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You’re reading through a new MLS listing, and you believe you found your ideal home. It’s spacious, in your perfect neighborhood, and at a surprisingly affordable price. But right as you’re about to call your real estate agent, you notice there’s a line in there that labels it a foreclosure. Undoubtedly your mind starts racing, “What does that mean? Can you still put in an offer? How do you buy a foreclosure?”
Those are all very fair — and very common — questions. Foreclosures may present the perfect opportunity to buy in your ideal neighborhood at a low price. Or they may offer an affordable fixer-upper you can turn into your dream house. But, on the flip side, they may also come with headaches, repairs, and challenges that may end up costing more than you hope.
So how do you buy a foreclosure and make sure it’s the right home for you? We talked with veteran real estate agents with a combined 30-plus years working with foreclosures to bring you a comprehensive guide to the often confusing world of distressed properties.
What is a foreclosed home?
A foreclosed home is a property that has been seized by the bank after the homeowner failed to make their mortgage payments. This could happen for many reasons, including financial difficulty, divorce, a death in the family, or just because someone ignored their payments.
Of course, foreclosure isn’t an overnight process. In fact, the average foreclosure proceeding in the U.S. took over 900 days as of the second quarter of 2021. A home goes through several steps before the bank physically takes over the house and sells the property. The exact steps vary from state to state, but let’s take a general look:
Pre-foreclosure: As the name implies, a pre-foreclosure isn’t in foreclosure yet, but it’s on the way there. Usually, a home goes into pre-foreclosure after several consecutive months of missed mortgage payments, and the lender issues a notice of default. Again, the timeline varies by state, but this typically begins three to six months after the first missed payment, according to the Department of Housing and Urban Development (HUD).
Foreclosure: If a homeowner cannot resolve their payment issues within another grace period (usually 90 days) after the default notice, formal foreclosure typically begins, and the bank takes over the home. They’ll put the house up for auction either in a sheriff’s or public trustee sale (the name depends on what foreclosure process your state follows).
Bank-Owned or REO: If a home doesn’t sell at auction, it becomes a real-estate owned home, meaning the bank or lender officially owns it. The bank will then list the property on the market and try to sell the home in a similar fashion to your average property.
Note: Most states follow either judicial or non-judicial foreclosure proceedings. You can find your state’s exact foreclosure laws using this nifty tool.
Different types of foreclosure sales
During the COVID-19 pandemic, foreclosures stalled across the U.S. due to both federal and state-imposed foreclosure moratoriums. Distressed sales accounted for just 1% of all home sales in April 2021. However, as those forbearances end toward the later part of 2021, foreclosures will likely become more readily available and may even hit the market in droves, says Florida real estate agent Christina Griffin, who has 20 years of experience in the industry.
So, it’s helpful to know precisely how to find them. Let’s take a look at the most common foreclosure sales and how they work.
A short sale isn’t necessarily a foreclosure sale, but it’s common to see a short sale done to avoid foreclosure. With a short sale, a lender agrees to a property sale for less than the remaining mortgage balance. For example, a homeowner and lender agree to sell a house for $200,000 even though there is a balance of $250,000 on the mortgage loan. A seller will usually have to prove financial hardship for the lender to agree to the sale.
Short sales can typically be found through the MLS database or your buyer’s agent. There are even some real estate agents that specialize in short sales that may have more resources than your typical Realtor.
After a notice of default, a homeowner might opt to sell their house to stave off foreclosure and avoid the messy legal proceedings. This is different than a short sale because a pre-foreclosure seller usually still has equity in the house (meaning the home value is more than their mortgage balance). So selling the home at this point will avoid foreclosure while the seller still might have the potential to walk away with something from the sale.
Once a bank takes possession of a house, it will usually want to get it off their hands as quickly as possible. They’ll put it up for auction either at a sheriff’s sale or public trustee’s sale, depending on the exact foreclosure process your state follows. Simply put, a representative from the lender will typically take bids from those in attendance, and the highest bidder will win the home. The goal here is for the lender to at least earn back the balance left on the mortgage.
A foreclosure auction typically takes place in person at a county courthouse or public space, but online auctions are becoming increasingly popular, especially since the start of the COVID-19 pandemic.
