Buying a foreclosure is a great way to get the home you want at a more affordable price, but what you see is not always what you get. Buying a foreclosed home is different from buying a conventional home. There is a lack of transparency, fewer financing options and different expectations after the sale finalizes. Foreclosures aren’t for everyone. First time homebuyers need to be especially aware of potential pitfalls often associated with them.
To avoid disappointment, costly repairs and other obligations, there are a few things that you should know before you buy, and a couple of tips you should keep in your back pocket to make the most educated choice possible.
What is a foreclosed home?
A foreclosure is a home that was repossessed by a lender after the homeowner was unwilling or unable to meet the mortgage obligations. Realtor.com estimates that 1 in 13,000 homes end up in foreclosure, which generally happens after a homeowner falls behind on their loan payments and is unable to catch up within a specific time frame. If the owner is unable to catch up or sell the home themselves, the lender forecloses on the property and sells it “as is” in an effort to recoup some of the investment.
Buying a foreclosed home offers you a way to buy a home at a discounted price, but it also means that you may not have all the important historical information regarding repairs, structural damage, infestations or other issues. The lack of historical information makes foreclosures less attractive to some buyers, but this type of transaction is a way to find a good deal on a home — if you know what to look for, that is. If you want to buy a foreclosure, be prepared to do your homework and get professional advice before you buy.
Types of foreclosed homes
There are four kinds of foreclosed homes that you could buy: pre-foreclosures, short sales, auctions and REO listings.
During pre-foreclosure, the homeowner can sell the home outright or via short sale — if the lender agrees to accept a lower settlement for the mortgage — to avoid going into foreclosure. If neither option works, the lender takes possession of and forecloses on the home.
After foreclosure, the home becomes an REO property, which is just another way of saying that the bank or real estate company owns the home. The lender can then place the home up for auction to recoup its loss. If the home doesn’t sell at auction, the mortgage lender will list it for sale on their website or with a real estate agent.
How to buy a foreclosed home
Once you find a foreclosure that interests you, take your time to to vet it to avoid ending up with a costly disappointment, and take note of these other tips, too.
1. Don’t skimp on the inspection.
It is usually the buyer’s responsibility to have the home inspected. Consider hiring a professional to perform a title search to check for tax liens or other problems that you may be responsible for later.
2. Find an experienced real estate agent.
Not all real estate agents specialize in home foreclosures. Find one who is so you’re sure they know how to properly handle this type of transaction and can walk you through the process.
3. Weigh the benefits.
Most foreclosures are not move-in ready; they’ll often need significant cosmetic or structural repairs. Compare the costs of necessary renovations and repairs to determine if you’re still getting a deal and if the repairs are something you can realistically take on.
4. Get preapproved for financing.
Foreclosures must often be bought with cash because many private lenders will not finance them, so if you can come up with the full purchase price for the home out of pocket, you’ll have a better shot at purchasing it. If you can’t come up with that much cash, there are a few alternatives to consider, such as a 203(k) loan, for example.
4. Bid competitively.
Bidding on a foreclosure doesn’t always mean offering the lowest price, especially if it’s a home you are certain you want to buy. If similar homes in similar neighborhoods are selling quickly, you might be better off bidding the full asking price or higher to increase your chances of winning the bid.
Risks of buying a foreclosure
Buying a foreclosed home is not without its risks. Unlike conventional homes, foreclosures come with a lack of transparency and are sold “as is.” Lenders are not required to tell you about problems with the property and any necessary repairs are up to buyers.
Roger Whitehouse, owner and realtor at Riverside Realty, warns buyers to beware of foreclosure pitfalls.
“For the most part you are totally on your own because most foreclosures do not disclose anything about the listing,” Whitehouse said. “You are purchasing a listing that could and usually does have multiple issues that are often quite costly to remedy.”
”A home sold at a trustee sale or a sheriff sale may have hidden tax liens or other debt that you have to pay,” Phil Georgiades of VA Home Loan Center said. “I have seen an investor purchase a home that had $100,000 tax lien on it. This almost bankrupted him.”
Always arm yourself with knowledge. Have an inspection and title search done and most importantly, don’t rush the process.
Loan options for buying a foreclosed home
Many private lenders shy away from funding the purchase of home foreclosures because of the high cost of repairs that are generally associated with them. However, that’s not true of all lenders. Always double-check your lending institution’s policies on buying home foreclosures before ruling them out.
If conventional lending doesn’t work for you, then there are a few alternative financing options available if you qualify. You can finance REO homes with VA loans, USDA loans or FHA loans. Be aware, though, that sometimes homes must adhere to HUD or other policy restrictions in order to help meet financing requirements, even with those types of loans.
If an approved home needs repairs, you might also be eligible for a rehab FHA loan under a 203(k) loan, which can give you up to an additional $35,000 for necessary repairs and renovations — all on the same loan as your FHA mortgage. Fannie Mae also offers some financing opportunities for foreclosed homes as well through its HomePath program.
If you’re looking to turn it into an investment property or a secondary residence, you may need to look at alternative financing options because many of the lenders who will fund foreclosure purchases have primary residency as a requirement for their loans.
The bottom line
If you’re buying a foreclosure as your primary residence, be smart and do your homework before you begin the buying process. Don’t write off the power behind information, inspections and title searches. That information might make all the difference and help you find the hidden gem that you’ve been searching for.