How To Buy A Foreclosed House: Everything You Need To Know

Buying a foreclosed home is not quite as simple as a traditional real estate transaction but that little bit of extra effort could result in huge savings. The first step to the successful acquisition of a foreclosed property is understanding the foreclosure process.

What Does Foreclosure Mean?

The term foreclosure refers to the legal process that a lender uses to recover the balance of a loan from someone who has stopped paying. To collect, the lender forces the sale of the home that serves as the collateral for the loan. An understanding of each type of foreclosure will position you for the successful purchase of a foreclosure property. This includes purchasing an existing home or buying land for building a house.

Pre-Foreclosure

When someone stops making payments on their home, they are considered in default. This can happen due to a loss of income, significant unexpected medical expenses, or any other financial hardships. 

Once the bank that owns the mortgage on a home notifies the buyers that they are in default, the property is in pre-foreclosure. During this period, the homeowner has the opportunity to sell the home themselves before it is offered for sale by the bank at auction. 

If the homeowner successfully sells the property during the pre-foreclosure period, they may be able to use the proceeds to pay off the loan and avoid foreclosure. This is a huge benefit, as they will likely prevent the negative effect on their credit score which would make it hard for them to borrow money in the future.

Short Sale

A short sale occurs when the lender indicates they are willing to accept less money than is owed on their home loan to settle the debt. To achieve this, homeowners need to provide evidence that they are experiencing financial hardship, but they don't necessarily need to be in default. 

In this scenario, the property is usually worth less than the amount owed on the loan, a concept known as “being underwater.” This is why the lender must be willing to accept less to settle the loan. This is a tough spot to be in for the owner of the home, but an opportunity for someone looking to buy it.

Sheriff’s Sale Auction

Sometimes a homeowner is notified by their lender that they are in default and then given a certain period of time during which they can get up to date on mortgage payments. If they are unable to catch up on their payments, the lender seizes the home.  Next, an auction can occur, allowing the bank to collect money quickly on the property. 

These auctions can also be used to settle tax liens ordered by a court. A tax lien prevents a home from being sold or refinanced until unpaid taxes are paid.

Bank - Owned Properties

Also known as a real estate-owned property (REO property), this refers to houses that were not purchased at auction.  In this case, the sale of the property is usually handled by a department at the institution that specializes in selling REO properties. This can include the employment of bank-owned property sales.

Government-Owned Properties

Suppose a home is purchased with a Federal Housing Administration (FHA) loan, a Department of Veterans Affairs (VA) loan, or any other type of loan that is guaranteed by the federal government. In that case, they are repossessed by the government if they go into foreclosure.  

When this happens, they are then sold by brokers that work for the specific federal agency that guarantees the loan. As you might imagine, working with government agencies to buy a home can be a little complicated. We will cover more on that process later.

How To Find And Buy Foreclosed Homes

Foreclosed homes present several unique opportunities and challenges to potential buyers. The process can be complicated, but the opportunity to save money can be substantial. Let’s take a look at how to find and buy foreclosed properties at each stage of the process.

Finding And Buying Pre-Foreclosures

Your local courthouse is an excellent place to look for pre-foreclosure listings. Often they are posted on the walls of local government buildings. In addition, there are many online resources at your disposal, including Foreclosure.com. 

Find a list of properties in the pre-foreclosure phase and see if any of them are right for you. Once you find one that seems appealing, be aware that it might not actually be for sale yet. This is the phase of foreclosure where the owner may still be trying to avoid losing their home by figuring out how to make their loan payments, so selling isn't their last resort quite yet. 

Finding And Buying Short Sales

Look online for properties listed as “pending bank approval, and you will find short sales. Short sales are the type of foreclosure sales that are most like the traditional way of purchasing a home, but the contracts will be slightly different. The most crucial difference is that the purchase agreement will be subject to the approval of the bank that holds the mortgage that is in default. 

The bank can take a long time to respond to an offer, sometimes many months, so the timeline compared to a traditional home purchase will likely be longer. Compared to a conventional sale, the price will almost always be less, though, so a bit of patience can go a long way.

