Buying a home. We all dream of doing it some day. However, many prospective homeowners don’t have the savings or budget to afford their dream home. This is why an increasing number of potential buyers are starting to look into foreclosed properties as a way to achieve their dream of home ownership.
Foreclosures offer buyers the chance to get into a new home at a price that is typically far less expensive than a house for sale on the market through traditional methods. However, buying a foreclosure can oftentimes prove to be more complicated than a traditional home purchase.
To the uninitiated, the process may prove overwhelming, but we’re here to help you navigate the long road to a foreclosure purchase. We’ll walk you through all the basics you need to know, discuss the perils that might lie ahead, and tell you how to avoid making the common mistakes that can delay or even sink a deal.
Buying a foreclosed home doesn’t have to be daunting, it just takes some patience and hard work. It is a time-consuming endeavor and there are a lot of extra steps to take, but once you’ve made it to the other side you could have the home of your dreams at a dream price.
What is a Foreclosure?
Let’s start with the most basic question that most people might have about a foreclosed property. If a borrower or homeowner defaults on loan payments (usually associated with a mortgage), a lender can take legal recourse by assuming ownership of the property as security for the loan. Once a lender has initiated this legal action by way of public notice through a Notice of Default or Lis Pendens, the home is then foreclosed upon.
However, just because a lender takes these steps doesn’t mean that the borrower or owner can’t reclaim the property. Most homeowners have a grace period, known as a pre-foreclosure, where that party has a fixed amount of time to reinstate the loan by paying off the default amount in full before the grace period ends. If a borrower can’t pay their balance outright, then they can raise enough money by selling the property to a third party. These sales will allow a homeowner to unburden themselves of their debt without devastating their credit score. In fact, a foreclosure can cause one’s credit score to dip by 200-300 points and will remain listed on the report for seven years.
In addition to these possibilities, a third party could purchase the home at a public auction, which would take place at the end of the pre-foreclosure grace period. Finally, there’s the fourth option where a lender can take ownership directly from the borrower through a short sale during the pre-foreclosure duration or buy it back at public auction. If the lender has taken ownership of the home it is now considered a bank-owned or REO (Real Estate Owned by lender) property. If the lender has repossessed the home from the original borrower in any capacity and it has not gone to a third party purchaser or the home is available through a public auction, that’s where you, the potential new buyer, comes in.
Buying a Foreclosed Home
Now that you know how and why a home has been foreclosed upon, we’ll cover how you can purchase that home. The process starts with finding the home that you want, which shouldn’t be too difficult if you are already searching for a new home. Foreclosures are listed in much the same manner as traditional homes on the market, such as through online real estate listings. You can also find foreclosures in just about every price range through websites that specialize in foreclosures as well as certain bank and government websites.
There is a wealth of online resources available to help you find foreclosures and, if you’re not finding listings that appeal to your tastes, you can simply do a Google search for “REO properties” or “foreclosures” to lead you to even more sites with foreclosures for sale. You can even find listings in your newspaper to broaden your search further.
For buyers who would prefer to investigate the public auction route, there are two common buying methods you can take. Most homes are typically first offered through a public foreclosure auction once a bank or lender takes ownership of the property. If the home is not sold during this auction phase, it is then listed through a real estate agent.
If the home has still not sold after a determined period of time, then the bank will usually send the home to an auction company.At this phase, the home is lumped in with foreclosures for the auction company to sell to the highest bidders, either in person or online. These auctions can get you some pretty deep discounts on a property, particularly once is has reached an auction company. At this point, the home has languished on the market, remaining unsold after a public foreclosure auction and under a realtor’s direction.
Now, as you’re weighing your options as to which route makes more sense to you, just keep in mind that auctions offer you little time to think about what it is you’re buying. Auctions are fast-paced, high pressure affairs so you should do what limited due diligence you are able before you start bidding. Whatever happens, don’t let the excitement of the moment get to your head; the last thing you want is to pay more for a home than it is worth. Whether you’re at a public foreclosure auction or an auction company event, the price you’re paying for the property can quickly get out of hand.
Before you enter into any purchasing situation you’ll want to set a budget for yourself. It’s vital to have your price set ahead of time whether you’re buying through a real estate agent or an auction. Most buyers usually hire an agent to get the buying procedure started, but many buyers do go the public auction route which is a little bit more straightforward. Whichever way you decide to proceed with a foreclosure purchase, there are a few things you should be cognizant of before you begin.
