How to Buy a Foreclosed Home

Before the mortgage crisis of 2007–2009, buying a foreclosed home was a tricky proposition. Real estate bargain hunters had to follow auctions put on at courthouses or sift through reams of legal filings. The response to the subprime meltdown not only increased the number of available properties but also made it easier to find and acquire them. In fact, today’s process is quite similar to a search for any type of home.

While foreclosure rates have plummeted, some homes are available in virtually every real estate market in the United States, providing opportunities for homeowners and investors alike. Once you find the foreclosed home you want to purchase, find the right mortgage lender, and you could be on your way to homeownership. If you’re not paying cash for a foreclosed home, you might qualify for a government assistance program.

How to Find Foreclosed Homes for Sale

Finding foreclosures can be rewarding, yielding diamonds in the rough or real estate fortunes sold below market value. Here are some ways to find foreclosed homes.

1. Website and print publications. Foreclosed properties can be found on various websites and print publications, via online real estate searches, at bank offices and websites, and in local newspapers.
2. Multiple listing service (MLS). In local multiple listing services, the foreclosure status of a property may not be highlighted; the fact may only be stated in the property description.
3. Foreclosure websites. A more direct route is to go through websites that specialize in foreclosure homes and properties, such as Fannie Mae’s HomePath. Some financial institutions, such as Bank of America, also have web search pages for foreclosed homes.
4. Real estate professionals. Lenders are increasingly selling seized assets through real estate agents, so don’t hesitate to ask a broker or agent for opportunities. Some real estate pros even specialize in foreclosure properties.

The Types of Foreclosure Sales

Finding a foreclosed home depends on where exactly it is in the foreclosure process. Properties in the early stages of foreclosure or offered in a short sale may still be owned by the original homeowner or held by a bank or government.

Here are five types of foreclosure and the approaches to buying:

1. Pre-Foreclosures

A property is in pre-foreclosure after the mortgage lender has notified the borrowers that they are in default but before the property is offered for sale at auction. If a homeowner can sell the property during this time, they may be able to avoid an actual foreclosure proceeding and its negative effect on their credit history and future prospects.

Pre-foreclosures are typically listed in county and city courthouse buildings. In addition, many online resources, including Foreclosure.com, list properties that are in the pre-foreclosure phase.

2. Short Sales

In a short sale, a lender is willing to accept less for a property than the amount that is owed on its mortgage. Borrowers do not necessarily need to be in default for a lender to agree to a short sale. However, they typically need to prove some type of financial hardship that is likely to result in default, such as the loss of a job.

In these cases, the home is likely to be underwater, meaning that it is worth less than the outstanding mortgage balance. To qualify as a short sale, the lender must agree to “sell the property short” by accepting less than is owed, and the home must be listed for sale.

These properties are usually advertised as short sales “pending bank approval.”

Purchasing a short-sale property is, in most respects, the same as a traditional purchase, but the language in the contracts will differ, specifying that the terms are subject to the lender’s approval. A bank may take several months to respond to a short-sale offer, so the process can take considerably longer than a traditional purchase.

Many real estate websites, including individual firms and listing services, offer the option to search by short-sale status.

3. Sheriff’s Sale Auctions

A sheriff’s sale auction occurs after the lender has notified the borrower of default and allowed a grace period for the borrower to catch up on mortgage payments. An auction is designed to help the lender get repaid quickly for a loan that is in default.

These auctions often occur on a city’s courthouse steps and are managed by local law enforcement authorities. The property is auctioned to the highest bidder at a publicly announced place, date, and time.

Notices can be found in local newspapers and on the web. Search for “sheriff sale auctions.”

4. Bank-Owned Properties

Properties that do not sell at auction revert back to the bank, becoming real estate-owned (REO) properties.

These properties are often managed by the institution’s REO department. Online sources such as RealtyTrac have extensive listings of bank-owned properties that can be searched by city, state, or ZIP code.

5. Government-Owned Properties

Some homes are purchased with loans guaranteed by the U.S. government’s Federal Housing Administration (FHA) or Department of Veterans Affairs (VA). When these properties go into foreclosure, the government repossesses them and sells them to brokers working on behalf of the federal agency.

To purchase a government-owned property, buyers must contact a government-registered broker. The U.S. Department of Housing and Urban Development (HUD) website lists registered brokers.

