The Ultimate Guide to Buying a Foreclosed Home
Image credit: ThomasPhoto/Shutterstock
By: Natalie Campisi
APRIL 27, 2018
Homebuyers typically seek out foreclosures because they’re often a good deal. However, the amount you might save depends on a variety of factors, such as which stage the foreclosure is in and how many other bidders are competing against you. Buyers can sometimes save money with foreclosures by getting a house that needs some work and then doing the repairs themselves.
Foreclosures in today’s market
Many foreclosures in today’s market cost just as much as regular listings, says [real estate investor] and author of [book].
“Ten years ago, you could buy foreclosures for 50 percent of the value any day. Today, foreclosures are sometimes just as expensive as other houses. Banks have gotten a lot more efficient at doing foreclosures,” [real estate investor] says. “There are a lot less foreclosures today than there used to be, so with less supply and more demand the prices go up.”
In 2017, there were 676,535 foreclosure filings, which include default notices, scheduled auctions and bank repossessions. This was down 27 percent from 2016 and 76 percent from a peak of about 2.9 million in 2010, according to the 2017 U.S. Foreclosure Market Report published by ATTOM Data Solutions.
If you’re considering getting a foreclosure, here are some things you need to know so you can close the deal and avoid pitfalls.
Stages of foreclosure
The term foreclosure is a catchall for a process that can happen over a year or much longer. The process of foreclosure can’t legally begin until 120 days after you’ve missed your first payment. Once that happens, the lender will begin the legal process of foreclosure, which includes a notice of default or a lis pendens, depending on your state.
For buyers, there are three stages of foreclosure purchasing:
- Pre-foreclosure: At this point, the bank hasn’t actually taken the property back yet. At this stage, the owner has three months to cure the default.
- At foreclosure: This is when the home is sold at auction, usually on the steps of a courthouse. This is also called a trustee sale.
- After foreclosure: If the house isn’t sold at auction, the bank takes possession of it. This is called a bank-owned property or an REO (real estate owned). These houses are listed through the MLS like all other properties.
There are different buying strategies for each stage, according to investors. Most experts agree that getting a house in pre-foreclosure or at foreclosure will likely yield the best deal.
Buying in pre-foreclosure
Getting a house in the pre-foreclosure stage can be tricky because you either have to know someone who is late on their mortgage payments or you have to do some digging. There are websites that will list homes that are in pre-foreclosure. In order to buy that home, you must contact the owner and make an offer.
The upside is that you likely won’t face much competition. You might also avoid some of the problems other types of foreclosures come with, such as angry tenants who deliberately cause damage or an empty house that’s been sitting vacant for a while.
“If you know someone who can’t make payments and is about to be foreclosed on, you can strike a deal where you might pay their late fees and just buy it. In this case, you don’t need an agent. You would only need a title company or attorney,” [real estate investor] says.
TIP: Hire a title company or an attorney to facilitate the process. Not only will they make sure the title is legitimate, they can also discover if there are any liens on the house. Once the house is in your name, you’re obligated to pay outstanding debt that was borrowed against it.
Buying at foreclosure
Getting a great deal at auction means doing some research beforehand. While some listing companies will host an open house so you can see the property pre-auction, many don’t. Do your best to see the house before the auction.
It’s illegal to enter private property without permission, so you must get the owner’s permission to enter. If you get permission, you will have an advantage when it’s time to bid because you’ll know more or less what you’re bidding on, says Adam Leitman Bailey, residential and commercial real estate attorney and founder of Adam Leitman Bailey, P.C.
At the very least, drive by the property before the auction, Bailey says. Other exterior factors that will affect the value include things like the school district, nearby sales and crime reports. These are all things you should research before bidding.
Like any other house, be sure to conduct a title search to ensure there are no liens on the property. Outstanding debt could easily cut into your savings.
TIP: Bring cash or certified checks in small denominations to the auction because you will have to put down a deposit. Usually, the required deposit is 10 percent.
“They’re going to give you between 30 and 90 days to close, so before you enter that auction room, you want to be preapproved by a bank,” Bailey says.
The main drawback of buying at foreclosure is not being able to properly inspect the home. You could end up with a house that’s in distress, which could cost you a lot of money to repair.
