You’ve seen them in the online real estate listings at prices too good to be true. Buying a foreclosed home sounds like a great idea, doesn’t it? Man, think of the deal you can get! Whether you’re a first-time home buyer or looking to invest in real estate, the idea of buying property at a bargain is extremely tempting.
The truth about the matter is that you can find deals when buying a foreclosed home. But it’s not for the fainthearted. It can take a lot of time and work, and there are dozens of ways to mess it up.
Unfortunately, there’s no beginner’s guidebook called Buying Foreclosed Homes for Dummies, but that’s okay. You’re smart, and you’ve got us! We’ll teach you how to buy foreclosed homes—from getting a good deal to deciding if a foreclosure’s right for you in the first place.
Let’s get started!
What Is a Foreclosed Home?
A foreclosed home is a house that now belongs to a bank or mortgage lender instead of an individual homeowner. But banks don’t just go around buying houses for fun. Let’s take a look at how a foreclosure works.
You’ve heard of the repo man? He’s the guy who comes and takes your car when you stop paying the bills. (And he’s one of the reasons we recommend paying cash for a car. No payment equals no repos.) A foreclosure is the same concept—but with houses. When a homeowner gets behind on their mortgage and can’t make payments, the bank moves to take the property back.
This process can take anywhere from a couple of months to years, depending on the location (laws vary from state to state). But the motive behind it is the same: A foreclosure allows the bank to repossess the house and sell it to try to get back some of the money they lost when the borrower stopped making their loan payments.
Types of Foreclosures
Now, there are two types of foreclosed homes: bank-owned and real estate owned (REO). It’s kind of confusing because the bank actually owns the home in both cases. The difference is that REO foreclosures are in a later stage of the reselling process.
Here’s the breakdown:
- Bank-Owned Foreclosures: Bank-owned houses are in the early stage of foreclosure—the big, meaty part. This means the homeowner has stopped making payments and the lender has started the legal process to remove them from the property. This can be a long, drawn-out process in some cases. Once it’s complete, the house is put up for auction, where the bank tries to sell it for as much as possible to recover the money it lent. If nobody buys it at auction? Then it’s REO time, and we don’t mean the band from the 1970s.
- Real Estate Owned (REO) Foreclosures: When the bank forecloses on a home and nobody buys it at auction, the bank’s next step is to sell the property the regular way: by creating a real estate listing. Banks usually do this through a real estate agent who specializes in REO sales. So, an REO property is just sitting empty and, since no one bought it at auction, has the potential to be a really good deal for a smart buyer like you.
Is Buying a Foreclosed Home Cheaper?
It’s true: Foreclosed homes are usually priced cheaper than other homes on the market.
One reason is because the bank or lender wants to get the foreclosed home off their hands as soon as possible. The longer they keep it, the more money they lose because they aren’t getting mortgage payments or profits from selling the home. Since the bank wants that money in its pocket now, they aren’t exactly waiting around for the highest possible offer.
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Another reason foreclosed homes are almost always cheaper is that they’re usually sold “as is.” That means you get the house in the condition you found it—without repairs. And you can expect that these homes will need repairs because, in most cases, nobody has lived there while the bank has owned it. And the bank, which is trying to maximize how much it gets for the house, won’t spend a ton of money on upkeep.
Usually, a foreclosed house has been sitting closed up for months, with no air conditioning—perfect for spawning mold, mildew and nasty odors. Yuck! And the previous owners could have made things even worse if they left clutter or trash. Unoccupied houses are sometimes targets for vandalism or theft too, which can mean missing appliances, removed copper piping, graffiti, you name it. The yard will also probably be overgrown and in desperate need of cleanup and landscaping. Not to mention that you’ll need to carefully examine the structure of the home, since big problems could be lurking there.
A long list of heavy repairs can add to your budget—not to mention your workload and your timeline. And that’s your first lesson in how to buy a foreclosed home: Expect and prepare to make repairs!
How Do I Get a Good Deal on a Foreclosed Home?
When you’re investing in real estate—the keyword there being investing—you make money by finding a good deal first, then selling at a higher price later. This means you want to buy something below market value.
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One of the most important rules about buying foreclosed homes is that you must get a good deal. As an investor, you can generally consider a home to be a “good deal” if you can get it for 80% or less of market value minus the cost of repairs.
