Learn what to watch out for when buying a foreclosure.
When Riley Adams and his parents began their house hunt in New Orleans in 2012, they came across a number of high-priced condos that were well above their price range. They were afraid they wouldn’t find something within their budget. At that point, the question of how to buy a foreclosed home had yet to even cross their minds.
The bulk of properties listed fell outside their desired criteria. But when they saw a two-bedroom, one-bathroom condo in the Big Easy’s beautiful, oak tree-lined Garden District, they jumped at the chance. The property was in foreclosure, and they paid $148,500—while comparable properties in the same building were expected to sell in the low $200,000s.
All in all, the Adamses were happy with their foreclosed property and plan to hold on to it indefinitely. “This condo will remain in the family for years to come as a home base for my parents, and then when my wife and I return to New Orleans to visit in the future,” said Adams, who is the founder of Young and the Invested.
If you’re house hunting, buying a foreclosed home might be appealing. Especially if you’re on a budget, these homes tend to have a lower ticket price than standard homes listed on the market.
What is a foreclosure?
In a nutshell, foreclosure is the legal process whereby the lender can regain ownership of a property should the borrower default on the loan, explained J. Scott, a real estate agent, investor and author of “The Book on Estimating Rehab Costs.”
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When a homeowner can’t pay the monthly mortgage on their home, the lender—generally a bank— can gain control and ownership of the property.
To cut its losses, the lender will usually try to sell the property at auction. If that fails, oftentimes the lender will sell the property using a real estate agent and the multiple listing service, which is more commonly known as the MLS.
There are two main types of foreclosures:
A bank-owned foreclosure is a home that a bank has recently repossessed. When a bank forecloses on a property, it will attempt to sell that property publicly at an auction in order to recoup its investment, interest, legal fees and other costs, explained Scott.
When you buy a bank during an auction, you’ll need to purchase it with cash on the spot—in the form of a cashier’s check, explained Rick Albert, a broker associate with Lamerica Real Estate. You’re also actively bidding against other people.
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What’s more, at this point in the game, the buyer will need to absorb any and all risks that come with buying a foreclosure. You won’t have the opportunity to walk through the home, do inspections or ask questions about the property, pointed out Albert. “More importantly, if there are occupants in the home, it is the responsibility of the buyer to evict them at their own cost,” said Albert.
Real estate owned (REO) foreclosures
Foreclosures that don’t sell at auction are referred to as real estate owned, or REO properties. “REO is typically just another term for a bank-owned foreclosure that has unsuccessfully gone through the auction process,” said Scott. It then goes back to the lender, which is usually a bank or government agency.
The bank now legally owns the foreclosure, and they can do with it what they please.
The lender then prepares the home to be put on the market. The bank will make sure nobody is living in the home. They’ll also usually clear the property of any liens, determine a listing price and pass it on to a broker or real estate agent to put it up on the market.
Pros and cons of buying a foreclosed home
If you’re a deal-seeker, a foreclosure might have vast appeal to you. However, it’s important to look at both the pros and cons of buying a foreclosed home before deciding whether it’s the right choice for you:
Pros of buying a foreclosure
Less expensive. A major draw of a foreclosed home is that you can usually purchase one that’s below market price. The bank is generally not trying to turn a profit. Rather, they’re trying to cut their losses on the property.
Title is clear. While this isn’t always the case, there usually won’t be any other liens on the property, explained Scott.
You’ll be able to receive financing from the bank. With REO foreclosures, banks will sometimes offer you financing. And if a small, local bank is the lender, you’ll stand an even greater chance of receiving some form of financing.
Reasonable inspection and financing periods. What’s more, when it comes to REO foreclosures, banks typically offer a reasonable time frame for you to get the property inspected and obtain a mortgage. This is not the case with bank-owned foreclosures sold at auction, however.
Banks might be willing to make repairs or compensate for repairs. As evident in the case of the Adams family condo purchase in New Orleans, the lender might be open to footing the bill for certain repairs, or make them before you make an offer.
This really depends. You’ll stand a better chance if the lender is having a tough time selling it. Maybe they’ve had it for a long period of time, it’s in an undesirable location and there has been little interest.
Cons of buying a foreclosed home
While foreclosures certainly come with a number of advantages, there are a handful of downsides to take into consideration:
Bank-owned foreclosures must be purchased in cash. If you’re buying a foreclosure at auction—that is, before it becomes an REO—you’ll need cash on hand, explained Scott. Once the home becomes an REO, you can take out a mortgage just like with any other standard property.
Can’t do an inspection. A big risk of bank-owned foreclosures sold at auction is that you won’t get a chance to get the home properly inspected. Not knowing what you’re getting into could mean you’ll have to deal with repairs, pest infestations, squatters and other unforeseen scenarios. As noted earlier, however, this is less of an issue with REO foreclosures.
Might need serious repairs. Oftentimes, the previous owners have left the home in serious disrepair and the property has been vacant for a while, Scott said. This contributes to mechanical or structural problems, and you might have to make costly renovations to make the home livable.
And if you’re buying the home at an auction, you could encounter some major work that needs to be done. For instance, Albert has had clients buy a home at an auction. After they closed on the house, they discovered the entire foundation needed to be redone.
Tips for buying a foreclosure
As the process for buying a foreclosure at an auction and as an REO are slightly different, there are different tips to keep in mind:
Buying a bank-owned foreclosure at auction
Scott recommended conducting a preliminary title search before bidding. This will ensure there are no liens against the property. And because you won’t be able to do an official inspection at this stage, you’ll want to drive by the property. You can also order a CLUE report, which shows a history of homeowner insurance claims made on the property.
“Do a visual inspection of the exterior and try to get an idea of the interior condition,” said Scott. You’ll also want to talk to neighbors to try and find out if there were any major issues. For instance, they may know if there’s been repeated flooding or illegal activity, or maybe the area is noisy in general. An online property search may help reveal some of this information in one convenient stop without requiring visits to multiple government offices.
Buying an REO foreclosure
When it comes to buying an REO foreclosure, because it’s going through a broker and typically listed in the MLS, the process is pretty much the same as a non foreclosure: Work with a real estate agent, get pre approved for a mortgage and find a home that meets your specifications.
That being said, there are some pointers specific to buying an REO foreclosure to make sure you get the best deal, and to ensure the homebuying process is a smooth one.
First, you’ll want to find a solid real estate agent who knows the ins and outs of buying REOs, recommended Scott. Once you find one, it’s wise to tap into their expertise and enlist their help.
As for scoring a great deal, it turns out that banks often times lower the list price of REOs on a fixed schedule. For instance, every 30 days, 60 days, 90 days and so forth. “If you can figure out this schedule, you can use it to your advantage when making offers,” said Scott.
Another way you can land the best deal on an REO foreclosure? Put in an offer after another buyer backs out. “They’re more desperate for a sale,” explained Scott. Lastly, offer to close either before the end of the month, end of a quarter or end of the bank’s fiscal year. “Banks try to get assets off their balance sheets during these times,” said Scott.
Sometimes when the bank loses, you win
Buying a foreclosed home could mean purchasing a home at a price that’s far lower than comparable properties. However, to know what deal you’re getting into, and to figure out if it’s a true bargain, you’ll want to closely examine the pros and cons of purchasing a foreclosure to understand the true costs and risks involved.
Whereas the Adamses lucked out and landed on a foreclosure that was a great bargain in a charming neighborhood, that isn’t always the case.
Bottom line: Your situation and the level of risk you’re comfortable bearing will clue you in on whether it’s the best choice for you. When it comes to foreclosures, the more you know about the homebuying process and property, the better decisions you can make.