How to Buy a Foreclosed Home

Foreclosure properties can be sold at a major discount when compared with conventional homes, making them a great opportunity for prepared buyers. However, there are important risks and key differences between a foreclosure and a conventional sale.

We’ll explain how to buy a foreclosed home, including where to find foreclosure properties, what the sale process is like and what risks are involved.

Understanding Foreclosures

A foreclosure is a legal process a mortgage lender or institution can use to repossess a property to recover money lent to the property owner if they fail to make their mortgage payments.

Most foreclosure properties are bank foreclosures, where the lender takes the property back after the borrower stops paying. However, homeowners associations (HOAs) and taxing authorities can also foreclose on property for failure to pay property taxes or HOA fees.

Eventually, the property goes to a public sale where the institution can attempt to recover as much of the borrowed money as possible by forcing a sale.

The Foreclosure Process

The foreclosure process varies by state and can be judicial or non-judicial. A judicial foreclosure moves through the court system and requires judge approval before being sold at a public auction called a “sheriff’s sale.”

A non-judicial foreclosure does not go through the court system before the property is sold at a public auction and is typically called a “trustee sale.”

Both judicial and non-judicial foreclosures begin by sending a notice of default to the borrower to tell them how much is owed, how they can repay the past due amount, and their options to avoid foreclosure.

This stage of the foreclosure is called “preforeclosure” and is often when homeowners list their homes to avoid further impact on their credit scores or losing any of their home’s equity. If they are unsuccessful in selling before foreclosure is complete, the home will go to public auction so the lender can recoup the debts owed.

If the property doesn’t sell at auction it may now be called a bank-owned or real estate owned (REO) property. In this case, the foreclosing party is now responsible for the property upkeep until it is sold by a real estate agent or rented.

Benefits of Buying a Foreclosed Home

One of the biggest benefits is the potential to buy a home for a discount. “If the property is in disrepair, to the point where institutional financing is not available, you can sometimes get a good deal,” says Robert Arnold, the managing broker of Sand Dollar Realty Group in Altamonte Springs, Florida.

Real estate agents and banks price the home based on the total debt owed and the level of distress it’s in. Many times, the asking price will be much less than the current or potential value of similar homes in the same real estate market.

Also, purchasing a foreclosed home that needs repairs means you can significantly increase its value through renovations, building more equity while enhancing the overall quality of the neighborhood.

Challenges and Risks of Buying Foreclosed Properties

One of the biggest risks of buying a foreclosed home is not being able to fully assess its condition before the sale is finalized. Foreclosed properties are sold as-is and you may not be able to see interior pictures or get inside before buying.

As an investor of 10 years, I’ve purchased foreclosed properties with a basement used for dog fighting and mold infested rooms after sitting vacant for years.

Competition among investors at public auctions can drive purchase prices up to where they are no longer a good deal, especially if inexperienced buyers overbid.

Also, prepare for extra fees to pay for taxes, documentary stamps, filing and recording services. Depending on the type of sale, there can also be a sheriff fee that adds 1.5% to 6% to your winning bid, depending on the state or municipality.

Always conduct thorough research to ensure you know what type of foreclosure you are buying. “I have known several people who bought a property at auction only to find out that the foreclosure was of a second mortgage or homeowner association lien and there was still a big first mortgage on the title,” says Arnold.

Because of this, you should research if there are existing municipal liens or code violations which can survive foreclosure.

How to Find Foreclosed Homes

One of the easiest ways to find foreclosure listings is to look at homes for sale and filter by “listing type” to include foreclosures. You can also use REO websites, including:

• Auction.com
• Foreclosure.com
• Homepath (Fannie Mae)
• Homesteps (Freddie Mac)
• HUD Homestore (The Department of Housing and Urban Development (HUD))

If you want to find homes in foreclosure before they become an REO, check the county’s foreclosure sale calendar to see what properties will be up for auction soon. You can also look in public records for recently filed lis pendens, which is the first step in the foreclosure process. Then, send a letter to the homeowner asking them if they want to sell.

