How to buy a foreclosed home

Key takeaways

• Foreclosures can offer steep discounts, but buyers face higher risk because properties may not allow inspections and have serious damage and often come with financing, title or occupancy complications.
• Foreclosed homes can be found through major housing platforms, government agencies, auctions or specialized agents, but buyers must carefully evaluate condition, liens, title status and local foreclosure rules before bidding or making an offer.
• Success depends on preparation: understanding the foreclosure process, securing appropriate financing or cash, budgeting for repairs and fees and avoiding common mistakes like overbidding, skipping due diligence or misjudging true costs.

Buying a foreclosed home is a great way to get a property at a steep discount. But it can be risky. A purchaser may not get a chance to tour the property before it is sold. Foreclosed properties also may not qualify for conventional home loans. Here's what to consider before buying a foreclosure.

A foreclosure occurs when a lender repossesses a home after an owner fails to pay the mortgage. Homeowner associations and taxing authorities can also foreclose on property for failure to pay homeowner association fees or property taxes. The property will go to a public sale where the lender, association or tax authority tries to recover as much of the borrowed money as possible.

Each state has its own laws on how to foreclose on a house. In general, there are two ways.

• A judicial foreclosure moves through the court system and requires a judge's approval before being sold at a public auction. This is sometimes called a “sheriff’s sale.”
• A non-judicial foreclosure does not require court approval. The authority to foreclose is in a document called a Deed of Trust that is filed with the register of deeds office where the home is located. The property is sold at a public auction and is typically called a “trustee sale.”

A judicial foreclosure has some advantages in Washington, D.C., for instance, said Carol Blumenthal, a senior partner with the law firm Blumenthal, Cordone & Erklauer in Washington, D.C.

“Lenders on residential properties file judicial foreclosures because the administrative on-judicial procedures are cumbersome, unworkable and more time consuming,” she said.

Both judicial and non-judicial foreclosures start by sending the borrower a notice of default telling them how much they owe, how they can repay it and options to avoid foreclosure. This phase of the process is called “preforeclosure” and gives homeowners time to sell the property and avoid hurting their credit scores or losing any of their home’s equity. If they fail, the home will go to public auction so the lender can recoup the debts owed.

Sometimes properties don’t sell at auctions. The foreclosing party is now responsible for the property upkeep until it is sold by a real estate agent or rented.

To find a foreclosed home, check Homes.com. Look for homes for sale and filter “listing type” to include foreclosures.

Other web sites with listings of foreclosed properties include:

• Homepath (Fannie Mae)
• HomeSteps (Freddie Mac)
• HUD Homestore (The Department of Housing and Urban Development HUD))

You can find properties in the process of foreclosure by contacting your local county’s foreclosure sales calendar. You also can check public records for a lis pendens, a notice that a property is going into foreclosure. If the owner owes more than the market value, their lender may agree to a “short sale” — accepting less than the outstanding amount owed on the mortgage.

Another source is an agent who specializes in selling foreclosed properties. The National Association of Realtors has a Short Sales and Foreclosure Resource certification program for agents. They represent distressed sellers and are trained to negotiate with lenders and draft short sale transactions. The Homes.com agent directory is a great place to find one.

Foreclosed homes that are auctioned often aren’t open for a tour or an inspection. Buyers can get an indication of the area, though, by driving around a ZIP code and checking Homes.com for information on a specific neighborhood. Search for a nearby house for sale and look at the school/residential/environmental data that Homes.com posts on its listings.

Buyers can usually tour and inspect foreclosed homes that aren’t on the auction block. Calling an inspector or contractor to walk through with you and point out issues you need to repair is a good way to learn what you’re getting.

Compare the property with similar homes to determine fair market value. The Homes.com database lets you search for recently sold homes in the area.

Getting a home at a discount is a big plus of purchasing foreclosed properties, said Ray Hicks, a home loan specialist with Churchill Mortgage in Brentwood, Tennessee.

"If you are a first-time homebuyer in this market, a foreclosure could be the way you get your foot in the door with real estate being so expensive," Hicks said. "You generally get quite the haircut on the price, since it’s a home that needs to be sold — and be sold fast."

Repeat buyers benefit, too, Hicks said.

"Many of my clients find their 'diamond in the rough' forever home by pursuing foreclosures," he said.

