The average sale price of U.S. homes rose to an all-time high of $542,900 in the third quarter of 2022, up from $383,000 in the first quarter of 2020. Mortgage rates are also rising, peaking at an average of 7.08% in November 2022, up from a historic low of 2.65% in January 2021. These high prices and interest rates can put homeownership out of reach for the average American.
One way homeowners might be able to save money on their next home purchase is by looking into foreclosed homes. These can sometimes sell for far under market value, and while they may need a little work, they have the potential to become a good investment. However, foreclosed homes do come with some inherent risks. Learn more about buying a foreclosed home to see if it’s the right choice for you.
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What Does It Mean When a Home Is Foreclosed?
If a homeowner fails to pay their mortgage, taxes, or other bills, the shorted party can put their home into foreclosure. This is usually the lender or the government. They take possession of the home to compensate them for the missing payments. Then, they sell the property to try and cut their losses.
For example, if you don’t pay your mortgage for four months, banks are legally authorized to begin foreclosure proceedings. If you don’t square up quickly, your bank can take ownership of your home and kick you out.
Because homeowners are sometimes forcibly evicted, they may leave their homes in rough shape. If you’re considering buying a foreclosed home, know that you might need repairs before moving in.
The Foreclosure Process, Explained
Legally, a bank can begin the foreclosure process after a homeowner hasn’t paid their mortgage for 120 days. At this point, the lender might send a notice of filing for foreclosure, a warning that they’re beginning the foreclosure process. The next step depends on the state’s laws. Homeowners might have anywhere from 45 days to three years to catch up on their payments or negotiate new terms with their bank. The mortgage lender may submit a claim to the court during this time so it’s officially documented.
Once the foreclosure deadline is up, the bank legally takes possession of the home and evicts the homeowner. It will then usually try selling the property at auction. If that fails, the bank might list it the traditional way on the multiple listing service (MLS), meaning it shows up on sites like Zillow or Realtor.com.
Types of Foreclosures
There are several different types of foreclosures, often depending on the state’s laws and the entity that is owed money.
- Judicial Foreclosures: Judicial Foreclosures occur when a court decides the entity (the lender) has a right to foreclose on the home. Depending on how fast the court works, the process could take anywhere from six months to three years. These foreclosures usually result in an auction run by the local sheriff’s office.
- Non-judicial Foreclosures: Non-judicial foreclosures, also called Statutory Foreclosures, are foreclosures that don’t have to go through a court system and are legal in 33 states. In non-judicial states, mortgages usually contain a power of sale clause that states the lender can sell the home if the homeowner defaults. This gives lenders the power to set up their own auction to offload the property and recoup their losses.
- Strict Foreclosures: A Strict Foreclosure occurs when a lender files a lawsuit against the homeowner that has defaulted. The court then sets a deadline for the homeowner to catch up on payments, and if they can’t do it on time, the lender assumes ownership of the home. These bank-owned properties are usually sold on the open market.
What Is the Advantage of Buying a Foreclosed Home?
Buying a foreclosed home has a lot of benefits, particularly in today’s challenging market. Although the process can take a little more work than buying a traditional home, many home buyers find it worthwhile for the following reasons.
You Could Potentially Get a Great Deal
In many cases, foreclosures sell below market value. There are a few reasons for this. First, banks usually want to offload homes as fast as possible so they can get their money back. Second, they don’t want to waste time and effort on repairs. Third, a bank usually doesn’t take the time to do a comparable market analysis to assess pricing trends in the neighborhood.
For all of the reasons mentioned above, getting a great value on a foreclosed home is possible. Over the last five years, the average price of a foreclosed home ranged between $93,000 to $166,000. That’s far below the average sale price of $373,200 to $542,900 during this same period.
You Could Find Yourself With More Options
While the monthly supply of new houses available is rising (after a historic low in 2020), it’s still challenging to find precisely what you’re looking for. Opening up your search to foreclosures gives you more options to sift through. In 2022 alone, there were 324,237 foreclosed homes — about 5.4% of total homes sold. While you may have to put a little more elbow grease into a foreclosure purchase, securing a home with your dream features might be possible.
You May Expedite the Home-Buying Process
In many cases, banks want to sell quickly. They’ve already taken a loss on the home, so they want to move on. You might be able to use this to your advantage if you’re looking for a quick sale. Additionally, because foreclosed homes are sometimes cheaper, you might need a smaller loan, which could also make your financing process faster.
You might also be able to catch a home in pre-foreclosure, the period before the bank takes ownership, but when foreclosure is imminent. These homeowners might want to sell on their own terms so they can avoid having a foreclosure on their record.
