You’re looking through online home listings, reading the search results email from your agent, or driving through your target neighborhoods when a home that really catches your eye pops up. It has curb appeal, an excellent location and — amazingly — also appears to be priced below what you would expect given your research into the local market.
At some point, through perusing the details of the listing, or perhaps through something as obvious as a small rider attached to the yard sign, you realize this home is in foreclosure.
What does that mean? Can you still buy it? How? And why is it priced so low?
Answering these questions, as well as others that will occur to you, requires a look at the sometimes wacky and sometimes wonderful world of foreclosures.
Foreclosure as a process
The first thing to understand is that foreclosure is what happens to a home when the owner stops making payments on the loan used to purchase it. It’s similar to what happens to a car when the owner fails to make payments on the auto loan. That is, the lender takes possession of the asset — in this, case, the home. That gives you, the prospective homebuyer in search of a great house at a great price, the opportunity to buy it.
Also understand that foreclosure is a process — sometimes a lengthy one — and that foreclosed homes come in two main varieties depending on their place in that process: preforeclosure and post-foreclosure.
“Preforeclosure could mean one of two things,” explains Ed Kaminsky, who works with 66% more single-family homes than the average Manhattan Beach agent and has an annual sales volume of over $180 million. “It means for sure that the homeowner is behind on their payment. It could be that an actual notice has been given to the owner that they are behind and the bank is about to take action against them if they don’t get caught up. It doesn’t mean the home is going to be foreclosed on.”
So a house doesn’t go into foreclosure as soon as a homeowner misses one mortgage payment. Instead, there’s a process, and it will be slightly different in terms of timing depending on where you are buying.
“Each state has their own rules on how much notice has to be given,” Kaminsky says. “In California, if a homeowner is 30 days behind on their mortgage, the bank has the right to issue a notice of default. That means they’ve defaulted on their payments.
“This is a 90-day notice that the bank has the right to foreclose on the home. Once those 90 days are up, the bank can go to the next step, which is a notice to foreclose.”
Even in California, many lenders may not file that notice of default after one missed payment; they’ll usually try to work with the borrower first. But as a rule, no matter where you are, after the homeowner has missed between three and six months of payments, the lender will record the notice of default with the city or county recorder.
Now the house is in preforeclosure. However, the homeowner still has a chance to work out some kind of deal with the lender to stay in the home. Again, depending where you are, this grace period could be from between a month and several months long.
“At any time, the homeowner can contact the bank and work out a payment plan to stop the foreclosure,” Kaminsky says. “Most banks don’t want to foreclose. They want to avoid foreclosure.”
If no deal can be arranged, or the homeowner doesn’t try to stave off foreclosure, the house will go into foreclosure and the lender will take possession of it. But that is unusual.
Kaminsky estimates that 90% of homeowners who receive notices of default manage to work things out with their lenders and avoid foreclosure.
Buying a home in preforeclosure
With all this in mind, you can potentially buy a house that is in preforeclosure. As long as the homeowner is in default (the bank has not yet foreclosed and taken possession of the house) and is still the home’s owner, they can decide whether or not they want to list the house. And they sometimes do.
Also, your agent may have become aware — likely through checking county records of notices of default — of a home that isn’t listed for sale but is in preforeclosure. This can give you (or any other buyer) the opportunity to submit an unsolicited offer.
Sometimes homeowners in default welcome such offers. They might be looking for a way to get out from under their mortgage payment. Your offer to buy it could be their way out.
There’s no guarantee, however. Some defaulted borrowers will consider an unsolicited offer to be an unwelcome distraction from their effort to catch up on missed payments or otherwise settle the matter with their lender. For instance, a deed-in-lieu-of-foreclosure agreement lets the homeowner avoid foreclosure, and the resulting hit on his or her credit, by simply handing over the home.
Another possible wrinkle is that the balance on the loan might be more than the house is worth. If that’s what’s going on, it would be sold as a short sale. The lender has to agree to a short sale, even if you and the seller agree on a price. If the lender doesn’t like the offer, they can and will reject it. Either way, it could take months for the lender to give the offer the thumbs-up or thumbs-down.
To find out what’s going on, ask your agent to contact the homeowner to find out the details. He or she may already have done that.
“It’s a method of agents to find new listings to call homeowners who are in default before the banks take the property,” Kaminsky says.
Keep in mind that houses at any stage of foreclosure may need significant repairs. If you’re buying a preforeclosure from the current owner, you can and should order an inspection. However, a seller in financial distress may not be able to fix much so the sale could be as-is.
Otherwise, assuming it’s not a short sale requiring the bank’s okay, a preforeclosure sale is no different from another purchase.
After the foreclosure
When an owner doesn’t or can’t sell or keep up the payments, the process of foreclosure continues until, often after months have passed, the bank takes possession of the house. At that point, the first and only thing the lender wants to do with the house is sell it — lenders aren’t in the business of owning property.