Buying a foreclosed home that needs repairs can be a good investment. The asking price may be less than the current market value, and a flipper can renovate the home and sell for a profit. Renovated homes also improve the property values of nearby homes.

But there are many risks, mostly relating to the property's condition, said Harvey Jacobs, a real estate attorney at the law firm Jacobs & Associates in Rockville, Maryland. Owners who know they're going to lose their home don't make repairs or do routine maintenance.

"For example, if there is a small leak, an owner facing foreclosure may not make a repair and over time that small leak causes major damage to floors, walls, etc. [and] could allow mold to invade the property, causing expensive remediation," he said.

"There are legions of foreclosure horror stories where the owners removed anything of value from the home prior to foreclosure, including appliances, [heating and air-conditioning] units, hot water heaters, toilets, windows, doors, copper pipes, wiring, even plants and dirt from the backyard," Jacobs added. "I have personally seen a family on a main road with a sign out front advertising 'clean fill dirt — $35 a truckload' literally have a pre-foreclosure 'yard sale.'”

Foreclosure often results from a significant life event, like an illness, death, divorce or accident, Jacobs said, that can create legal issues and delays, he said. The owner, tenant or even a squatter may not vacate the property, meaning you have to force them out, he said.

There are a few make-or-break factors that really determine the success of financing a foreclosed home, said Hicks.

Foreclosed homes may not have power or other utilities, he said. They need to be on for an inspection or appraisal. If they're not, lenders will not approve a loan. Buyers who pay cash still run a "massive" risk by not seeing whether utilities can function, he said.

Auction houses typically charge a 10% deposit on the sales price, Hicks said. Some treat this as an earnest money deposit, while others charge it as part of their fee. Paying the charge cuts into any savings, he said.

Another risk is that sellers typically won't accept any contingencies placed on a property. Buyers will have to pay for repairs, he said.

There are other potential pitfalls.

The property may have liens or code violations attached to it that will become your responsibility if you purchase it. Check with your county building inspector’s office to see any past violations. While you’re there, check with the deeds office to look for any liens attached to the home.

Public auctions can be daunting. You will compete with other investors, driving up the price. You’ll also have to pay auction fees and a so-called “sheriff’s fee” of 1.5%- to 6% of the sales price.

They raise an additional concern, said Neil Brooks, an agent and spokesperson for lender NewDay USA in Scottsdale, Arizona.

"Title issues are more prominent if you purchase a foreclosure on the steps of the courthouse in an auction in which case no title search has been done," Brooks said. "You’re safer if you’re purchasing a foreclosed property that’s been listed in the MLS [multiple listing service] and represented by a real estate agent because a full title search has already been completed and the title insurance has been issued."

Foreclosed homes have opportunities and risks. While the price is lower than conventional sales, there are more difficulties with home inspection, financing and closing. Wrongly valuing the home, overbidding or failing to read the contract or funding requirements carefully are some common errors.

Homes in preforeclosure can be sold by making an offer to the homeowner. Make sure you do this through an agent, who can draft the paperwork and negotiate the offer.

Bidding in a trustee or sheriff’s sale typically requires registering with the county of the property beforehand. The county may have a website of foreclosed properties and auction dates.

Should you win, you’ll need a deposit to secure the property. It’s usually 5%- to 10% of the sales price. Most counties allow 10- to 30 days to pay the remaining balance by check or wire.

If the property is listed as an REO, for real estate owned, make an offer directly to the agent. Keep in mind that agents sometimes list a property at a low price to attract multiple offers. This can bid up the purchase price. Stay within your budget. Also understand the contingency and earnest money requirements before making an offer.

It’s a good idea to get preapproved for a mortgage before starting your search. If the property is in fair condition, it may qualify for a conventional mortgage or government-backed loan program.

If the property is in poor condition and won’t qualify for a traditional home loan, it still may qualify for a Federal Housing Administration 203(k) loan, which can be used for a home purchase and renovation. Another option is Freddie Mac’s HomePath program, which provides CHOICERenovation Mortgages to purchase one of its real estate-owned properties.

Foreclosed homes bought through a trustee or sheriff sales may require a cash payment within a specific period. The county may provide all of the closing documents.

In many cases, the closing process for foreclosures is similar to standard closing with a local title company.

Like a traditional sale, closing fees for a foreclosed home may include the agent’s commission, traditional closing costs, title insurance, prorated home insurance and prorated property taxes.