By buying a foreclosed home, you can score a great deal during a time when deals are hard to find.
“The advantage of purchasing a foreclosure property is, in short, price,” says John Soffee, a Realtor with Freedom Realty Services in Midlothian, Virginia.
However, the process is more nuanced than buying a traditional listing, and it’s important to remember that foreclosures are currently at record lows. Many lenders have stopped foreclosing during the coronavirus pandemic, and generous forbearance programs allow troubled borrowers to skip payments for up to a year. It’s possible, though, that foreclosure levels will tick up in 2021.
If you’re wondering how to buy a foreclosed home, consider this your primer.
What is a foreclosure?
Foreclosures happen when a lender takes a property from an owner who has defaulted on their mortgage and has fallen behind on payments. Lenders, in turn, will try to recoup as much of their investment as possible by selling a foreclosed home for slightly less than it might be worth.
In the right situation, “you are getting something below market value because the bank is motivated to get the home sold,” says Rose Sklar of The Sklar Team of Coldwell Banker in Weston, Florida. “Also, the bank tends to negotiate more than a typical seller would.”
5 steps to buying a foreclosed home
Here are some tips to prepare you before buying a foreclosed home:
- 1. Find an agent specializing in foreclosures.
- 2. Get a preapproval letter.
- 3. Look at comps before making an offer.
- 4. Bid higher if other foreclosures are selling fast.
- 5. Be prepared to buy a foreclosure in “as-is” condition.
1. Find an experienced real estate agent
Hire an agent who is knowledgeable about the foreclosure process to represent your interests and will keep the transaction moving. One strategy for finding the right agent is to visit websites with a database of foreclosed homes in your desired area. Look for Realtors who have specialized real estate training in this area, such as the Certified Distressed Property Expert (CDPE) or the Short Sales and Foreclosure Resource (SFR) designations.
A buyer can work directly with the bank’s real estate agent instead of using a buyer’s agent to save on the commission split. This can be a risk, though, because “buyers feel more secure when they are (directly) represented,” Soffee says.
If you find an agent you want to work with to buy a foreclosed home, ask them to look out for foreclosure properties that meet your criteria. These listings can go fast, so be prepared to move quickly.
Your agent can guide you through various types of distressed sales. These include:
- Preforeclosures, when a buyer bails out a seller before the bank takes the property
- Short sales, where the borrower owes more than the home is worth and the bank agrees to forgive some of the debt
- Public auctions, where bidders have a chance to make offers on foreclosed properties at the local courthouse
- Bank-owned homes, which belong to the lender
Some lenders – including Bank of America, Citibank and Wells Fargo – post their bank-owned properties online. The U.S. Department of Housing and Urban Development also lists its inventory of foreclosures.
2. Get a preapproval letter
Unless you can afford to pay cash, you’ll want a mortgage preapproval letter in hand when you make an offer on a foreclosure. “It separates the lookers from the buyers,” Soffee says.
Preapproval letters detail how much money you can borrow based on the lender’s thorough assessment of your credit score and income. Find a mortgage lender who understands your goals, and gather the necessary paperwork to obtain a preapproval letter.
“It’s always good to be prepared,” Sklar says. “Having your proof of funds will make it an easier transaction.”
You’ll also want to consider what kind of loan to get preapproved for. Foreclosed properties often require repairs or upgrades, and an FHA 203(k) loan can help. These loans allow buyers to finance up to $35,000 for repairs.
Although foreclosures tend to get scooped up by real estate investors who pay cash, don’t let that discourage you; many lenders will help you find the right financing to buy a foreclosed home.
3. Look at comps before making an offer
Finding the right price to offer is as much an art as it is a science. Your agent can run a comparative market analysis (CMA), which helps you understand recent sale prices of comparable properties, or “comps.”
Soffee says he runs a CMA from the last 180 days and evaluates several factors, including the pace of home sales, tax assessment history and a deeper analysis of similar properties nearby that have recently sold.
If you’re up against cash offers, knowing this information can help ensure your offer is a competitive one. Your lender will require an appraisal to assess the home’s value, so keep that in mind when making your offer, as well. If there’s a shortfall between your offer and the home’s appraised value, you might have to make up the difference in price if the bank (the seller) doesn’t budge.
4. Bid higher if other foreclosures are selling quickly
There’s no exact formula on what the bank’s bottom line will be, so if foreclosed homes in your area are selling quickly, it’s important to work with your agent to craft a strong offer, backed up by your preapproval letter if obtaining a mortgage. In many instances, foreclosures are already discounted, so an offer that’s too low might be a non-starter for the bank.
Keep in mind that the type of house and location matter, and some homes might sell faster than others. In competitive markets, you might need to offer asking price (or slightly more if there are multiple bids) and keep contingencies to a minimum.
5. Be prepared to buy a foreclosed home in ‘as-is’ condition
When purchasing a foreclosure, the property is usually sold in “as-is” condition. This means that the seller can’t guarantee the property’s condition, such as whether it has termites, structural issues or lead paint, for example, and is unlikely to make repairs.
“Since a foreclosure is owned by the bank, there is no one to fix any current issues,” Sklar says.
Get a home inspection if you plan to buy a foreclosed home so you know exactly what you’re in store for. A home inspection isn’t required to buy a foreclosed home, but it can identify major issues the bank isn’t aware of so you can decide whether to move forward with your home purchase or to walk away from the deal if you included a home inspection contingency in your contract.
Buying a foreclosed home: Pros and cons
Buying a foreclosed home is a personal decision and it depends on a variety of factors, including your risk tolerance, the property’s potential reward, financing and your ability to move quickly. You could reap big savings if the foreclosure is priced right, so don’t discount this type of listing in your home search.
- Good value – Scoring a low price is the biggest attraction for foreclosure shoppers. Especially in down markets, foreclosed properties can sell for a discount.
- Strong returns – If you find a well-priced foreclosure and perform repairs cost-effectively, your reward is a property worth more than you paid.
- Extensive repairs – Foreclosed properties often need work. Struggling homeowners might ignore routine maintenance, so the repair bills can be expensive.
- Complicated process – Compared to a typical transaction, buying a distressed property requires more specialized knowledge. Short sales are notoriously time-consuming, while finding pre-foreclosure sellers requires legwork on the buyer’s part.
- Cash requirements – If you buy at auction, you’ll probably need to pay cash for the property.
- Stiff competition – Foreclosures typically are the purview of professional investors, and competing against them isn’t always easy.