Prospective home buyers looking to get a deal may be in luck with a foreclosed home. Before you jump at a foreclosed with a lower price, though, you need to fully understand what it means to buy foreclosed and how to buy a foreclosure the right way.
As there are many benefits, there are also some drawbacks and risks to be aware of. You’ll also ≠need to decide on the funding option that is best for the purchase. It’s a lot to take in, but when done properly, you can find yourself owning a beautiful home at a healthy discount when you buy a foreclosure.
What is a foreclosed home?
A foreclosed home is a house or condo that the owner has failed to make mortgage payments on, and the lender has decided to move forward with taking possession of the house or condo. The reason homes can be foreclosed on is that a mortgage is a secured loan that uses the home as collateral in case the borrower stops payment. The agreement between the buyer and the lender is that if the homeowner can’t keep up with payments, the lender gets the house.
It’s not an ideal situation, but it’s the way this type of loan works, and it can create a unique buying opportunity for a prospective home buyer.
Types of foreclosed homes
Foreclosed homes can be classified in two different ways — by the type of foreclosure and the stage of the foreclosure process the house is in. The latter of the two is more important to people looking into buying a foreclosure.
The two types of foreclosures are judicial and non-judicial. The difference between the two is whether or not the owner of the house needs to be proven by the lender in a court of law. If it does, the foreclosure goes the judicial route, which is more expensive. The exact laws and regulations for each of these depend on the state where the house is located.
When you’re buying a foreclosure, the more useful way to look at a foreclosed home is the stage it is in the process, which determines your options to buy.
- Pre-foreclosure/short sale — In pre-foreclosure, the homeowner usually has between 30 and 120 days to work out a deal with the lender, come up with the outstanding balance or complete a short sale. Outside buyers can step in during this period and complete the short sale purchase, which is where the lender agrees to sell the house for less than it is worth.
- Auction — Once the house has moved through the pre-foreclosure period with no remedy, it is sent to a foreclosure auction. Buyers can purchase the home — in cash — during this process if they are the highest bidder.
- Real estate owned (REO) — If no deal is reached at the auction, the house becomes a bank-owned property. The more common term for this is a real estate-owned (REO) property. At this point, the home will be listed for sale, creating another opportunity to buy a home in foreclosure.
[Read: What Is a 203k loan?]
How to buy a foreclosed home
1. Determine your cash liquidity and what you’re looking for.
Get a clear picture of your financial situation, how much cash you have on hand and what your potential borrowing options may be. Without this information, it will be hard to make informed decisions or speak with a lender about securing a loan.
2. Research homes in the foreclosure process.
Look online in the state listings for foreclosures that are on the market in your preferred area. While you might not be ready to purchase yet, you can start getting a pulse for the market and see what homes are in the different stages of the process.
3. Decide what stage is the best for you to buy.
During the foreclosure process, there are several different stages in which you can purchase the home that’s in foreclosure. Find the stage that works best for you and look for homes that fit that criteria — or
will fit those criteria in the near future.
4. Reach out to a lender (if necessary) to have a plan for funding.
Find the right lender with the best rates and repayment terms that offers the type of loan you are looking for. If possible, get a preapproval for the funding to make the process simpler and show the bank that owns the home that you’re serious about the purchase.
5. When the opportunity arises, do your due diligence and make the purchase.
Be aware that other investors or home buyers may also be shopping the same listings, so be prepared to act. That being said, don’t be reckless just to secure a deal. Unless you’re buying a foreclosed home at auction, you have the right to get an inspection, so do it. Make sure you also complete your paperwork properly and follow the expert’s guidance.
Risks of buying a foreclosed home
While you do have the opportunity to get a great deal when buying a foreclosure, there are risks you also need to be aware of.
- It’s a unique process: Most people don’t have a lot of experience buying foreclosures. This may be your first time, and it’s important to fully understand the process and nuances. Be prepared for any unexpected occurrences.
- You may have to buy the house as-is: You may be dealing directly with the lender, and they will be looking to sell the property as quickly as possible. In most cases, your only option will be to buy the home “as-is.” This means the lender won’t be fixing any issues that arise on the inspection — you’ll have to decide whether you’re willing to foot the bill or forego the purchase of the home due to major repairs.
- Maintenance concerns: You may have a homeowner in the home that no longer cares about the property after it has gone into foreclosure (or a homeowner who can’t afford to maintain it due to financial constraints). If things break, they will probably go unfixed, which could create an issue with multiple systems due to poor upkeep. You may not find out what needs to be fixed until you’re actually in the home, either — inspections don’t catch everything. So be aware that repair bills may exceed what you expect.
Loan options for buying a foreclosed home
Unless you are a cash buyer, you are going to need financing to complete your purchase. There are several types of mortgages that you can use to complete your purchase.
- Traditional mortgage — You can buy a foreclosure using a traditional mortgage in many cases. This can be a fixed-rate or variable-rate loan. In either case, you’re borrowing the money to buy the house and then make fixed payments for the life of the loan. This is your standard loan option. Traditional loans are only capped by the amount a mortgage lender will approve you for.
- 203(k) rehab loan — A 203(k) rehab loan is a government-insured mortgage that allows you to include the cost of the home purchase as well as the cost of rehab into the loan. If you’re looking to buy a home that needs significant repairs and work, this might be your best option. The loan is capped out at 110% of the future home’s value or the home price plus the cost of the upgrades — whichever is lower.
- VA loans — Members of the armed forces and veterans may qualify for VA home loan benefits. These loans are available with low or no down payment options and no need for private mortgage insurance (PMI). If you’re looking to buy a foreclosure without putting a lot of money down, this could be the right option. VA loans have different maximum amounts you can borrow depending on where you live in the country.
- USDA loans — You may qualify for a USDA loan if the area you’re looking for a home in is located in an eligible rural or suburban area and you don’t make more than the maximum income eligibility requirements for the area. This loan is ideal for buyers who fit the strict eligibility criteria and may be having trouble getting a traditional mortgage. There is no written maximum for these loans, but based on the eligibility criteria, the loans are not ideal for higher-priced homes.
- FHA loans – An FHA loan is a mortgage loan that is backed by the Federal Housing Administration (FHA). These loans can help you get into a home with as little as 3.5% down. FHA loans also have a lower credit score requirement than traditional loans (generally 580 or higher for the 2.5% down). The maximum on these loans is dependent on where you live in the country and generally adjust every year.
Alternative financing options for investment properties/secondary residents
There are a few other ways you may be able to fund a secondary home purchase or an investment property. Each of these methods comes with its own set of risks that needs to be thoroughly researched before moving forward.
- Home equity loan — A home equity loan allows you to tap into the equity of your existing loan to get access to cash. Depending on how much equity you have, you may be able to get the funds necessary to complete your foreclosure purchase.
- Fix-and-flip loans — These short-term loans are known as hard money. The loans are designed for flippers to get in and out quickly on an investment property. These loans are expensive and should only be used by experienced flippers.
Too long, didn’t read?
Foreclosed properties can create unique opportunities for the right buyer to get the home of their dreams at a steal or even pick up a discounted investment property. As long as you are aware of the associated risks, are prepared to handle them and have found the right funding source, buying a foreclosed home can be a unique, thrifty investment and an opportunity to buy in a neighborhood you may otherwise not be able to afford.
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