Risks to Keep in Mind
While there’s a lot to gain from buying foreclosed homes, the process also comes with its own unique challenges. Your real estate agent can advise you on the risks of your specific situation, but here are some common ones to look out for.
You Will Buy the Home in “As-Is” Condition
Foreclosed homes are typically sold “as is.” The bank or government doesn’t make any repairs before selling you the house, so you could take ownership of a property that’s in less-than-ideal shape.
Homeowners are in financial distress during foreclosure, so they sometimes fall behind on repairs and maintenance. In some cases, they might even be angry and frustrated over their foreclosure and damage the property on purpose. Make sure you have enough time, energy, and financial flexibility to put work into the property if you have to.
There May Be Undisclosed Issues With the Home
Usually, when a home is sold, the seller has to disclose any issues they’re aware of with the property. However, since the bank has never lived in the home, it’s not required to submit these disclosures. Major and costly issues, such as a leaky basement or cracked foundation, could go overlooked.
Having a quality inspector survey the home can protect you from many issues. However, in many cases, you might not have the chance to inspect the property before buying the home, especially if you’re buying at a foreclosure auction.
The Paperwork and Processes Can Be Complex
In some cases, buying a foreclosure can be an extremely complicated process. For example, during foreclosure auctions, you usually have to pay entirely in cash at the close of the auction. You also need to know where and how to bid — it’s different in every state or county.
Pay more attention to the title search to ensure the previous homeowner doesn’t have any other liens against the property. Further, if you’re taking out a loan and the appraisal comes in lower than expected because of damage or neglect, the lender might not give you the total amount.
Get Ready: Get Help and Look For Foreclosed Homes
Because the foreclosure process is so complex, it’s a good idea to partner with a real estate agent experienced in foreclosures. They can guide you through the process, whether you want to bid at an auction or put offers on bank-owned properties.
Of course, a real estate agent is one piece of the puzzle. When you’re ready to start looking, there are several other places you can turn to find homes.
A short sale occurs when the bank agrees to let a homeowner sell their home for less than what’s due on their mortgage. The lender collects the profits and considers the debt paid off.
Because of the bureaucracy involved in these transactions, they usually take much longer than a traditional sale, sometimes six months or more. Be prepared to play the waiting game and complete a lot of paperwork before the sale is finalized. However, if you successfully complete the transaction, you can usually score a home at a great price.
To find a short sale, look on popular real estate websites. They’re usually listed like a traditional home, but sometimes with extra verbiage explaining the short sale situation. Be aware that even if you submit an offer and the seller agrees, the bank has the final say as to whether or not your price is acceptable.
Real Estate Auctions
Foreclosure auctions are usually hosted by the local sheriff’s office or county clerk — it depends on the state. States also have laws governing how these auctions have to be announced. Some require them to be printed in a local newspaper for several weeks or months before the auction, while others require them to be posted online.
Real estate auctions have the downside of requiring full or near-full payment very soon after the auction closes. This means you usually can’t use financing to pay for an auction. Also, remember that you usually can’t see or inspect the home before bidding, and buying sight unseen means you could inherit a house with serious problems.
On the plus side, you can usually score a great deal with an auction. The closing period is much faster than a traditional sale, meaning you can move in more quickly. To find auctions, search your county’s public records database or consult sites like Auction.com or RealtyTrac.
Direct From Lenders
If a house doesn’t sell at auction, it becomes a bank-owned or real-estate-owned property. Bank-owned properties are typically listed like traditional homes. The difference is a bank, not an individual, is selling them.
Because the bank is selling the home, you may find it takes longer to get a response if you have questions. It might also take a while for the paperwork to be exchanged. However, you can often get a good deal with a bank-owned property since the bank wants to offload the home. Banks also take the time to settle title liens and back taxes before listing the home, so you can rest assured no one else has a claim to the property.
You can find bank-owned properties on the usual home-buying sites. Some banks also put together a directory of the properties they’re selling, making it easier to find them.
Direct From the Government
If a homeowner defaults on a government-sponsored mortgage, the government takes ownership of the home. The government can also take possession of the home if the homeowner doesn’t pay their taxes.
Buying a home from the government has many of the same pros and cons as buying from a bank. You may be able to get a home below market value. Some types of government sales also block investors, meaning individual homebuyers get priority. However, government-owned properties might not have their liens cleared, unlike bank-owned properties. In other words, you could be responsible for paying any debts attached to the home.
Finding government properties depends on what organization you want to buy from. The HUD Home Store is a popular resource for homes purchased with an FHA loan. You can also buy homes on which the Internal Revenue Service has foreclosed. Other resources include the USDA-RD/FSA property listings site, the Fannie Mae HomePath site, and the Freddie Mac HomeSteps site.
