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If you’re thinking about buying a home, there’s no better feeling than seeing real estate listings at prices too good to be true. And a foreclosed home can present a great deal.
But before you fall in love, you’ll need to understand the ins and outs of how to buy one.
“What it really comes down to is price. That’s what people get out of buying a foreclosed home; they’re looking for a bargain,” says Yawar Charlie, an estate director at Los Angeles real estate agency Aaron Kirman Group. “That’s the only benefit of buying a foreclosed home.”
Indeed, the process can be more complicated than buying a traditional listing, and there’s a chance you might not even save money.
If you’re wondering how to buy a foreclosed home, here’s what you should know beforehand.
How Common Are Foreclosures Now?
Think back to the collapse of the housing market nearly a decade ago, when borrowers defaulted on subprime mortgages in high numbers, and millions of homes went into foreclosure as a result.
Foreclosures and short sales flooded the market between 2007 and 2012, according to the Federal Reserve Bank of Philadelphia.
But those days are over, at least for now. Charlie says there’s tough competition for what few properties remain on the foreclosure market nowadays. And you’ll need cash, or you risk losing to investors who can come up with the funds quicker.
“Pre-COVID, the economy was very strong, and you were lucky to find a short sale or a bank-owned foreclosure,” Charlie says. “Not saying they didn’t exist, they did, but they were harder to come by.”
Could the pandemic-ravaged U.S. economy lead to a wave of housing foreclosures, like the Great Recession did? That’s up for debate, says Vinnie Enriquez, a realtor and team leader of the San Diego real estate agency The Enriquez Group.
Currently, there are federal foreclosure and eviction moratoriums in place to keep homeowners and renters in their homes as they navigate these uncertain times. The moratorium on foreclosures and evictions on single-family homes was recently extended until August 31 of this year. It was originally set to end on June 30.
In addition to this, the CARES Act allows homeowners financially affected by coronavirus with federally-backed loans to delay or reduce payments for up to a year. At the end of the forbearance period, they.are not required to make a lump sum repayment.
The coronavirus recession is unique in many respects, and many are wondering what will happen when additional government relief dries up. Some housing experts say we’re headed towards an eviction cliff, and a crisis could be next. In contrast, others say it’s difficult to make reliable housing market predictions as long as the coronavirus pandemic persists.
“If we don’t continue to have programs in place, then we might start seeing foreclosures by the end of the year. We’ll have to see what the government does to deter that from happening,” Enriquez says.
What Is a Foreclosure and How Does It Work?
A foreclosure takes place when the lender or bank takes ownership of a home after a homeowner can no longer make their mortgage payments.
“Oftentimes, homeowners will try to modify their loan or save their house or negotiate with the bank. When that doesn’t work out, the house ends up being foreclosed on,” Charlie says.
But homes are expensive to upkeep, and most banks want to sell any foreclosed homes they own as quickly as possible. To do this, lenders and banks will usually put the house up for sale at a lower price than buyers would expect to pay for a similar home in the same neighborhood.
“There are legal costs they have to incur, and if a house sits on their books, they can’t lend that money to other areas,” Charlie says.
There are a few different types of foreclosures you can find in the market. Here’s a rundown of your options:
When the homeowner still owns the property, but they’re in default of mortgage payments, it’s known as pre-foreclosure. To avoid foreclosure proceedings, the lender will sometimes give the homeowner permission to sell the property for less than what they owe on their mortgage, also known as a short sale. In most short sales, the lender will agree to take this loss to get the mortgage off the books. Sometimes, however, the lender will reject an offer if it’s too low.
You can purchase a foreclosure at a real estate auction. These auctions are run by local law enforcement and designed to repay the lender quickly for the defaulted loan. At an auction, you can purchase a home quickly and often for a low price. But there are some setbacks, too. For example, you typically need cash on hand, and few details are revealed about the properties up for auction. You can find home auctions through local governments, real estate agents, and online sites such as RealtyTrac.com and Auction.com.
If you see this term, it stands for “real estate owned,” which means it’s a property owned by a bank or lender. If a foreclosed home doesn’t sell at auction, the bank or lender has to keep it on its books. By this stage, the lender or bank wants to sell the home to recover what’s owed and will usually hire a real estate agent to put it on the market.
Any home purchased with a loan guaranteed by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA) will be repossessed by the government if the owner stops making payments. These properties are similar to those owned by banks or lenders, but you have to reach out to a government-registered broker to purchase this type of foreclosure.