Note: You can find foreclosure auctions in almost every county in the country. They can typically be found through your county’s public records or even through specialty websites like Auction.com.
If a home doesn’t sell at auction, the bank will formally take ownership of the house and list it as a real-estate owned property. These typically sell through a similar process to your average home, but there are more ways to find them. Many properties will be listed on the MLS database while many lenders may have REO listings available right on their websites (for example, Bank of America and Wells Fargo have sites dedicated to their REO properties).
If none of these programs work for you, you can always go straight to the source. Many foreclosed properties end up in the hands of HUD or the government-sponsored enterprises (GSE), Fannie Mae or Freddie Mac. These organizations have their own programs to buy distressed properties and even offer incentives for some first-time buyers.
Fannie Mae has its HomePath program, Freddie Mac has a HomeSteps program, and HUD has HUD homes. HUD also provides a Good Neighbor Next Door Sales program that offers foreclosed properties at a steep discount to teachers, law enforcement officers, and other first responders.
Benefits of a foreclosed property
You may find a good deal
The biggest reason a buyer might seek out a distressed property is that they’re looking for a good deal, and they might be in luck. Distressed properties sold at a 36% discount compared to the average home price during the third quarter of 2020. After all, lenders and banks don’t want to hold onto a property if it’s not making them money, so they want to move it quickly, even if that means taking a lower price.
However, Griffin, our Florida real estate agent, cautions that may not always be the case. Depending on the property, a foreclosure might look like a great deal on paper, but there may be hidden costs. We’ll cover that more later on.
Chance for less competition
Griffin believes the world of foreclosure can open up a whole new level of inventory for homebuyers, and if done correctly, that may also mean less competition. She says the average buyer typically doesn’t seek out a foreclosed home, so investors and cash buyers will be your main competition. However, some special programs give you a leg up to get in first. For example, Fannie Mae’s HomePath program provides a “First Look” window that lets owner-occupants (meaning those who will use the home as their primary residence) view and purchase a foreclosed home before investors.
Chance for a clean slate
If you’re looking for a fixer-upper that’s available at an affordable price, a foreclosed home may be your best bet. Kyle Keller, an Arizona real estate agent who has flipped over 75 properties, says a distressed house may be perfect for someone looking to buy a home and make it their own. Plus, a physically foreclosed property will typically have its liens wiped out during the foreclosure process, so you know you’re typically getting a home with a clean title. However, Keller cautions that a pre-foreclosure and auction sale might still have multiple liens on a property, so he warns all buyers to complete a title search before closing if possible.
Drawbacks of a foreclosed property
They’re usually sold ‘as-is’
Many foreclosed homes, especially REOs and those sold at auction, are likely to be sold “as-is,” or in the exact condition you find them. That means the bank is highly unlikely to make any repairs before the sale or even offer any credits toward them. So, it’s essential to make sure you know you will be on the hook for all future repairs and issues lurking inside the home. That’s why a home inspection is so important if you’re able to do one.
It’s a riskier investment
While a foreclosure might present a good deal on paper, both Griffin and Keller agree it can sometimes be a gamble. Distressed properties can often be in rough condition, especially if they’ve gone through a prolonged state of disrepair or sat vacant. Griffin says she’s worked with many homes that have had their air conditioning units ripped out and walls completely stripped while they sat during the foreclosure process. On top of that, if you’re buying at auction, you’ll most likely be buying the property sight unseen, and you may also be responsible for any liens or debts on the property.
Griffin also cautions that, while uncommon, you may become responsible for evicting the previous homeowners if they were allowed to stay during the foreclosure process. That could involve legal eviction proceedings and actions to get the previous owner out. So a home that looks like a steal might just end up causing you more money and headaches down the line if serious issues surround the property.
It can be a drawn-out process
The average home closing in the U.S. can take anywhere from 30 to 60 days, but with a foreclosure, you might be looking at a much longer process. After all, a home can take upwards of 900 days to go through foreclosure proceedings. Buying a distressed property requires more paperwork, more approvals, and more time, so the process may get dragged out. That’s especially the case if you’re hoping to finance your purchase, which can be tricky depending on the condition of the home and the property requirements your lender has.
How do you finance a foreclosed property?
That brings us to our next question: Can you finance a foreclosure in the same way as an average property? Griffin says that depends on how you’re buying the home and its condition.