Financial Help for Homebuyers

If you’re on a very tight budget, you may be eligible for one of several federal programs that are designed to make homeownership attainable.

USDA Loan Program

The U.S. Department of Agriculture (USDA) has two programs, called the Section 502 Direct Loan Program and the 504, that help low-income and very low-income people who live in rural areas obtain safe and decent homes.

• The Section 502 program subsidizes loan payments used to buy a modest residence in a rural area. Eligible citizens must be low-income or very low-income.
• The Section 504 Single Family Repair program offers loans for repairing and upgrading homes in rural areas. The loans are for very low-income people who cannot obtain bank financing. Elderly people may be eligible for outright grants.

Veterans Affairs Loan Program

The federal Veterans Affairs Department has a mortgage guarantee program that is open to current service members, veterans, and surviving spouses. According to Military.com, the loans can be used to buy repossessed properties, although a bit of advance preparation is needed.

Benefits include zero-down-payment loans, reduced closing costs, and a waiver of the mortgage insurance requirement.

Why Foreclosed Homes Are Cheaper

The biggest selling point of a foreclosed home is, of course, its marked-down price—often significantly lower than similar properties in the same area (known as comparables, or “comps” in broker-speak).

Most foreclosures are sold at a sizable discount from market value, with the exact amount varying from region to region. The seller may offer additional incentives such as a reduced down payment, lower interest rate, or the elimination of appraisal fees and some closing costs.

What makes these properties such a deal? If the residence is in the pre-foreclosure or short-sale stage, its owners are in a financial bind, and time is not on their side. They have to unload the property and get what they can while they can before they lose possession of it.

In short, these sellers aren’t negotiating from a position of strength. While it may seem cruel to take advantage of their misfortune, a buyer can benefit.

The buyer can benefit even more if the property has been seized. The sheriff’s office isn’t interested in hanging onto a house, and banks don’t want to be in the landlord business. Financial institutions typically want to rid themselves of foreclosed properties promptly. They need to get a reasonable price; they have to answer to their investors and auditors. Still, buyers have an edge.

You should know that foreclosed homes are usually sold “as is.” If there’s damage, repairs by the owner aren’t part of the equation—but, as used-car and vintage furniture aficionados know, “as is” translates into a discount.

Of course, “as is” can be a double-edged sword.

Risks of Buying Foreclosed Homes

The chance for a below-market price is a big plus in buying a foreclosed home.

Nevertheless, these properties also carry their share of pitfalls.

Property Problems

It can carry a compensatory discount, but as-is condition can be pretty grim.

If the home is still being occupied by the owners, it may be poorly maintained. If the people can’t make the mortgage payments, they could fall behind on regular upkeep, not to mention major repairs.

Some folks facing foreclosure are embittered, and they take out their frustrations on their home before the bank repossesses it. This can extend to removing appliances and fixtures or deliberate vandalism.

Hidden Costs

Auction properties often have delinquencies such as back taxes and liens attached to them. The liens may be imposed by the Internal Revenue Service (IRS), the state, or other creditors. This can add further costs to an otherwise desirable house.

Whatever is owed, the government must be paid before the buying process can proceed.

This applies mainly to properties being auctioned off. Banks pay off any liens attached to a property before reselling it.

Slow Process

Any or all of these complications can mean a lot of paperwork for the buyer.

Foreclosures generally require a number of additional documents to prepare for the closing, which isn’t always as timely as a buyer might wish.

In a short sale, the owner’s lender has to approve the deal, which can delay closing. Serious damage to the house can result in a lower home appraisal, which may affect the buyer’s ability to secure a loan. Some lenders won’t lend below a certain dollar amount because the profit potential on a lesser loan isn’t worth the risk.

While you would think a bank would be eager to unload a repossessed residence, response times between the bank and other involved parties can be sluggish with REO properties.

The time that it takes to get a response to your bid varies widely. If the bank holding the property is swamped with foreclosures, processing your request can take a long time. Banks with substantial backlogs have been known to take up to 90 days to respond to an offer.

If you plan to finance the purchase, you’d be wise to obtain pre-approval for a mortgage. It’s likely to speed up the process.

Competition

Increased interest and competition—not only from potential occupants but also from investors and professional house flippers—are inevitable when dealing with worthwhile foreclosed properties.

