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 is that there are deals to be found when buying a foreclosed home. But it’s not for the fainthearted. You’d better know what you’re doing!
So, what does it take to buy a foreclosed home? We’ve got you covered!
What Is a Foreclosed Home?
A foreclosed home is a house that now belongs to a bank instead of an individual homeowner. You’ve heard of the repo man? He’s the guy who comes and takes your car when you stop paying the bills. 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, which can take anywhere from a couple of months to years depending on the location (laws vary from state to state), allows the bank to sell the house and try to get back some of the money it 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, in both cases, the bank owns the home. The difference is what stage the foreclosure is in. Here’s the breakdown:
- Bank-Owned: 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 that part is 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): When the bank forecloses on a home and tries to sell it at auction and nobody buys it, the bank still owns the house. The next step is to sell the property the regular way, usually through an 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.
Are Foreclosed Homes Cheaper to Buy?
It’s true: foreclosed homes are usually priced cheaper than other homes on the market. One reason is because the bank or lender in possession of the foreclosed home wants to get it off their hands as soon as possible. They aren’t exactly waiting around for the highest possible offer.
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Another reason is that foreclosed homes are almost always 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, the house has been sitting closed for months with no air conditioning—perfect for mold, mildew and unpleasant odors. Yuck! And the previous owners could have made things even worse if they left clutter or trash. Unoccupied houses sometimes are 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. With all these potential projects to consider, it should be no wonder why foreclosures can be a bargain!
How Do I Get a Good Deal on a Foreclosed Home?
When you’re investing in real estate—keyword there being investing—you make money by finding a good deal first, then selling later. This means you want to buy something below market value so when you do sell it, you make money. You can generally consider it a “good deal” if you get it for 80% of market value minus the cost of repairs.
Even if you’re taking the house “as is,” you can account for the cost of repairs in your offer. 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. There’s your offer. You’ve got some room to negotiate, but don’t go into debt to get the deal done.
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 and you could get a great deal by helping them prevent a foreclosure.
Have your 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 hiccups down the road.
Okay, so what if you’re not an investor? Is it 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 getting a good deal (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 isn’t for you because it’ll take considerable work. 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. Talk to our friends at Churchill Mortgage about getting preapproved before you start your home search.
What Are the Risks of Buying a Foreclosure?
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 breaks! 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 and can be 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 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 foreclosures 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 Foreclosure?
Like we mentioned, foreclosure homes are usually priced lower than other homes on the market. If you’re an investor and willing to put a little sweat equity into the project, you could make a pretty sweet return on investment. Other benefits include 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 otherwise, start by hiring a real estate agent to help you find and negotiate the best deal possible. Our Endorsed Local Providers (ELPs) real estate agents are experts in their local market and they’re here to guide you through the process. Just make sure when you interview your agent that you ask if they have experience buying foreclosed houses.