If you’re buying a home at auction, you most likely won’t be able to finance your purchase, except in rare cases. Instead, you will probably need to buy your new property in cash due shortly after your winning bid.
However, if you’re buying a pre-foreclosure, short sale, or REO property, financing is still an option as long as your property isn’t in disrepair. Your home needs to meet the property requirements required by your loan type. These are to make sure the house is “safe, sanitary, and secure,” Griffin says.
If you’re buying the home through a foreclosure program (like HomePath or HomeSteps), then the house will most likely meet all of these standards, Griffin says. However, sites like Auction.com warn that traditional financing might be hard to obtain when buying one of their homes due to their condition. Griffin adds, in that case, you may need a hard-money loan, equity line of credit, or cash to purchase the property.
“When you get traditional financing, you have to have [the standard utilities], electric, heat … water running,” Griffin says. “If there’s a problem with that, that’s where you have to be able to pivot your financing.”
Here are some other options to keep in mind if a conventional loan doesn’t work out: FHA 203(k) loan, also known as a rehab loan; Fannie Mae’s HomePath ReadyBuyer program, which gives closing cost assistance for REO homes; or Fannie Mae’s HomeStyle loan, another type of renovation loan commonly used to purchase and restore a property.
6 steps to buy a foreclosure like a pro
Buying a foreclosure can be a complicated process, but it doesn’t have to be as hard as it seems. With the help of our veteran agents, we developed several must-follow steps to make the process as simple as possible.
Note: These steps are geared toward buying a home that has already been physically foreclosed on. Buying at an auction is a bit of a different process and requires another set of skills.
Just like a traditional home search, getting pre-approved for a mortgage should be your first step when buying a foreclosure. This will give you an idea of what you can afford and even streamline the process once you actually find a home.
Find a trusted agent with foreclosure experience
Griffin believes this is the best way to set yourself up for success when pursuing a foreclosure. Find an agent who has experience working in the world of distressed properties and knows how to navigate its ins and outs. Ideally, your agent should be a “hunter,” Griffin says — someone who can seek out opportunities for you and stay on top of the process, anticipating any challenges that might pop up.
Conduct a thorough home search
Your agent can help you find foreclosures listed on the MLS database, but it’s helpful also to do your own research. County records will have properties entering pre-foreclosure and those going to auction. Specialty sites like Auction.com and RealtyTrac also offer databases for distressed properties for sale, while foreclosure programs like HUD homes will also have extensive listings available.
If you find a home you’re interested in, Keller advises researching comparable homes, or comps, in the area to ensure the price is reasonable compared to the average home. He says you don’t want to pay more for a distressed property than you would on a house in good condition.
Make an offer
Once you have your ideal property, it’s time to submit an offer. Your research should have given you an offer price that’s both fair for the seller/bank and beneficial to you. However, it’s important to know there might not be much wiggle room on negotiations since the bank is looking to recoup the money it lost from its mortgage loan.
Griffin suggests adding a title review period into your offer and contract to make sure you can check the title for any liens or judgments. If you’re unable to do that, she strongly recommends conducting a title search yourself (along with your agent’s help) before locking into any contract.
Gather a team of experts
Your real estate agent will be your go-to expert when navigating foreclosures. However, it’ll take an entire team to make sure you’re covering all of your bases. On top of a home inspector, Griffin suggests finding a trusted general contractor who can take a look at your potential new home because they can “look at things a little differently.” They may be able to offer a more comprehensive insight into what repairs you might be facing.
It’s also important to find a trusted real estate attorney who can make sure you’re writing your real estate contracts correctly and protecting yourself in case of any complications.
Pay attention to the details
Griffin stresses that all foreclosures are different, and the purchase process may differ depending on the situation. On top of that, most banks and lenders don’t operate in the same way, so there isn’t a one-size-fits-all guide when buying a distressed property. So, it’s essential to read your documents carefully and pay attention to the details right up until closing, she says. This will not only ensure the transaction will continue without any hiccups but also that you’re properly protecting yourself.
That way, you can make it to the closing table with as few problems as possible. And when you officially sign the documents for your new home, you can feel comfortable knowing you’ve made a sound investment.
Header Image Source: (Mitchell Luo / Unsplash)