Finding And Buying At Sheriff’s Sale Auctions

You will find these In a room at the local courthouse or even sometimes on the front steps. The auction process is organized and run by local law enforcement, and the property is auctioned to the highest bidder.  Announcements regarding date, time, and place can be found in newspapers or online. 

The process for purchasing them is pretty straightforward once you find the auction. All the attendees bid against each other, and the person willing to pay the most gets the house.

Finding And Buying Bank - Owned Properties

Reo agents can help identify these properties for you. In addition, there are several online sources, such as RealtyTrac, where you can search for these types of properties. In most cases you can search online by city, state, or ZIP code.

Negotiating with a mortgage broker can take more time because they are not the homeowner. When someone sells the home they live in, they devote a great deal of attention and time to it. When a mortgage broker sells a home, it represents a small portion of their business and day-to-day responsibilities, so it takes longer for them to respond to offers and move transactions along to the closing table. 

However, the options you can negotiate with are more plentiful. For example, if you get a loan to buy the house through the same mortgage lender that holds the loan on the foreclosed home, you may be able to get a lower sales price and interest rate. This isn't true in all cases, but most lenders will accommodate.

Finding And Buying Government-Owned Properties

Check out the U.S. Department of Housing and Urban Development (HUD) website to search for government-owned properties you may be interested in purchasing. Once you find one, it gets a little tricky in terms of the proper channels you need to go through to buy them.

A government-registered real estate agent must be contacted, so it's not as simple as choosing any real estate buyer’s agent you want. The process they will lead you through has a lot of rules and regulations that a standard property purchase doesn't.

So, now that you know how the buying process for a foreclosed home works, let’s look at some of the advantages of dipping your toes into the foreclosure market. First of all, you can get a great deal on a home because foreclosure properties almost always come with a lower price tag compared to homes listed for sale in the traditional way. 

When a home is priced, one of the critical factors is the financial situation of the sellers. If they are in a tight financial bind and need a certain amount of money fast, like in the case of a foreclosure, they will price it low so that it will sell quickly. If they don’t need a certain amount of money quickly, they can price it higher and see if someone will pay what they want. 

The farther along a home is in the selling process, the better the price will be. When a homeowner is selling it themselves as part of pre-foreclosure, they will price it high enough to get at least what they owe on the loan. When it goes into the hands of a bank or government entity, they don’t want to hold on to the house, so they will reduce the price even further to make sure it sells quickly. 

Finding homes at prices below market value is not the only advantage. Many potential buyers are turned off by foreclosed homes, usually because they don't know enough about them, so there is less buyer competition. Working on purchasing with less competition is always a good thing in a seller’s market- where home prices are high, and inventory is low.

From a purchase price perspective, the urge to buy a foreclosed home will be strong. Sometimes it almost seems like a deal too good to be true. Well, sometimes it is. Foreclosure homes are usually sold “as is,” which means there might be something wrong with them.

During the traditional home-buying process, the home inspection period allows you to go through the house with a certified inspector and determine what is wrong with it. Once you find any deficiencies, you can negotiate with the seller to fix the problems or reduce the price of the house. When a property is sold “as is,” the inspection is not an opportunity to negotiate. Sometimes you can’t do an inspection at all. When it comes to the house’s condition, you are operating in the dark with foreclosure sales. After you purchase the home, there may be costly repairs or renovations to do. 

Physical issues with the house aren't the only problems that can arise with foreclosures. The home may also have liens on it. A lien is a legal right or claim against a property that needs to be repaid or resolved before the property can be sold or refinanced. A mortgage is a type of lien, but there are other types as well. For example, if a homeowner doesn't pay their taxes, the Internal Revenue Service (IRS) may place a tax lien on their home. This means that the unpaid taxes need to be collected before the house can be sold. 

If you buy from a bank or the government as part of a foreclosure sale, you don't have to worry about liens. The mortgage company or municipality will pay off all the liens before offering the property for sale.