Lenders usually sell repossessed properties at foreclosure auctions. Foreclosure auctions happen everywhere, in just about every county in the country. You can find out about foreclosure auctions in a variety of ways, including local newspapers, courthouse postings, and online databases of them.
And, although the process varies somewhat depending on where you are, the standard foreclosure auction happens at the local courthouse. A representative of the lender solicits bids on the property, the bidders bid, and the highest bid wins the house. (That’s a simplified version.) During the coronavirus pandemic, many auctions have been taking place online only.
“You have to check with your jurisdiction,” Kaminsky says. “But, generally, they’re live auctions held by a trustee of the bank. They literally are standing on the courthouse steps.”
There are different types of auctions. Sometimes the bank will accept the highest bid no matter what it is. Other times, if the highest bid is lower than a predetermined minimum, the bank can decline to sell to the auction winner.
In Kaminsky’s experience, the first bid amount set by the lender is usually the balance owed on the mortgage. “If it’s a $1-million home, and the homeowner owes $550,000, the first bid is typically $550,000,” Kaminsky says.
Getting ready to bid
If you want to bid on a house at a foreclosure auction, you’ll have to prepare. This is not like ordinary house-hunting.
For one thing, you won’t be able to get the home professionally inspected or even walk through it to check for problems before making your bid. “You have to buy the house sight-unseen,” Kaminsky says. This means, among other things, that you need to have a cash cushion to address any repair issues that aren’t visible before the auction.
That’s not all. Kaminsky notes that many foreclosed homes still have the former owners living in them. “You have to find a way to legally get them out of the house,” he says.
There’s more, starting with the way you’ll finance the purchase. In short, you likely won’t finance it. Although local practices may vary, the majority of foreclosure sales have to be paid for with cash, either on the day of the sale or very soon thereafter. “There’s no option,” Kaminsky says. “You can’t finance a foreclosed property if you’re going to the courthouse steps.”
Another important concern: No title insurance for homes purchased at a foreclosure auction.
“Title insurance ensures that you’re getting title to the property and there are no senior loans,” Kaminsky says. “You’re buying, in a sense, not the house at auction, but the loan. If there’s something senior, such as a government property tax lien, you’re responsible for paying those off. So you need to do due diligence with a title company to find out what you’re buying.”
As if that’s not enough, you may do your due diligence, come up with the necessary cash, take a deep breath and submit the highest bid — only to find out that the current owner of the house doesn’t have to give it up after all.
In states with “right of redemption” rules, borrowers have a certain amount of time to come up with the amount they owe on the loan and stop the foreclosure process, so this can be another snag in the process.
After the auction: REO homes
Often, foreclosed homes don’t sell at auction. If this happens, it becomes a bank-owned home — what is known as an REO property, which stands for “real-estate owned.” A foreclosed REO home is likely to be listed on the market for sale as-is.
“The moment the bank gets the property after an investor doesn’t buy it, they hire a real estate agent and put it up for sale on the local market,” Kaminsky says. “You buy it through the normal process.”
Government home loan programs have set up entire systems to ease the process of buying their REOs.
- HomePath is a system set up by Fannie Mae to sell its REOs.
- HomeSteps is run by Freddie Mac to help buyers shop its REO inventory.
- HUD Homes is the Department of Housing and Urban Development (HUD) system for selling its REOs.
Some major private lenders also operate online tools to help you buy their REOs.
In addition to being easier to find, you do have the opportunity to inspect or walk through these homes — although they’ll be sold as-is. You can also buy them with the same sort of financing you’d use for any home purchase, although some lenders are cautious about foreclosure loans.
This last approach, buying an REO, is probably the easiest, most accessible way for you to buy a foreclosed home. And the good news is, REO lists are where many foreclosed homes wind up.
“A very large percentage of homes that get foreclosed upon do come in the open market, and you can buy it with traditional financing, traditional title insurance, and buy it safely,” Kaminsky says.
The state of the foreclosure market
Of course, along with location, timing is very important in real estate. And right now, thanks to recent and current price appreciation trends, there aren’t that many houses in foreclosure. The reason is because when a homeowner gets behind on the mortgage in a house that is worth a lot more than is owed, most of the time they don’t go through foreclosure.
“We’re not in a foreclosure market right now,” Kaminsky says.
“We’re in a hot market where most sellers have plenty of equity. If they fall behind on payments, there’s still a good chance they can put it on the market and sell it and get their homes paid off.”
Clearly, buying a home in foreclosure is a bit tricky. Working with an agent who has experience with these deals (at any stage) can keep you from potentially making an expensive mistake.
But for the right kind of person whose dream home shows up as a foreclosure, it is worth the effort. “If you’re an opportunist and can pull together cash,” Kaminsky says, “learning about the foreclosure process can be very risky — and very profitable.”
Header Image Source: (Andy Dean Photography / Shutterstock)