrades into the loan, which is particularly helpful since foreclosure properties often need a lot of work.
Search for foreclosed homes
An experienced agent should have no trouble helping you find foreclosure listings. However, if you're eager to do your own research, check out these resources:
- HUD Foreclosures and HomeSales.gov point to various agencies with government-owned foreclosure listings.
- HomePath.com is Fannie Mae's foreclosure listings service, and HomeSteps.com is Freddie Mac's. Both allow you to search by address, ZIP code or MLS number.
- Zillow and Realtor.com have search portals specifically for finding foreclosed homes.
- Auction.com is a great resource for auction listings, but it is primarily designed for investors.
- Foreclosure.com is a helpful resource for finding preforeclosures before they hit the market.
- Banks and lenders may have their own sites with foreclosure listings.
Make an offer
It's vital to understand the current housing market in your area before you make an offer. Supply and demand for foreclosures may follow their own specific market trends, so research is critical.
Foreclosure rates have been relatively low since the foreclosure moratorium was established in 2020, to offset financial challenges during the pandemic. While the moratorium ended on July 31, the Federal Housing Administration has extended forbearance-related evictions and the White House extended the window for forbearance enrollment until Sept. 30. Still, Bhatt expects we'll see an increase of foreclosures toward the end of 2021 and in early 2022.
"We're in a crazy seller's market, and often properties are selling for more than list price," he says. "When inventory starts expanding, supply and demand will start to balance out, and at that time, buyers will find attractive deals."
An experienced agent can run a comparative market analysis in real-time to help you determine the going rate for properties in your area, along with how quickly foreclosures are selling. Your agent can also help you decide on the right offer to make to stand out but avoid overpaying.
Review your appraisal and home inspection carefully
Once your offer has been accepted, you'll proceed to the next two hurdles: the home appraisal and inspection.
Unless you're paying in cash, your lender will require an appraisal to ensure the home's value aligns with your offer. If you're paying in cash, you might consider ordering an appraisal to ensure the property you're buying is worth its selling price.
Even more important, though, is the home inspection. As a buyer, it's your responsibility to order a home inspection -- this step is critical with a foreclosure. You'll want to know about every potential issue because there's a strong chance you'll have to buy it as-is.
"Many banks and HUD will sell properties 'as-is' and will make no repairs after the sale," says Bhatt. "But some banks will consider repairs after inspection and more so after appraisal, especially if they are lender-required repairs."
Review your inspection results carefully to decide if the issues found are worth the discount you're receiving on buying a foreclosure. Attempt to negotiate repairs for anything major, but be prepared to walk away if the damage is too extensive.
Reasons to buy a foreclosed home
Foreclosures are appealing to many buyers for several reasons, including:
- Lower prices: In most cases, buying a foreclosed home will cost you less than buying a comparable home on the market.
- Better return on investment: Because of the potential upfront savings, homeowners can invest extra funds into home improvements -- which can produce a significant return when it's time to sell.
- Fewer title issues (in some cases): Bank-owned properties are thoroughly vetted ahead of time. The bank will clear the title for you, and you don't have to worry about any issues the homeowner may have. That's not the case with properties that are still technically in the homeowner's possession or up for auction.
Risks of buying a foreclosed home
Don't let an appealing price tag lead you into. There are serious risks involved.
- Expensive repairs: "Most experienced agents will not take first-time homebuyers to foreclosed properties since, often, they are in rough shape and could become money pits," says Bhatt. Count all the costs before you close a deal.
- A drawn-out buying process: Because you're dealing directly with a bank, there can be more red tape involved.
- Steep competition: If home prices continue soaring in 2021, foreclosures may become a popular way for buyers to find a deal, leading to increased buyer competition and higher prices.
- Redemption periods: Most states offer a period of redemption after a foreclosure sale. During this period, the original homeowner could still catch up on payments and earn their home back -- even after you've moved into the house. Redemption periods can range from 30 days to a year, so be sure to check your state's laws before you buy a foreclosure.
- Squatters: If a property has been abandoned for a while, squatters may be living there. And if they've been there for an extended time, you might run into problems. All states have laws that grant squatters rights of adverse possession after a certain period of time — meaning the property legally becomes theirs. In some states, this window is as short as five years, but it's usually longer. Make sure you assess your property thoroughly to avoid any potential squatter disputes.
Is a foreclosed home the best option for you?
Foreclosures present a great opportunity for homebuyers looking to save money and invest in rehabbing a property that may have been neglected. But foreclosed homes are not for everyone. Be sure you understand how to buy a foreclosed home and all of the risks involved before you get in over your head.