Finding the Right Realtor
This is one of the most common mistakes that most first time buyers make when they’re considering a foreclosure. Not every realtor is well-versed in dealing with foreclosure sales due to the often complex nature of these types of transactions. Foreclosure deals are best made with a real estate agent who specializes in closing these types of sales. A skillful agent can guide you through all of the additional paperwork that comes with buying an REO property and prove useful in advising you on whether or not the house in question is worth the money that’s being asked as a purchase price. Just because you love the property doesn’t always mean it’s a smart investment. The right realtor can help you decide with your head instead of your heart.
Setting Your Budget
You have to determine just how much home you can afford before you start searching auction companies and lender websites. The last thing you want is to get into a home that you ultimately can’t afford because the next thing you know you’ll find yourself on the other side of the auction block.
Figuring out how much you can afford to pay on a foreclosure usually requires factoring in your monthly expenses associated with a mortgage, homeowner’s insurance, and the inevitable property taxes you’re likely to incur as well. A general rule to thumb holds that these costs should not exceed 30% of your annual income before taxes.
Once you’ve determined what you can afford, you’re going to want to get prequalified with a lending institution. Prequalification will help you know how much you’ll be able to take out on a loan and will also make you more viable in the eyes of sellers with whom you’ll be discussing properties. If you’ve already taken the step towards supplying the bank with your financial information and down payment capacities, the seller knows you’re serious about purchasing a home. These factors will make them more likely to accept your purchase offer over other buyers who haven’t yet taken that important first step in the process.
When you’re seeking out loans or other financial products, you will want to explore the many different options for buyers of foreclosed properties that are available from both traditional lenders and the government through the Federal Housing Administration (FHA). FHA loans can cover a range of costs that come with purchasing your first home and foreclosure properties, often at lower interest rates.
The Potential Hazards of Foreclosures
Purchasing a REO property is a much different proposition than buying from a traditional home listing. For starters, it can take longer to negotiate a deal since there are more approvals necessary before you can close on the house. Submitting an offer for a foreclosure will also go through closer scrutiny than on a typical home since you’re dealing with a lender-owned property.
An offer will need to strike that delicate balance between meeting fair market value while also taking into consideration other factors that are inherent to a foreclosure purchasing scenario. There is usually very little wiggle room with respect to negotiating a better price on the house. Trying to haggle the cost of the property down could be a protracted endeavor and one that might result in you losing the property to another buyer who is prepared to buy it at the current listing price.
Foreclosed properties are a good opportunity for saving money, but be careful about trying to save more than the owner is willing to give up just to sell it. Banks don’t want to own property, so on the one hand they’re looking to sell it fast, but on the other, they don’t want to leave money on the table that they know someone else can give them. That’s why budgeting is important before you go house hunting for REO’s; you want to be prepared to pull the trigger quickly and know going in that you may not have a lot of leverage for negotiation.
Out of Pocket Costs
Another component of purchasing a foreclosure is the possible issues that you may find with the property itself. Once a home has been foreclosed upon, the house is vacated, meaning that nobody has lived there (and maintained the property) since the previous owners moved out. You’ve never set foot in the place either so you have no idea what what the condition the property is in now that it’s been empty for an extended amount of time. In fact, it might be a full year or two since someone has even walked inside the dwelling and there could be significant maintenance or repairs needed before you could even move in.
If you buy this home, you will be solely responsible for making those refurbishments – with that money coming out of your pocket. So before you incur any type of costs whatsoever on this property, you will want to spend the money to hire a good inspector to go in and make a full assessment of the home, inside and out. That cost will be yours to deal with alone, but it’s a necessary step to take if you’re buying a foreclosure.
You can avoid making a major financial mistake by conducting a complete inspection of the property. This will help to identify all the current and potential problems with the house before you proceed with the purchase. You will want to take all of the identified issues into account before you decide on the offer you submit on a property. Since no one else is going to supply with you the necessary disclosures as to the current condition of the home, you’ll want to make doing your due diligence a top priority.