Get Set: Confirm Your Needs, Budget, and Mortgage Pre-approval
After you’ve decided what type of foreclosure to pursue, there are a few more things to consider. Finalizing your wish list, planning a budget, and getting mortgage pre-approval are essential steps.
Decide Your Must-Haves, Nice-to-Haves, and Dealbreakers
Whenever you’re buying a home, it helps to have a wishlist. This is an even more important step when considering buying a foreclosed house. In many cases, you might not have the opportunity to inspect the home before making an offer. Therefore, you may need to cut back on your must-have column. For example, it’s unrealistic to expect a foreclosed home to have granite countertops or heated floors in the bathroom.
In many cases, the bank doesn’t list a foreclosed home’s amenities or even offer pictures of the inside of the property. You may have to submit your bid knowing the bare minimum about the property. Try to keep your nice-to-have list as general as possible so you don’t exclude homes that would otherwise work.
When it comes to dealbreakers, this is something you can probably work with. Many foreclosed homes list the number of bathrooms and bedrooms, so it’s fine to include those qualities on this list.
Calculate How Much You Can Afford
Any time you buy a foreclosed home, you take the risk that the property might be distressed. Therefore, when buying these homes, you must account for more than your mortgage payment and utilities. Make sure you have a sizeable renovation and repair budget. The good news? Since you might save a lot on the purchase price, you can put this money into a repair budget.
Fixing up a foreclosure is a double-edged sword. Renovations make the home a comfortable place to live, but they could also raise the property tax you pay, especially if the house has been distressed for a long time. Account for these inevitable increases whenever you’re planning out your budget. They could raise your monthly payments by several hundred dollars, depending on how much you fix up the house.
Get Pre-approved For Your Mortgage
To truly know how much you can afford when buying a foreclosure, get a mortgage pre-approval. To get pre-approved, you must provide your mortgage lender with details about your financial history. This might include giving them copies of your pay stubs, tax returns, and bank account statements. They might also run a credit check to look at your credit score and see more details on your debts.
After compiling all of this data, your mortgage lender makes a good-faith estimate of how much money you can borrow (and at what interest rate). Pre-approval is not a mortgage guarantee, but it’s an essential tool for knowing the top levels of your budget. Going the pre-approval route might disqualify you from bidding at foreclosure auctions, as those typically require you to make a cash payment for the home.
Go: Inspect the Home and Make Your Offer
In many cases, you can’t see a foreclosed home before offering. But if you can, don’t waste the opportunity. Seeing the home beforehand can help you make an informed offer based on what you expect to pay in repair costs.
Why Home Inspections Are Critical
Inspecting a foreclosure, whether on your own or with a home inspector, can help you determine if the home is worth your offer. Home inspectors are qualified professionals trained to identify common issues with homes. Having them walk through the home to look for problems is vitally important in the case of foreclosures because you usually don’t receive any disclosures from the seller. Banks or the government never lived in the home, so they don’t know if there’s an issue with a leaky roof or sloping on the second floor.
Once you find out everything wrong with the home, it helps you know whether or not the house is worth bidding on. For example, if you find out the home needs about $50,000 in repairs to be liveable, you might want to pass. Also, unless you have a massive renovation budget, you may want to avoid buying at auction since you likely won’t be able to inspect the home first.
How to Make a Competitive Offer
Because you’re usually dealing with banks when making an offer on a foreclosure, you can try a few things to negotiate a better deal for yourself. First, offer to split closing costs. Since the lender is likely losing money already, they may be more willing to take any chance at saving a few dollars.
You may also want to shorten the inspection period. This helps the sale move through faster. If you can get an inspection before putting in the offer, you may be able to waive the inspection contingency altogether. That means there’s one less way for you to back out of the sale, but since you already know about the home’s problems, this isn’t a huge loss on your side.
Make sure you include your pre-approval letter as well. This shows the bank that you have the finances to afford the house, reducing the chance that the sale might fall through.
What to Expect After Your Offer Is Accepted
After your offer is accepted, you need to get a home inspection if you haven’t already. The next step is to get an appraisal. In this process, a certified appraiser comes to the home and takes note of its condition and any major faults. Then, the appraiser estimates the home’s market value using their knowledge of the local market.
If the appraisal comes in lower than your offer, your lender might refuse to offer you a mortgage for the total amount of the home price. You either need to cover the difference or back out of the sale. Remember that you usually don’t have time for an appraisal in a foreclosure auction.
Otherwise, be prepared to wait. While some sales might go through faster because the bank wants to close, others may drag on due to bureaucracy and slow paperwork processes. Like a traditional home, it can take a few weeks to a few months to finalize the closing.