Buying after foreclosure
If the house doesn’t sell at auction, the bank takes possession of it. At this point, the house will be listed on the MLS, just like any other house. This is how most people buy foreclosures, [real estate investor] says.
Buyers should go after these houses like they would other types of property. This includes getting an agent, preferably one with experience in foreclosures.
“Agents who have never dealt with foreclosures might freak out if they see mold on the wall, not knowing this isn’t uncommon,” [real estate investor] says. “An agent who’s dealt with this before will just get some bleach water and take it right off. It might scare everyone else off, but you can get a really good deal.”
TIP: Speed is key in getting a foreclosure in this market.
If you’ve found a deal that’s been on the market for a few weeks, you’re probably already too late, [real estate investor] says. Ask your agent to send you alerts when a house that meets your criteria is listed.
In this competitive market, it’s important for buyers to do their homework, such as knowing how much houses are selling for in your desired neighborhood, having a preapproval letter from your lender and being able to look at houses quickly.
If you want to live in the home, prepare to make a competitive offer. You will probably want to offer what the seller is asking, [real estate investor] says.
“Buyers are competing against investors like me,” [real estate investor] says. “I work very fast. I’ll get an email that pops up, I’ll look at the pictures, I’ll analyze the deal and I’ll make an offer within 30 minutes. I might not even look at the property.”
The downside of buying a house after foreclosure is that it might have been empty for a long time. When houses sit empty, they could end up with mold or vandals could steal things, such as the wiring.
Additionally, houses that have faced foreclosure might have been subject to destruction by the previous owner.
“The person left and they were probably angry because they were getting evicted,” [real estate investor] says. “People will kick holes in the walls. I’ve heard stories of people pouring concrete down the drains. I had somebody flush a bunch of huge rocks down the toilet. That cost $1,000 to repair.”
What to look for in a foreclosure
Before you make an offer, there are a few things you should do first. Most important: understanding repair costs. You might be lured by a low price tag, but if you need to rehab the house from water damage or other costly problems, you could quickly lose the money you saved on the price. Be sure to get a thorough inspection. Buying a house sight unseen can become a huge burden if the house is riddled with damage.
Secondly, give the neighborhood a thorough review. If there are several other foreclosures nearby, this could decrease the value of the area and affect your resale price. Be sure to drive by at night, as well as during the day. Check the crime reports in the area, and even talk to people there.
Finally, look for hidden bedrooms, [real estate investor] says. Look for houses that are listed as having two bedrooms but are larger than 1,000 square feet. Often, these houses will actually have a third bedroom that’s either called a “bonus room” or is a back room that could easily be converted into another bedroom, which would increase the value of the home, [real estate investor] says.
“Most agents, especially if they’re dealing with foreclosures, are not that good at understanding the property. They might not even look at the property,” [real estate investor] says. “Oftentimes, if a room doesn’t have a closet, they won’t call it a bedroom; they’ll just call it a bonus room. So the agent will list it as a two-bedroom. But with just $500 worth of sheetrock and wood, you can create another bedroom.”
Securing a mortgage
If you need to get a mortgage (as opposed to buying with cash), your first step is getting prequalified. Borrowers should be aware that government-backed mortgages, which most big banks like Wells Fargo and Bank of America supply, have much stricter guidelines than community banks and credit unions.
Big banks typically do automatic underwriting, per Fannie Mae and Freddie Mac standards, which has a prescribed list of qualifications. For example, houses with mold would disqualify a borrower from getting a mortgage, according to these standards.
Although there is no rule against big banks giving mortgages on foreclosures, borrowers should do their due diligence to make sure they choose a property that meets their qualifications. If the house is in good condition and your credit score meets their requirements, then you should have no problem securing a traditional 30- or 15-year fixed rate mortgage. Compare rates on 15-year mortgage rates and 30-year mortgage rates to find a loan that fits your needs.
An alternative route is going with a credit union or community bank. Because these banks are often using their own money, they’re not subject to the same rules as Fannie- and Freddie-backed mortgages. This means you often can speak directly to the decision maker, allowing you to make a case for the property, explain how you intend to fix it up and what the value will be.
“If you’re going with a small, local credit union or community bank, you can convince them it’s worth the risk,” [real estate investor] says.