The Most Common Issues
Foreclosures can come with a plethora of complications and headaches which can range from the condition of the house to obstacles with lenders that you’ll need to negotiate. Buying a foreclosed property requires a lot of dedication and hard work on your part before you can finally call that house a home. Knowing what you can run into will make your decision of whether to put the time and effort into the purchase or simply walk away an easier one. Since every foreclosure is usually a result of a homeowner having to relinquish the home because he or she was unable to make the payments on that property, the dwelling may be suffering from a myriad of issues, both cosmetic and otherwise.
Lack of Upkeep
Routine maintenance may have fallen by the wayside due to the owner’s financial troubles. If they were unable to remain current on the mortgage, it stands to reason that basic upkeep likely suffered as well. The house may need small fixes, or worse, major repairs stemming from long term neglect. These issues could be anything from water damage due to leaky plumbing, overgrown and unkempt lawn and landscaping, chipped or peeling interior and/or exterior paint, broken fixtures, pest and rodent issues, or damage caused by individuals.
Since many of these homes have not been lived in for a significant amount of time they can be filthy on the inside. Thick layers of dust, grime, or even mold can accumulate in a house that hasn’t been lived in or maintained for months on end. Unfortunately, these fundamental problems mar many foreclosures. In some cases, it doesn’t take more than a good cleaning crew to go in and scour the place back to its original luster. In others, there is substantial work to be done that requires contractors and crews to fix and replace affected areas of the home.
Vandalism
A house that hasn’t been lived in for any extended period of time is more likely to be the target of vandals than one that is occupied. This is a sad fact that holds true in just about any community in the country, regardless of the socioeconomic status of the neighborhood. Foreclosed homes often fall victim to issues of vandalism that can be perpetrated by certain parties who are both directly and indirectly involved in the foreclosure itself.
When an owner has lost his or her home due to foreclosure, it’s not uncommon for that individual or individuals to try and exact some form of revenge on the bank or lender that has taken over the property through inflicting damage to the home. A foreclosed home is almost immediately recognizable by broken or shattered window panes. These are most often damaged because the previous owner has broken in with the intent to retrieve personal property that was still in the house at the time the home was foreclosed upon or simply to vandalize the home out of anger and spite.
Sometimes a previous owner will even attempt to make the home uninhabitable by breaking in and removing items of value, such as fixtures, appliances, copper tubing, wires, and anything that can be resold or traded in. In some instances, the owner has broken in to the house and caused dramatic physical damage by smashing holes in the walls, ripping up molding, and worse. This is almost always done as a way to get back at the lender or bank for taking their home away, even though these actions make the owner subject to criminal penalties and fines.
However, it’s not always the previous owner who causes damage through vandalism. When thieves find a home that isn’t occupied then it will become a prime target and they will steal valuable items from the property. Sometimes squatters can take over a house once they realize that the home has been foreclosed upon and no one is coming to check in on it anytime soon. That can result in a property that is overrun with people who have no claim to the house and don’t belong there. Their disregard for the condition of the home can turn it into a trash dump with refuse and detritus strewn about in every room. Graffiti can become a major concern as well as vandals break in and deface the inside and outside of the home just for kicks.
Lender Issues
The biggest problem you’ll encounter with lenders is that they will refuse to loan you money on a home that is uninhabitable or appraised for far lower than the current purchase price. It doesn’t matter how much work you’re willing to perform to get the home back to its original state, if the bank determines that it will cost you far more than the home is actually worth, you will be denied. Some banks may also take an extraordinarily long time to consider your offer, particularly if they feel it’s too low. You can avoid both of these problems with some due diligence up front.
Our Final Thoughts
Foreclosed homes are sometimes a double-edged sword with respect to value and responsibility. Many of these types of homes aren’t worth the headache and you may cull through hundreds of listings just to find one or two within your price range that are worth making an offer on. This guide should be a good start for helping you navigate and head off the many pitfalls and setbacks you may encounter in your journey towards ownership.
A good realtor will help you avoid many of the common mistakes and concerns we’ve discussed here and some we haven’t, such as making sure you do a title search on the property to find out if there are any liens or other outstanding debts that can be collected once a new occupant takes over the deed. Without it, you could be liable for that money owed or worse, the transaction could fall apart entirely and you’re back to square one in trying to find a house to buy. But as long as you walk into any potential deal with your eyes open and your head up, you should find your way through the selling process in no time at all.