Even if you’re taking the house “as is,” your offer should still account for the cost of repairs you’ll have to make after you buy it. (After all, you’ll still need to replace the roof or patch up the hole in the wall.) You just need a home inspection and a good bid on repairs so you can apply the formula for getting a deal on the house:
80% of the appraised value minus the cost of repairs
For example, let’s say you find a foreclosure listed at $125,000. You and your real estate agent agree this is a fair market value for the house in pristine condition. But it’s not in pristine condition and your contractor estimates repairs at $15,000.
Now do the math: 80% of $125,000 is $100,000, minus repairs of $15,000 equals $85,000. That’s the offer you make. Remember, the deal is made at the buy. That means you don’t buy unless you’re getting a deal. You’ve got some room to negotiate, but don’t go into debt to get the deal done. (That’s another rule of investing in real estate, by the way: Investors pay cash. Period.)
Times (x) 80%
Minus (-) Repair Costs
Another option as an investor is to buy a home from the owners before the foreclosure. The owners have the right to sell the house at any point before the auction. Even better, they’re probably highly motivated to sell, and you could get a great deal by helping them prevent a foreclosure.
Have your real estate agent contact the homeowners and make an offer. The transaction will have to happen quickly, though. Good thing you’ve got cash! And remember to buy title insurance to protect yourself from liens or other problems down the road.
Okay, so what if you’re not an investor? Is it still a good idea to look at a foreclosed home as a first-time home buyer? Maybe.
You’ll want to apply the same formula for how to buy a foreclosed home at a good price (reminder: 80% of the appraised value minus the cost of repairs). But to know you’re ready to buy a home in the first place, you’ll also want to make sure that you:
- Are out of debt
- Have an emergency fund of 3–6 months’ expenses
- Have a down payment of at least 10–20% for a 15-year fixed-rate mortgage
- Have enough cash saved above that amount to cover closing costs and any repair costs not accounted for in your offer
If you’re looking for a move-in ready home in great shape, then a foreclosure most likely isn’t for you. It usually takes considerable work to get a foreclosure livable again. But if you’re willing to be patient and look past a little neglect, there’s good potential for you to score a deal.
Just know what you’re getting into up front. And talk to our friends at Churchill Mortgage about getting preapproved before you start your home search, so you’re ready to make an offer when you do find the right place.
What Are the Risks of Buying a Foreclosed Home?
Imagine you’re the proud owner of a foreclosure. You got an awesome deal, you’ve got a schedule for all the repairs you need to make, and you know how much they’re going to cost. You’re all set to move in (or have some renters move in), right?
Pump the brakes! Some states have what’s called right of redemption, which means a homeowner who has been foreclosed on has a period of time to redeem, or buy back, the property. That means that if you worked hard to buy our example property for $85,000, the previous owner has the right to buy it back from you for $85,000 plus some interest.
The period of time varies by state and can last up to one year. You don’t want to fix up someone’s house for free, so you might want to wait to make any improvements until after the redemption period expires to be safe. Check out the laws in your state to see if this applies and ask a trusted real estate agent for their advice.
Buying a foreclosure can also be a slower process than your typical home purchase because there’s more paperwork, people and moving pieces involved. Even if the bank is eager to get the house sold, it could take weeks for an offer to get reviewed and accepted. Keep this in mind if you’re on a tight timeline or can’t afford to wait around on a deal that could fall through.
What Are the Advantages of Buying a Foreclosed Home?
Like we mentioned, foreclosures are usually priced lower than other homes on the market, so you can get some killer deals if you know how to buy a foreclosed home that’s right for you.
And if you’re an investor who’s willing to put a little sweat equity into the project, you could make a pretty sweet return on investment.
Another benefit is less competition from traditional home buyers, which gives you the ability to negotiate a little more than normal in a hot market like this one.
Ready to Buy a Home?
If you’re ready to buy a home, congrats! Whether you’re leaning toward a foreclosure or a regular listing, start by hiring a real estate agent to help you find and negotiate the best deal possible. Just make sure that when you interview your agent, you ask if they have experience buying foreclosed houses.
For a fast and easy way to find a great agent, try our Endorsed Local Providers (ELPs) program. Our ELPs are expert real estate agents who really know their stuff in their local market, and they’ll guide you through the whole process. That’s why they’ve earned the title RamseyTrusted—because we trust them to serve you with excellence.