You’ve heard stories about people buying foreclosures, and you’ve seen them pop up on listing sites — but you have questions. Questions like: How does buying a foreclosure work? What even is a foreclosure? How do you get your hands on one? Do they really save you money? And is it a good idea to buy one in the first place?
Worry not, we have answers. We enlisted the help of top experts and put together this handy guide on how buying a foreclosure works. Here’s what smart homebuyers need to know to stay ahead of the curve.
What is a foreclosure?
You see foreclosures listed on your favorite real estate sites, but what does that term really mean?
“A foreclosed property is a property that has gone through the legal process of foreclosure where the bank seeks to regain ownership of the property to make good on a debt,” explains top Seattle real estate agent Ken Crotts, who works with over 66% more single family homes than the average area agent.
But let’s back up a minute. Why would a lender “seek to regain ownership” of a home?
“If somebody hasn’t made their payments for a period of time, the law allows the bank to repossess the property to make good on the debt,” states Crotts.
Essentially, foreclosure works like this.
1. Missed payments: The homeowner stops making payments for a period of time, typically at least three to six months (though the timing depends on the state).
2. Preforeclosure: The lender sends a notice of default to inform the owner that they must get up to date on their mortgage payments within a certain timeframe — or they will face foreclosure. This kicks off the “preforeclosure” phase.
3. Foreclosure: If the homeowner can’t resolve their payments or work out some kind of forbearance plan with the lender within 90 days, the bank will carry out the remaining foreclosure process and repossess the home.
But that doesn’t mean the owner will be kicked out six months after their first missed mortgage payment: All in all, the foreclosure process takes an average of 922 days nationally.
4. Auction: Once the home has gone through the legal process of foreclosure and repossession, the property is auctioned to the highest bidder, typically on the courthouse steps, though foreclosure auctions are increasingly happening online.
5. REO owned: If the home doesn’t sell at auction, it becomes real-estate owned, meaning the bank or lender owns it. The home will be listed and sold similarly to other homes on the market.Another thing to note is that the foreclosure process can be a little bit different in each state. Check with your lender or real estate agent to learn more about how it works where you live.
How are foreclosures sold?
“There are [potentially] three different opportunities to buy a foreclosure property, at different times during the foreclosure process,” reveals Crotts.
These opportunities might include:
- Pre-foreclosure sale
- Foreclosure auction
- REO listing
Let’s walk through each option and what it looks like in practice.
Sometimes, a homeowner will agree to sell their home before they reach foreclosure. This is usually done through a preforeclosure sale.
Remember that notice of default the lender sends out, initiating the preforeclosure phase?
“Some of these notices are made public, and when they’re made public, there are buyers that will directly contact those owners and seek to buy that property before it goes into foreclosure,” Crotts says.
Something to note here: Many of these preforeclosure homes are not listed for sale. Just because a homeowner is behind on their mortgage payments doesn’t mean they’re necessarily ready to sell their home.
However, investors and agents often see these preforeclosures as an opportunity. They routinely scour public lists of preforeclosures and proactively reach out to the owners — often through a phone call, a mailer, or a friendly door knock — to show their interest in making a purchase.
“That provides a remedy for the homeowner and stops the foreclosure,” shares Crotts.
However, it’s rare that everyday buyers go the preforeclosure route, as it’s usually handled by experienced professionals.
“When you’re browsing properties online, there are sites that will display preforeclosure properties. I would avoid those,” Crotts advises.
He says that in most cases, the homeowners aren’t really looking to sell, whether because they have a deal worked out with their lender, or because they’re planning to make good on their missed mortgage payments.
“You’ve got to contact a lot of those people to find one who’s in a position to sell and is willing to sell the property. So it’s an enormous amount of work to find a preforeclosure deal that will actually come together — literally hundreds of homes you’d have to go through.”
The next opportunity to purchase a foreclosure is at auction.
At this point, the home has been repossessed by the lender, who’s trying to unload it quickly by selling it for cash to the highest bidder — often on the courthouse steps.
The process differs by state, but most foreclosure auction sales are done quickly and in cash. Today, more of these auctions than ever are taking place online.
“Washington’s foreclosure process is 150 days, culminating in an auction at the courthouse steps,” explains Crotts. The property is then “bid upon by would-be buyers who have cash in hand and can purchase and take title to the property almost immediately, right on that day.”
Again, most foreclosure auction purchases are completed by professional investors, because these deals are typically done in cash, and foreclosed homes may involve risks that everyday homebuyers aren’t up for (more on that soon).
That doesn’t mean you can’t buy a home at auction if you’re a regular buyer, but you’ll definitely want to do your research. According to Crotts, you shouldn’t even think about buying a home this way until you show up and observe a live auction yourself.
“If you’re interested in buying foreclosures, it’s something that you should witness,” Crotts shares. “It’s a really fun and interesting activity — kind of a circus or carnival type of atmosphere.”
Finally, a third way to buy a foreclosure is through a real-estate owned, or REO, listing.
This means that the home wasn’t purchased during the preforeclosure period or at auction, and instead it is now owned by the lender, who lists it and sells it much like a typical home sale.
Crotts explains that lenders often have systems for offloading these properties in a timely manner, usually through the help of asset managers.
This is the most common way that regular homebuyers purchase foreclosures, since it works similarly to any other home purchase. The one big difference is that the seller is a bank rather than an everyday homeowner.
