As home prices soar in many cities, buyers may look to foreclosures to land bargains on houses. Foreclosure happens when a borrower can no longer make mortgage payments, and the lender seizes and then sells the home to recover losses.
Foreclosed homes are often sold for less than their market value.
That discount could bring a home within reach, but the financing and the home’s condition could present challenges. Before you bid on a foreclosed home, make sure you know the risks and the limitations.
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Is It a Good Idea to Buy a Foreclosed Home?
Buying a foreclosure can save you some cash, but it comes with risks. If you pursue a foreclosure, it helps to have a “stomach of steel,” says David Reiss, law professor and research director of the Center for Urban Business Entrepreneurship at Brooklyn Law School.
Expect a lot more ups and downs than the typical homebuying process, says Reiss, whose work focuses on real estate finance and community development.
Homebuying, including financing, can be more complicated with a foreclosed home. Yet the lure of savings can be irresistible.
“It can be like a 15% discount on your neighboring houses,” Reiss says. “So, it can be significant.”
But your savings will depend on the local real estate market and the condition of the foreclosed home, says Vince Malta, a San Francisco Realtor and president of the National Association of Realtors. Properties that need a lot of work sell for less than market value because of their condition and lower demand.
Not every foreclosure is a “steal” or a very good deal, Malta says.
“The truth is, the bank doesn’t want to ‘give’ the house away or sell it for less than it’s worth,” he says. “Foreclosures generally sell for very close to the appraised value.”
How Do You Buy a Foreclosed Home?
Buyers can find foreclosures at auctions, on home search sites such as Zillow and from traditional real estate agents, to name a few sources. You can finance or use cash to pay for a foreclosed home, but the former can be tricky.
Will you need cash to buy a foreclosure? You don’t necessarily need a full cash payment, but when you think you might buy at auction, you should prepare. Have some cash ready to make an immediate down payment.
Ask the auctioneer how much you might need in cash and how long you have to pay in full. Many foreclosures close within 30 to 45 days.
If you plan to finance the foreclosure, you will want to obtain a preapproval from a mortgage lender before the auction and bring it with you.
If you’re buying a bank-owned foreclosure at auction, you might want to apply for a loan from the same bank to simplify matters. Just be sure the bank offers a competitive interest rate.
If you’re buying a foreclosure from a bank, you could get a loan from the same bank to make your purchase. It’s not required but could make the process easier. Still, be sure the bank offers a competitive interest rate, as even a slightly higher rate could cost you thousands over the life of the loan.
Fair warning: Some banks will not want to finance foreclosures or will require large down payments because they can be risky investments.
Government-backed loan programs from the Department of Veterans Affairs or the Federal Housing Administration may offer financing options, but the property will need to meet standards for approval. Fannie Mae’s HomePath program helps homebuyers purchase properties the government-sponsored mortgage buyer has foreclosed on, Reiss says.
The program provides up to 3% in closing cost assistance for buyers who complete a homeowner education course.
“I have seen Fannie Mae put a lot of money into properties to get them in the condition for an owner-occupant to purchase them,” Malta says. “But I’ve also seen properties that would only accept cash offers due to the overwhelming deferred maintenance and damage to the property.”
An FHA 203(k) loan could be another smart choice for foreclosures in disrepair. The 203(k) program allows borrowers to finance repairs and renovations into the mortgage.
[Read: Best Home Improvement Loans. ]
What Are the Risks of Buying a Foreclosure?
Buyers can embrace the process with eyes wide open, knowing the risks involved. The biggest risks can stem from buying property sight unseen.
“The big, scary thing is that with a number of foreclosures, you can’t actually inspect the property before you actually bid,” Reiss says. “That’s in part why the prices are below the market.”
Even if you pay for a home inspection, you typically have to buy the foreclosure “as is.” This means that if you purchase the home, any problem that pops up and the cost of fixing it are yours.
You can end up with a lot more of these problems in a foreclosed home, depending on the circumstances. A frustrated family might strip the home of valuable fixtures and appliances before leaving the house.
“Or they kind of just beat it up because they were angry about having to go through the foreclosure,” Reiss says.
A home lost to foreclosure could indicate a home neglected, Malta adds. “(You) have no idea what the previous owner has done for maintenance, or in many cases, hasn’t done,” he says.
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How Can You Reduce the Risks of Buying a Foreclosure?
You can take a few steps to reduce the risks of buying a foreclosed property.
Get an inspection. “Buyers should absolutely hire their own inspector and thoroughly inspect the property,” Malta says.
In most instances, the bank will disclose any defects in the house, but sometimes the bank doesn’t have these details, he adds.
Research public property records. If you aren’t allowed to inspect the property, which may sometimes be the case, Reiss recommends researching its publicly available history. A property record search can reveal information about sales, tax liens, changes to square footage and additions to the property.
You can check the county tax office, which may have records available online.
“Maybe you’ll see some good news, like a boiler was replaced two years ago,” Reiss says. “Or maybe you’ll see some scary news, like there’s all these permits, and you don’t know if the work was completed.”
Do some informal due diligence. Start by visiting the house and performing a “curbside inspection” of your own, Reiss says.
“Even if you can’t go inside the house, you want to look at the property,” he says. “If you can peek in the windows, you probably want to peek in the windows.”
Knock on the doors of neighbors and see if they can answer your questions about the foreclosure. Tell them you want to bid on the home but need to learn all you can about the previous owners, including how long they lived in the house and how well they maintained it.
Ask if the home has had squatters or recent break-ins.
“Try to get all that information,” Reiss says. “Neighbors are probably going to have a good sense of a lot of that, and I think that kind of informal due diligence can be helpful.”
Seek a real estate agent experienced in distressed properties. This may help you avoid some of the potential pitfalls of buying foreclosures, Malta says.
Some agents have earned a Short Sales and Foreclosure Resource certification from the National Association of Realtors. They can help guide you through processes unique to purchasing a foreclosed home.
“These transactions are handled differently than traditional sales,” Malta says. “With no prior seller knowledge and potential liens and other issues with the ownership, these sales should not be handled by the inexperienced or uneducated.”