Buying A Foreclosed Home In 6 Steps
Looking to buy a new home but worried you won’t be able to afford the monthly mortgage payment that comes with it? Or maybe you want to buy in a popular neighborhood, but you think its homes are too expensive for your budget? Purchasing a foreclosed home might be the solution.
A foreclosed home is one that’s usually owned by a bank or lender. Lenders can foreclose on a home when homeowners stop making their regular monthly mortgage payments, meaning that they take over ownership of that residence.
Banks and mortgage lenders will then try to sell these homes, often at lower prices or with a smaller down payment. And that’s the main benefit of buying a foreclosed home: You might nab a residence that would’ve otherwise been out of your price range.
Although there are certainly risks that come with buying a foreclosure, the process itself isn’t much more complicated than the typical home buying experience, and buying the right foreclosed property can get you a home at a bargain price.
Here’s a closer look into how to buy a foreclosure and the information you need to make the process as simple as possible.
How To Buy A Foreclosed Home
You might be intimidated by the thought of buying a foreclosed home. But the process of purchasing a home in foreclosure isn’t too different from the traditional way of buying a home. Buying a foreclosure does require additional research, and you’ll need to be comfortable taking on a bit more risk.
But if you work with a real estate agent who understands your local foreclosure market, the stress shouldn’t be much higher than during a traditional home buy.
Here, then, are the steps you need to take in order to successfully buy a foreclosed house.
1. Research The Different Methods For Buying A Foreclosure
As with any major purchase, the first step in purchasing a foreclosed house is research. That’s because there are several different ways to buy a foreclosure, and the best method for you may vary depending on your needs.
Here are the most common purchase paths to consider.
Buying From The Homeowner
A pre-foreclosure, or short sale, can occur when the homeowner still owns the property and knows there’s a potential for foreclosure. Owners want to sell their home before they end up in foreclosure. This means that short sales aren’t technically foreclosure sales.
Short sales can also prove to be challenging. In a short sale, owners get permission from their lender to sell their residences for less than what they owe on their mortgage. If the owners owe $180,000 on their mortgage, they might still list the home at $160,000 even though such a sale leaves them $20,000 short of being able to pay off their entire mortgage loan.
In some short sales, the owners’ bank agrees to take this loss as a way to get the home sold and the mortgage (which might otherwise go into mortgage default) off their books.
The goal for the owners is to offer their home at a price that’s low enough to ensure a quick sale before they fall behind on their monthly payments. Buying at this stage can be tough, though. Even if the sellers agree to your offer, their bank or lender might reject it if it’s too low.
Buying At An Auction
The traditional way to buy a foreclosed home is at a real estate auction. At an auction, third-party trustees run a sale of homes that banks or lenders have taken ownership of after the original homeowners defaulted on their mortgage loans.
Buyers can purchase a home quickly (and often for a low price) at an auction. But there are hurdles, too. One example is that an auction typically requires buyers to have cash on hand.
There are also plenty of risks:
- A home you buy at an auction might have a lien on its title from a government agency, especially if the former owners stopped paying property taxes on it.
- A home bought at auction might require expensive repairs.
- You might not have the chance to order an appraisal on the home. During an appraisal, a real estate appraiser determines how much a home is worth in the current housing market. Without an appraisal, you run the risk of paying too much for a home even if you buy it at an auction.
Buying From The Bank
You can also buy a foreclosed home directly from a bank or lender on the open market.
You might see the term “REO” while searching for home listings. This stands for “real estate owned,” and denotes a foreclosed property that’s now owned by a bank or lender. Typically, once the property becomes an REO, the bank will clear any liens on the property and evict the previous homeowner before selling the home, so you won’t have to.
At this stage, the bank has secured the home at an auction and is now selling the home to recoup what’s owed on the property. The bank will likely hire a local real estate agent to put it on the market.
Buying A Government-Owned Property
You might also consider buying government-owned foreclosure properties. These properties are similar to the ones owned by banks or lenders. Government agencies typically take ownership of homes after the owners default on mortgage loans insured by the federal government.
Let’s take a look at an example. When owners stop making payments on a home they financed with an FHA loan, the U.S. Department of Housing and Urban Development (HUD) takes possession of the foreclosed home. Government-owned foreclosures are mostly sold “as-is,” which means that any repairs are your responsibility. In some cases, the government may repair any structural needs before selling, or you could request a repair. You might have to place an offer or bid before viewing or inspecting the home.
2. Determine How Much Home You Can Afford
Budgeting matters when buying a foreclosed home. Yes, you might be able to nab your new home at a lower price tag. But foreclosed homes aren’t free. And despite what you might have heard, you can’t buy a foreclosed property for $1 either.
You’ll need to craft a household budget listing your monthly income and expenses (including estimates for discretionary expenses such as eating out and entertainment) to determine how much of a mortgage payment you can afford each month.
If you don’t do this, you might purchase a home you can’t afford even if you’re looking for a foreclosure. By purchasing a home that’s out of your budget, you’ll struggle to make your own mortgage payment each month.
As with any home purchase, it’s important to predetermine your debt-to-income (DTI) ratio. As the name suggests, this ratio analyzes how much of your gross monthly income your monthly expenses (including your estimated new mortgage payment) will consume.
Most lenders want your monthly debts to take up no more than 43% of your gross monthly income. If your debt-to-income ratio is higher than that, you’ll struggle to qualify for a home loan.
Be especially careful when buying a foreclosed home. You might be tempted to buy a foreclosure with a price tag that’s at the very top of your budget.
The problem with this is that the foreclosed home might require expensive repairs. If you’ve purchased a home at the top of your budget, you might not have enough money to afford those needed repairs.