The everyday homeowner might have a range of motivations for selling their property — including moving timelines and emotional concerns — but a bank will generally care most about their bottom line and recuperating as much money as possible from the sale.
Keep that motivation in mind if you plan to purchase a foreclosure! The bank will probably not want to offer the home at a massive discount.
“The asset manager — in protecting their client’s interest — has a specific process they’re going to follow to ensure that they get fair-market value for the property when they do sell it,” Crotts shares.
That’s why a top agent with experience buying distressed homes can be your biggest asset when negotiating a foreclosure purchase. They have relationships with these asset managers and understand their core motivations.
Is it a good idea to buy a foreclosure?
“All of that’s great,” you might be thinking, “but is it even a good idea to buy a foreclosure at all?”
That depends on the type of buyer you are and what you’re looking for in a home. But before we get into the buyers who are best suited to a foreclosure purchase, let’s run through the benefits and drawbacks of buying this type of property.
Pros of buying a foreclosure
You might get a good deal!
In a hot market, good deals are hard to come by. Crotts says distressed properties like foreclosures can offer an opportunity to pay a little bit less.
“The primary benefit of a foreclosure property is its condition and your ability to improve the condition of the property and build equity as a result.”
If you’re handy, patient, and have the cash flow to fix your new home up, you could get a good deal on a foreclosure and save some money in the process.
But again, understand that we’re not talking about a massive discount here — more like a modest savings and an opportunity to build equity as you improve the home.
You can build equity fast
Speaking of equity, “foreclosure properties offer a great opportunity to build equity in a home through improvement,” according to Crotts.
Most foreclosure properties need at least some work. Think of it this way: If the homeowner couldn’t afford to make mortgage payments, they probably weren’t able to afford upkeep or repairs, either.
That can present an opportunity to you, the buyer, to make value-adding improvements.
There’s less competition
Another plus of buying a foreclosure? There’s less competition from other buyers, since most are looking for move-in ready homes.
Keep losing out on bidding wars? Maybe buying a foreclosure and fixing it up over time is your path to homeownership.
Cons of buying a foreclosure
There’s more risk involved
That said, foreclosures are riskier than a typical home purchase. They’re considered “distressed properties,” and most need at least some repairs. They can even sometimes have squatters, or significant damage from previous owners.
If you buy a foreclosure, you’ll need to do your due diligence and understand the risks you’re taking. It’s important to protect yourself by having a top agent and a trusted real estate attorney by your side.
You’re buying as-is
“The seller’s not going to do a bunch of work to the property,” Crotts cautions. “They will do reasonable amounts of work if it means that the property gets sold. But in most cases, you’re taking the property more or less in as-is condition.”
As-is means take it or leave it — what you see is what you get. Make sure to get a good inspection, and know what you’re getting yourself into!
You may not be able to do an inspection
In some cases, it may not be possible to do an inspection on a foreclosure, or even to tour the home.
For example, if you’re buying a foreclosure at auction, then it’s very unlikely you’ll be able to enter the home or order a home inspection before making your bid.
“I would avoid properties that don’t have an inspection or won’t allow an inspection,” Crotts says. “Buying as-is is one thing, but buying without being able to see a property or get an inspection on a property puts you at substantial risk.”
Financing might not be an option
If you’re buying a foreclosure at auction, it’s unlikely that you’ll be able to get a mortgage to pay for it. Most auctions require cash and a quick payment, often within seven days — sometimes sooner. This is why most regular buyers avoid buying a home this way.
The good news is, most REO-listed homes do allow financing, so it still can be an option. But understand that some foreclosures (or all foreclosed homes at a certain stage of the process, such as the auction stage) may be out of your reach if you don’t have cash.
You’re at the bank’s mercy
Again, the bank owning the foreclosure is going to try to recover as much money as possible, and the buyer is essentially at its mercy. That means working on the bank’s timeline and potentially dealing with red tape in the process.
Who usually buys foreclosures?
“There are a few buyers out there that are purchasing properties for their own occupancy, but the vast majority are going to be considered investors,” Crotts reveals.
That’s because investors have the skills and cash flow necessary to make such purchases strategically. They’re usually able to fix up the property and either rent it out or sell it for a profit.
That doesn’t mean you can’t invest in a foreclosure for your next home. Real people can — and do — buy homes this way! One mega-investor started with buying a single preforeclosure more than a decade ago, and now he’s purchased hundreds.
But is buying a foreclosure a good fit for you?
What type of buyer is a good fit for a foreclosure?
Crotts says he sees two main types of buyers who tend to be a better fit for foreclosure properties:
- Value-oriented buyers who are looking to roll up their sleeves and build some equity. These buyers might be looking for a full-time home, or a rental or long-term investment opportunity.
- Choosy buyers looking for something very specific — whether location, lot type, or home style — which happens to be found through an available foreclosure. “Those types of buyers are very specific and need a lot of properties to look at in order to find that one that meets their criteria best,” Crotts adds.
Another possible reason you might go for a foreclosure is simply because you can’t afford a move-in ready home, and you don’t have much inventory to choose from where you’re looking.
Whatever your motivations, buying a foreclosure might be more accessible than you think. Just make sure to surround yourself with a top real estate team who can help you get a deal rather than a dud!
Header Image Source: (Jasper Graetsch / Unsplash)