Buying a foreclosure: How it all works
If the average sales price for a home in your ideal area is a bit out of range, or if you’re looking to invest some time and finances into a fixer-upper, buying a foreclosed home could offer the homebuying option you’re looking for.
While these properties are generally less expensive than homes on the typical real estate market, they do come with significant risk and potential complications that could hinder the sale and make buying a house in foreclosure seem like more trouble than it’s worth. Their shaky ownership history could cause property title disputes at closing, while a lack of occupants or upkeep may have left the property in poor condition.
For anyone considering purchasing a foreclosed home, it’s vital to understand what foreclosure means and how different types of foreclosure sales can take shape.
What does foreclosure mean?
When a homeowner misses or completely stops making their mortgage payments, the lender can repossess the property and the home goes into foreclosure. A mortgage acts as a lien on the property to secure financing when applying for a loan. This lien gives the lender the right to repossess the property in the event of a mortgage default.
When the mortgage is eventually paid off, this lien is released and the lender can no longer claim ownership. Failure to pay homeowners association fees or property taxes, however, can still result in home foreclosure.
When a lender does reclaim a property, they will attempt to resell it in an effort to recoup their losses on the failed mortgage. These homes are usually priced below market value and can be purchased from a variety of sellers.
Buying a foreclosed home
Buying on foreclosure might seem like a great way to buy property for a cheap price. However, there are different types of foreclosure, each offering their own benefits and disadvantages.
Before searching foreclosed houses for sale, it’s important to have a solid grasp on the various ways these property sales can take shape:
- Purchase through short sale
- Purchase from bank
- Purchase from auction
Purchase through short sale
When a homeowner encounters financial hardship and realizes they can no longer keep up with scheduled mortgage payments, they might request that their lender short sell the property. Short selling occurs when a lender is willing to accept less in a home sale than what is due through the current homeowner’s mortgage.
For example, if the amount owed on a home is $150,000, but the home’s value has dropped to $120,000, the lender may be willing to accept a short sale proposal.
The current homeowner must also be able to prove they’re likely to default on their mortgage payments. In this scenario, the homeowner submits a “letter of hardship” to their lender, which outlines their finances and explains why they are unable to make monthly payments. If the homeowner has no assets or means of paying back the loan, the lender can accept the short sale proposal and decide to sell the home at a reduced price.
Short selling allows lenders to recoup their losses on a failed mortgage. Buying a home in short sale presents less risk than buying after full disclosure. Since the home was never officially foreclosed, it hasn’t had time to fall into disrepair from lack of maintenance. This way, you can ensure you’re getting a suitable home for a fair market price.
Purchase from bank
When foreclosed homes fail to sell on the market or through an auction, ownership of the property is transferred back to the lender. These real estate owned, or REO, properties are marketed by the banks through a real estate agent or via online listings.
Buying REOs also comes with added risk. Foreclosed homes tend to fall into disrepair and the cost of those damages almost always fall on the buyer. Foreclosed homes like REOs are typically sold “as is,” meaning the bank will not be paying for any necessary repairs before selling.
Due to this uncertainty, many banks will price their properties below the average market value. If you’re willing to accept the potential costs, buying an REO might provide a less expensive path to homeownership.
Purchase from Auction
A riskier method of buying a foreclosed home is through an auction. These sales are usually conducted by a third party acting as trustee, where bidders compete against one another and the sale is granted to the highest offer.
It might sound like fun, but buying a home at auction carries a high degree of uncertainty for the buyer. Purchasing a foreclosed home at auction involves buying the property “as is,” meaning the current state of the home will not be changed and the cost of any repairs will be paid by the buyer.
In addition, you likely won’t have the chance to inspect the interior of the property before submitting your bid. This leaves the door wide open for unexpected issues like pipe leaks and structural problems that require expensive maintenance but are not visible from the street.
Buying a foreclosed home at auction also raises the possibility of ownership disputes. The ownership history of any foreclosed home is complicated, and certain laws could protect the previous owner’s claim to the land. Each state has a variation of the “right of redemption” law, which gives the original homeowner a set period of time where they can pay off overdue fees and reclaim ownership of the home. Before deciding to buy a home at auction, make sure to review the local “right to redemption” laws and diligently research the property’s foreclosure timeline. This way, you'll be well equipped for any ownership litigation that may surface later on.
Is it a good idea to buy a home in foreclosure?
You might be interested in buying a foreclosed home for the lower price point, but these locations come with risks that could cause expensive problems after the sale is closed.
Most foreclosed homes, especially those sold at auction, do not grant bidders access to the interior before bidding begins. This preserves the “as is” nature of the sale and gives the lender a chance to make back their money without having to pay for any damages caused by the previous owner.
Pipe leaks, structural flaws and foundational issues are just a few of the potential problems that could arise in a home and not be visible from the street. If a buyer decides to purchase a heavily damaged property, they are now solely responsible for the cost of repairs.
In conclusion
While buying a home in foreclosure does offer unique financing opportunities, avoiding the associated risks and potential barriers to ownership requires caution and an awareness of what is being sold.
Whether buying from short sale, at auction or directly from a bank, it’s important that your attorney conduct a thorough property title search to ensure a straightforward transfer of ownership.