Looking to score a stellar deal on your next home?
Foreclosure properties sometimes make great bargains — emphasis on “sometimes.” They can also come with hidden pitfalls and red tape in having to work with bureaucratic bank sellers.
Make sure you understand exactly what you’re getting into before making offers on assets worth hundreds of thousands. Use this checklist as your guide to buying a foreclosed home.
How to Buy a Foreclosed Home
Although you can buy properties at any stage of the foreclosure process, most homebuyers only consider homes already foreclosed and retaken by the bank. It’s the safest way to buy foreclosures, and the process outlined below.
1. Know the Different Types of Foreclosure
First and foremost, before buying a foreclosed house you should understand the foreclosure process.
When a homeowner defaults, lenders must wait a minimum of 120 days before even beginning the foreclosure process. That gives the borrower plenty of time to negotiate a payment plan or short sale, sell the property, or use another strategy to prevent foreclosure.
After 120 days, lenders can file in court to foreclose and advertise the foreclosure auction. The auction can’t take place less than 60 days after the 120 day waiting period ends, for a bare minimum of around six months between when a borrower defaults and when their home goes to auction. In reality it usually takes longer, sometimes as long as a year.
At the public auction, most mortgage lenders start the bidding at the total amount owed, including legal fees and back payments. Because that’s usually near or over the home’s market value — especially since bidders can’t enter the property to inspect its condition — most homes don’t sell at foreclosure auction. The lender then takes ownership, which takes more months of legal filings.
If the homeowner remains in the property after the lender has retaken legal ownership, the lender must then file for eviction, which takes months longer. Only after the property has been vacated do lenders list it for sale on the multiple listing service (MLS).
Theoretically, you can buy foreclosures at any stage of foreclosure. Once lenders file in court for foreclosure, it becomes public record, so you can contact the owner to try to buy the home before it goes to auction. This window offers the best potential for scoring a great deal, with the seller under a hard time limit. But most homebuyers don’t have the skills needed to coordinate these sales, so only professional real estate investors typically pull off purchases pre-foreclosure. But if you want to try anyway, check out Foreclosure.com.
You can also buy properties at foreclosure auctions. But these auctions take place on the courthouse steps, not at the property, so buyers have no way to verify the interior condition of the property.
Which leaves bank-owned properties post-foreclosure, also called “real estate owned” or REO properties.
2. Hire a Real Estate Agent
Because you’re aiming to find foreclosures publicly listed on the MLS, you should hire a real estate agent.
Your Realtor will help you search listings, schedule showings, view homes, make offers, and draw up contracts. Good ones also bring a wealth of contacts, from home inspectors to contractors to lenders.
Read up on how to find a good real estate agent, and ideally work with one familiar with foreclosures. Good real estate agents prove especially helpful for first-time homebuyers, who don’t know the process well.
3. Find a Foreclosed Home
Your real estate agent can help you find bank-owned properties listed for sale. Also check out the Department of Housing and Urban Development’s (HUD’s) list of foreclosed properties for sale.
These tend to be fixer-uppers in need of work. That work could range from cosmetic problems up to larger mechanical issues and structural defects. Know your own comfort level and budget limit with renovations, and stick to properties on the right side of that line.
Buying a fixer-upper usually means working with contractors once you buy, so make sure you’re comfortable with hiring, managing, and negotiating with contractors. As a real estate investor myself, I’ve found working with contractors a consistent source of headaches.
4. Look Into Financing Options
It’s harder to finance a fixer-upper than a move-in ready house.
If the property only needs cosmetic updates and is habitable, you can usually take out a conventional mortgage or government-backed mortgage with no extra hassles. But if the property isn’t in habitable condition, you’ll need a special renovation loan.
Most homebuyers use one of two loan programs to buy fixer-uppers: Fannie Mae’s HomeStyle loan or FHA’s 203K loan. These loan programs finance your repair costs in addition to the sale price, but you’ll still need to pay upfront for each phase of repairs before the lender reimburses you. Both programs come with strict rules, so research them carefully before pulling the trigger on a foreclosure.
Bear in mind that the better your credit, the better your odds of getting approved for a low-interest purchase-rehab loan. Pull your own credit report to check it for errors, and start working on improving your credit score if needed.
5. Get Preapproved for a Mortgage
Once you have a sense for what type of mortgage loan you want, start shopping around.
Compare interest rates and loan terms online through services like LendingTree. Then pick up the phone and call local mortgage brokers, banks, and credit unions to compare their pricing too.
Don’t be afraid to play lenders against one another. If you find a lender you like better than the others, share the lower price quotes you received elsewhere and ask if they can beat them.
When comparison shopping, don’t let every lender pull your credit however. It dings your score each time a lender does a hard pull, so just verbally give them your score when collecting quotes, and only let your final chosen lender pull your credit when they pre-approve you.
Note that pre-approvals differ from pre-qualifications. Pre-qualifications mean virtually nothing, whereas a pre-approval means the lender is likely to actually approve your home loan. When you make offers, you’ll want to include your pre-approval letter as evidence you can fund the purchase.
6. Make Offers
When you hunt for home bargains aggressively, you typically play a numbers game. You make many lowball offers, knowing that most won’t go anywhere.
But some sellers — in this case banks — will make counteroffers, and then the negotiation dance can begin.
Just beware that banks make for slow, bureaucratic sellers, with endless arcane rules. Don’t expect a fast turnaround on offer responses, counteroffers, approvals, or anything else.
As a final thought, make sure you include financing and property condition contingency clauses in your contract. If your financing falls through, or the property turns out to have a major structural problem, you want to be able to withdraw from your contract and get your earnest money deposit back.
7. Get an Appraisal and Home Inspection
Once a bank accepts one of your offers, it’s off to the races. You need to contact your mortgage lender to start the loan approval process, which includes you providing them with mountains of documentation.
It also involves them ordering an appraisal, and you paying for it. If the property fails to appraise for your contract purchase price, your loan falls through in most cases.
While the appraisal protects the lender, you should also order a home inspection to protect yourself. You need to know the exact condition of every plank, stone, wire, pipe, and shingle in that house. That helps you forecast your renovation budget, and avoid buying a money pit.
Not every foreclosure is a good deal, so don’t get complacent when buying a foreclosed home.
You need to run all the numbers conservatively, from closing costs to renovation costs, to make sure you can afford the home. Run the numbers through a home affordability calculator to double check your personal finances.
In particular, budget extra for unforeseen renovation and carrying costs. Add at least 20% to the total of your renovation budget as a buffer, because Murphy’s Law applies doubly to home renovations.
That said, foreclosures offer an increasingly rare opportunity to score a bargain on real estate. Take your time and get it right, and you can end up with a great deal on your next home purchase.