If the homeowner owes more than the home is worth, the lender may agree to a short sale, where they accept a payoff amount that is less than the mortgage balance. This is not a foreclosure per se, but is a type of sale you can see in a preforeclosure setting.

Driving or walking through neighborhoods can also be a worthwhile research opportunity. I found the last foreclosure property I bought in 2019 on my daily walk around my neighborhood in Florida. 

After noticing the home was empty, I looked in public records and discovered it went to foreclosure auction and was now an REO property. I researched further and found the REO agency that the bank uses to sell its properties. I contacted the real estate agent directly, who sold it to me before it went into the multiple listings service (MLS).

Evaluating a Foreclosed Property

Since you can’t get inside foreclosure properties before they are sold at auction, always do a drive-by or hire someone local to do it for you.

You can normally get inside an REO property for a tour and home inspection. It’s a good idea to hire an inspector to assess the potential repairs or problems it may have. 

From there, look at properties in similar conditions in the immediate area to come up with a likely value. Many real estate investors are comfortable deriving a value using recently sold properties and pending homes nearby or “comps”.

However, if you’re new to this and here to learn how to buy a foreclosed home, it’s a good idea to ask a real estate agent for a broker price opinion (BPO) or order a formal appraisal.

Arnold says it’s a good idea to hire a real estate agent who specializes in REO properties so that you, “have someone representing the buyer’s best interest and not just the bank’s best interest.”

Making an Offer

If the home is in preforeclosure, give the homeowner a verbal or written offer. If accepted, you’ll close with a local title company, like a conventional sale.

If it’s being sold at a trustee or sheriff’s sale, register on the county’s site before the auction. Most auctions are done online and the county should have a calendar with each property up for sale.

If you have the winning bid, a 5% to 10% deposit will be required to secure the property. So, be prepared with cash. Most counties allow 10 to 30 days to pay the remaining balance by check or wire.

If the property is listed as an REO, make an offer to the agent directly. “Make the offer as strong as possible, meaning a large earnest money deposit, short or no inspection contingency, few if any other contingencies and a short closing date,” says Arnold. 

If the property is listed for a low price to incentivize multiple offers, you may need to bid higher to win. Just ensure you don’t overbid, and fully understand the contingencies and earnest money requirements before submitting your offer.

Financing Your Purchase

Most REO buyers are investors who pay cash. Buying with cash is the best way to compete and allows you to buy a home in any condition.

If the home is in fair condition and would qualify for a conventional mortgage, FHA or VA loan, start by getting a preapproval letter. The REO agent will likely request this with your offer.

“A loan will only make you less attractive as a buyer if there are cash buyers competing with your offer,” says Arnold. “However, some banks will actually favor your financing offer if you apply for a loan through their bank.”

If the property is in poor condition and won’t qualify for a traditional home loan, you may need an FHA 203(k) loan, which provides money for specific improvements. You can also go through Freddie Mac’s HomePath program which provides CHOICERenovation Mortgages to purchase one of its REO properties.

Closing the Deal

Trustee and sheriff sales will require payment in cash within a specific period and provide all of the closing documents in-house. 

Most bank owned properties will close with a local title company, similarly to a conventional sale. 

Closing fees for a foreclosed home may include the agent’s commission, traditional closing costs, title insurance and proration for property taxes. You’ll also want to have insurance lined up before closing.

Is Buying a Foreclosed Home Worth It?

Buying a foreclosed home presents some benefits and challenges. While it can be a good opportunity, there are more moving parts when it comes to home inspections, financing and closing. Wrongly valuing the home, overbidding or failing to read the contract or funding requirements carefully can cost you a lot of money.

The biggest challenge in buying a foreclosed property today is finding the inventory. “Foreclosures are more abundant than they were in 2020, when there was a foreclosure moratorium, but they are definitely historically low numbers right now,” says Arnold.