Understand the pros and cons before diving into a foreclosure purchase
Foreclosed homes tend to be more affordable to buy than typical on-the-market homes.
The process of buying a foreclosed home can be long, uncertain, and difficult.
Many foreclosed homes are sold “as is,” making it more difficult to secure a mortgage loan or ensure the property’s condition prior to closing.
Buying a home can be one of the most exciting—and one of the most stressful—experiences of your adult life. Whether you’re a first-time home buyer or an experienced homeowner looking to purchase a rental investment, there’s bound to be some surprises and setbacks along the path from contract to closing.
This fact of home-buying is especially true if you’re considering buying a foreclosed home, which can be a far different experience than buying a conventional home. However, if you’re game, a foreclosed property can be an affordable housing option, especially for new home buyers and investors.
However, the key is to go into the process with your eyes open. Understanding the pros and cons of buying a foreclosed home is essential to deciding whether a foreclosed home is right for you.
In order to understand the pros and cons of buying a foreclosure, it’s helpful to know how the foreclosure process works. There are several stages to the foreclosure process: Preforeclosure, foreclosure, and post-foreclosure.
If a home is in the preforeclosure stage, the homeowner has fallen significantly behind on their mortgage payments, and the lender has initiated foreclosure proceedings. At this stage, homeowners may be willing to sell the home for less than market value or for less than the amount owed on the mortgage loan. This option is referred to as a short sale.
During foreclosure, the home title has likely been transferred to the lender or bank. A home in active foreclosure will be put up for auction and sold to the highest bidder who has the necessary proof of funds.
At the post-foreclosure stage, the property has failed to sell at auction and the lender has taken possession. If that’s the case, the property is usually considered a real estate owned property (REO), meaning that the bank or lender now owns the property and will be responsible for its sale. REO properties are listed on the multiple listing service (MLS) alongside other properties for sale, including conventional properties and other REO homes. Real estate agents use the MLS to find and compare available properties.
If you’re considering buying a foreclosed home, there are several potential advantages to consider.
The most significant pro of buying a foreclosed home is the low purchase price. In fact, if you buy a foreclosed home, you’re likely to pay less than the property’s fair market value. A less-expensive home purchase could lead to higher profits after renovating and reselling the home.
If you’re considering buying a home in one of the stages of foreclosure, you’ll likely work with highly motivated sellers. Homeowners in pre-foreclosure may be more willing to offer a bargain price and a quick closing to avoid the financial damage that a completed foreclosure can cause them. Likewise, banks and lenders may be willing to offer a very low sale price, especially in the post-foreclosure phase, to get the property off their books.
Buying a foreclosed home doesn’t mean limiting your financing options. Though it’s true that many lenders and loan packages aren’t available on foreclosed homes, several loan opportunities still remain, especially through state and federal financing programs, such as the Department of Housing and Urban Development (HUD).
For example, many FHA, USDA, and VA home loan programs offer mortgage loans on foreclosed properties, but restrictions often apply and the process may be a bit more complex than financing a conventional property.
Though there are potential benefits to buying a foreclosed home, there are also some substantial drawbacks.
Foreclosed homes are almost always sold as-is, meaning that you have little to no protection if you discover a health hazard or other significant deficiency in the property. If you buy a foreclosed home at auction, you won’t be able to inspect the property’s interior before purchasing.
In a foreclosed home, the as-is status means there isn’t a home warranty and, in many cases, appraisals and inspections are not performed unless explicitly required by the lender or home-buyer, often at the buyer’s expense. Keep in mind that homeowners who fell on hard financial times likely did not address major repair or maintenance needs.
While the cost of purchasing a foreclosed home is typically lower than buying a conventional home, the price of repairs and renovations is not. You can expect to make a hefty investment in your foreclosed home, depending on the condition of its interior and exterior. If you buy this type of home at auction, you won’t be able to fully evaluate the repair and renovation needs until after closing day.
Due to the as-is status of most foreclosed homes, it can be difficult to secure financing. Most lenders will not approve a mortgage on a foreclosed home but, as noted above, some state and federal financing programs will. That means you’ll have limited financing options or you’ll need cash on hand, especially if you’re attempting to buy the home at auction.
Another significant drawback in buying a foreclosed home is that there can be a lot of uncertainty surrounding the sale. For instance, home purchases may fall through if the homeowner in pre-foreclosure succeeds in catching up or refinancing their loan. Similarly, there can be a lot of legal legwork involved, especially as the title moves from the homeowner to the original bank or lender. You may have to jump through many hoops on the road to final closing, from securing financing for the foreclosed property to confirming that the home title is free and clear once the closing is complete.