When a foreclosed home is priced attractively, numerous offers can come in rapidly, and a bidding war ensues. A house that was a bargain can rapidly become a costly property.

Prospective buyers might consider submitting bids on several properties simultaneously in hopes that one pans out.

Don’t get discouraged if someone else trumps your offer. Check back periodically to see if it reappears in the bank’s inventory. Foreclosure deals quite often fall through.

Purchasing a Foreclosed Home

If buying from a bank, you’ll need to sharpen your bargaining skills and start with a lowball offer on the property you want.

Banks that have accumulated sizable inventories of foreclosed properties will be more inclined to negotiate on price. The longer the bank has held the property, the greater the odds that it will seriously consider low offers.

You could make an initial bid at a price at least 20% below the current market price, or even more if the property is located in an area with a high incidence of foreclosures.

You’re in an enviable position if you can pay for the property and any necessary renovations in cash. That’s why some buyers decide to team up with outside investors who can help them out on the front end and share any profits when the home goes on the selling block once again.

In fact, cash deals represent a sizable portion of REO sales.

Financing Options for Foreclosed Homes

Private lenders tend to be skittish about financing foreclosure deals. However, several government-sponsored financing options are available for those who qualify:

• 203(k) loans from the Federal Housing Administration (FHA)
• Fannie Mae’s HomePath ReadyBuyer program
• The HomeSteps program through Freddie Mac

203(k) Loans

The FHA designed its 203(k) loans to circumvent banks’ reluctance to finance high-risk REO purchases. By charging borrowers a mortgage insurance premium, the FHA guarantees loans made by private lenders who participate in the program.

Borrowers can finance the home purchase plus any required repairs in a single mortgage.

The more basic version, a streamlined 203(k) loan, is meant for limited repairs that don’t require engineering or architectural plans. Buyers can borrow up to $35,000 above the home’s sale price to cover basic repairs such as new appliances, siding, and windows.

If more extensive fixes are needed, such as building an addition or repairing structural damage, then a so-called “standard 203(k) loan” is usually the best option. Unlike the “limited” variation, homeowners must take out at least $5,000. The maximum amount is based on FHA limits for each county.

The buyer is required to pay for an independent consultant to inspect the property and verify that the work meets program guidelines.

A drawback to these loans is the price. Besides paying mortgage insurance, borrowers typically pay interest rates that are a quarter of a percentage point higher than those on conventional loans. They may also have to fork over one or two points—up-front fees that are each worth 1% of the principal amount.

HomePath ReadyBuyer

The HomePath ReadyBuyer program offered by the Federal National Mortgage Association (FNMA)—or Fannie Mae, as it’s affectionately known—is geared toward first-time homebuyers. After completing a mandatory online home-buying education course, participants can receive up to 3% in closing cost assistance toward purchasing a foreclosed property owned by Fannie Mae.

This government-sponsored enterprise offers other breaks, too. Homebuyers may need to put up only $500 in earnest money, and the required private mortgage insurance may be canceled after your equity in the home reaches 20%.

HomeSteps

Freddie Mac provides liquidity to the mortgage market by buying loans from banks, pooling them, and selling them to investors as securities. Its HomeSteps program offers special financing for those who want to buy one of the foreclosed properties that it owns.

HomeSteps has significant benefits. Chief among them is that you don’t have to buy mortgage insurance, which sets it apart from 203(k) loans. That alone can save buyers hundreds, if not thousands, of dollars over the course of the mortgage.

A HomeSteps mortgage doesn’t require an appraisal at origination, which can be a major hurdle for those seeking a conventional loan. Buyers can find a list of single-family, condo, and multifamily properties on the HomeSteps website.

The Bottom Line

On the surface, foreclosed homes can seem awfully appealing. However, costs can be highly unpredictable, and underlying damage could make a property undesirable. The buying process is often sluggish, which might spur second thoughts in the minds of some, while heavy demand for enticing foreclosed properties might push other hopeful purchasers away.

That said, foreclosed homes can wind up being incredible deals. Buyers have the unique opportunity to pay below market value for homes that wouldn’t be available to them under normal circumstances. If there are savings on the acquisition side, it improves the likelihood of the buyer realizing appreciation of their asset, as well as investment gains if they sell in the future. If done responsibly, purchasing a foreclosed home can allow a buyer to reap a myriad of benefits for many years to come.