Struggling to determine how much home you can afford? Try out our Home Affordability Calculator. It can provide you with the information you need to make the right buying decision.
3. Hire An Experienced Real Estate Agent
If you decide to go the route of purchasing a foreclosure, you’ll want to find an experienced real estate agent who has access to a local multiple listing service and knows the local market.
This agent can help you determine when a foreclosed home is offered at a bargain price or when it’s listed at an asking price that’s too high for the risk involved. An agent may also help you find foreclosed properties that other buyers might miss.
Additionally, a good real estate agent can discuss challenges you could run into with a foreclosed property. Bear in mind that every state has unique laws and regulations concerning foreclosures. It’s important to work with an expert who understands these laws.
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4. Get Preapproved For A Mortgage
Getting preapproved for a mortgage is a smart move no matter what type of home you buy. In the preapproval process, a lender will run your credit and verify your income and debt at no charge. This lender will then determine how much of a mortgage it can approve you for.
Once you get a preapproval letter from a lender, you’ll know exactly how much you can spend on a home. If a bank approves you for a mortgage of $200,000, you won’t waste time looking at homes that cost $300,000.
Having a preapproval letter also makes you an attractive buyer. Sellers (i.e., banks or government agencies in the case of foreclosures) prefer working with buyers who they already know can qualify for a mortgage. They don’t worry that you won’t be able to get a loan, thus dashing their home sale. If multiple buyers put in bids on a home, sellers are more likely to work with buyers who’ve already been preapproved for a mortgage (all things being equal).
Banks and lenders can be particularly sensitive to credit issues in foreclosure situations, so a good credit score will be especially important during the preapproval process.
The smart move is to shop around for mortgage lenders. Don’t simply work with the first mortgage lender you find. Instead, search for the lender that’ll give you the lowest interest rate and loan fees.
If you get preapproved from one lender and want to purchase a bank-owned property, that specific bank or lender may want you to get preapproved through them. Usually, that’s because they want to confirm your eligibility or are looking for the selling opportunity. Know that you’re not obligated to go with that lender. You can still use your preapproval from your original company to qualify for the bank-owned home.
Once you find your home and make an offer that’s accepted by the seller, you then apply for full approval. If you’ve already earned a preapproval from a mortgage lender, it’s often easier to apply for full approval from the same lender that’s already studied your income and credit. However, this lender might still require you to submit copies of your latest pay stubs, tax returns and W-2s before granting you full or final approval.
Your lender will want to make sure nothing has changed for you financially since you first earned your preapproval.
5. Make A Competitive Purchase Offer
If the home is in pre-foreclosure, your real estate agent will need to present the offer to the individual who currently owns the home.
If you’re looking at a foreclosed home that’s headed to auction, you’ll need to contact the trustee or attorney who’s running the auction to ask any questions about the house before the auction takes place.
A trustee is a third party who runs a foreclosure auction on behalf of a lender or government agency. This official accepts the bids during an auction.
If the house is REO, your agent will present your offer directly to the bank’s listing agent.
A buyer’s agent will never have direct contact with the bank. The process is similar for government-owned listings: Your real estate agent will again present your offer directly to the government agency listing the home.
You might be tempted to make a low offer on a foreclosed home. It’s true that foreclosed properties often sell for less than traditional homes. But if you make an offer that’s too far below market value, the sellers (whether they are a federal government body, a bank or a lender) might reject it.
It’s important, then, to work with your real estate agent to make a competitive offer. Your agent will advise you on what this figure should be.
You should also include a contingency for a home inspection in your offer. (Note: You won’t be able to do this if you’re buying a foreclosed home at auction.) This contingency says that the home sale can’t be finalized until you’ve scheduled a home inspection of the property.
6. Get A Home Inspection
Once again, keep in mind that you’re buying a foreclosed home as-is. This means no one on the selling side (whether you’re buying from a bank, lender or government agency) is going to pay for any needed repairs. These repairs are your responsibility.
Because of that, it’s very important that you inspect the property as part of your offer process. And if the home inspection uncovers too many problems or problems that cost too much to fix, you might want to pass on buying the home.
Banks or government agencies will usually allow for an inspection contingency as part of an offer. This means you have the opportunity to order a home inspection after your offer is accepted but before the sale closes. Your home inspector will tour the residence looking for everything from leaks in the roof to evidence of a shifting foundation.
After the inspection, you’ll receive a written report detailing the inspector’s findings. You’re able to walk away from the sale if there are too many problems. Foreclosed homes tend to offer little to no room for negotiation no matter what the inspection reveals.
Again, expect to spend more money on repairs for a foreclosed home. To get a better sense for the house’s current state, find out how long it’s been unoccupied and determine if the previous homeowner performed routine maintenance on the home.
It’s also a good idea to check with your local building department to find out if there are any open building permits that could present issues post-closing.
The process for buying a foreclosed home at auction is vastly different because you won’t get the chance to schedule a home inspection. You often won’t even get the opportunity to step inside the house.
This makes buying a home through the auction process particularly risky. Yes, the prices might be lower. But without a home inspection, you won’t know what problems lurk until after you own the home.
The Bottom Line: Consider Purchasing A Foreclosed Home
If you’ve dreamt of making the move to homeownership but your budget is tight, buying a foreclosed home might be the right choice for you. It’s possible to find foreclosed homes that are being offered at below-market rates.
Again, don’t rush into this decision. It’s best to work with a real estate agent who can explain both the pros and cons of buying a foreclosed home in your community. And before you make an offer, be aware of the additional risk you might be taking on when you dip into the foreclosure market.
Already on the search for a foreclosed home to purchase? If you’re not sure how to budget for a mortgage, use our mortgage calculator to estimate how much principal and interest you’ll pay each month.
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