Buying a Foreclosed Home in Five Steps
There’s a lot of missing information when you buy a foreclosed home, so the process can seem especially unclear to first-time homebuyers or anyone new to the foreclosure market. If you decide to move forward with a foreclosure purchase, make sure to do the following:
1. Math and Research
It’s important to do the research and figure out how much you’ll save by purchasing a foreclosed home. It’ll depend on location, the property’s condition, and the type of financing you get. There are online databases of foreclosed homes, like HUDHomeStore.com and Auction.com, to give you a sense of what’s available in your local market. You also could look at a local real estate website where you can filter the results to see only foreclosures.
“Make sure you go into this eyes wide open, and you’re not just looking at the price tag,” Charlie says, referring to the importance of setting a budget and taking home repair costs into account.
So how do you know you’re getting a good deal on a foreclosed home? First of all, you’ll need to buy it below market value. Look for a home selling for 80% of its market value—minus the cost of repairs, says Chris Hogan, a personal finance expert at Ramsey Solutions, the financial counseling and education company founded by author Dave Ramsey.
Look at the recent sales prices of comparable properties before you make an offer on a foreclosed home. Bid your highest and best offer if the foreclosed homes you’re looking at are selling quickly.
“If you purchase it for 80% of market value and take repairs in consideration, then you’ll have more room in the margin ,” Hogan says. “The number is arbitrary, but this will at least make sure you’re getting some return on your investment. “
For example, if you’re interested in a foreclosed home listed at $200,000 and the cost of repairs is another $20,000, you’ll need to do some math to figure out your best offer. Multiply 80% by $200,000 and then subtract $20,000. This equals out to $140,000 — your ideal bid price on the home in that scenario.
2. Find An Experienced Foreclosure Agent
Some pitfalls come with foreclosed homes, so you’ll want to work with a realtor or foreclosure specialist who has experience navigating the process and knows the local market. If you’re interested in an REO property, you’ll likely work directly with the bank’s broker in many cases.
An experienced agent can help you determine when a foreclosed home is offered at a bargain price, and when it’s not worth the risk involved. Every state has its own set of laws and regulations concerning foreclosures, and an expert can help you understand them to avoid hefty costs down the line.
The cost of closing, repairs, and property taxes can turn a bargain house into a money pit. The bank may also hold you financially responsible for any property debt that wasn’t paid by the previous owner. Working with an expert can help you understand what your financial obligations are beyond the mortgage.
“It doesn’t cost you a lot to use the right realtor, but it could cost you a lot to use the wrong one,” Enriquez says.
Lastly, know that the previous owner might have the right to redeem a foreclosed property. Many states in the U.S. give homeowners this protection, which allows them to reclaim their foreclosed home as long as they can repay their debt within a certain period of time.
But it doesn’t happen often. Many people who’ve gone through foreclosure aren’t typically able to come up with money quickly to repay the outstanding mortgage balance and any extra costs incurred during the process.
3. Get a Preapproval Letter
Unless you can afford to pay cash, you’ll want a mortgage preapproval letter in hand when you make an offer on a foreclosure. A preapproval letter will tell you exactly how much you can spend on a home, and it makes you a more attractive buyer. Don’t assume the bank selling the house will also finance the mortgage as part of the deal — it’s a separate transaction.
4. Make a Competitive Offer
Making the right price offer is as much an art as it is a science. You’ll likely be tempted to make a low offer on a foreclosed home, but it’s important to work with your real estate agent to create a competitive offer.
If you make an offer too low below market value, the bank, government, or lender might reject it, especially if there are multiple bidders. “They want the highest bidder at the end of the day,” Charlie says.
With a foreclosed home, Enriquez says you’re looking to get a price low enough to offset the possibility the bank or lender won’t do any repairs to the home.
5. Be Prepared to Commit to a House “As-Is”
Foreclosures are mostly sold “as-is,” which means any repairs are your responsibility. You could request a repair in some cases, but the entity owning the home may not be willing to credit you for it. Because the foreclosure market is competitive right now, you might have to place an offer or bid before viewing or inspecting the home.
“If there are material defects with the home, like plumbing or the roof, you as the buyer are responsible for that. You take that on as your own risk, and you’re doing it because you’re getting such a good price for the home,” Charlie says.