Heard that you can score a great deal when you buy a foreclosure home?
Buying foreclosed homes soared in popularity during the Great Recession as a wave of foreclosures hit the market and drove down prices nationwide. While foreclosure rates since then have fallen, there are always people who default on their mortgages.
And for real estate investors and homebuyers alike, distressed properties spell opportunity.
But learning how to buy foreclosure properties isn’t as simple as TV shows make it out to be. To begin with, you have to understand the foreclosure process — and how the strategies for buying foreclosures differ at each phase.
Home Foreclosure Process
When a borrower defaults on their monthly mortgage payment, it triggers a lengthy legal process:
- Missed payment outreach: When a monthly payment is 15 days late, the mortgage lender sends an informal notice that the borrower missed their payment. They must reach out again to the borrower when the payment is 36 days late, and send a written demand letter at 45 days late. The latter must include all loss mitigation and repayment options that are available.
- Notice of default: After three consecutive missed payments (90 days), the lender sends an official notice of default alerting the borrower that after 120 days, the bank will initiate a legal foreclosure action.
- Filing of foreclosure complaint: The bank hires a law firm to file a foreclosure lawsuit in court. At this point, the fees skyrocket, since the borrower now owes legal fees on top of late fees.
- Notice of trustee’s sale: The lender’s attorney schedules a foreclosure date and sends the borrower an official foreclosure auction date notice. At this point, the lender starts advertising the foreclosure sale publicly.
- Trustee’s sale (public auction): The property goes up for auction, typically at the local courthouse. Lenders typically start the bidding at the total amount owed on the loan, including late fees and attorney fees.
- Transfer of legal ownership: It usually takes a couple of months from the sale until the deed ownership changes hands.
- Eviction: If the previous homeowners remain as squatters, the new owner must go through the eviction process to remove them.
- Real estate owned (REO): If the lender “bought” the property at the auction, they now own it and list it for sale with a real estate agent.
How to Buy a Foreclosure Home
The strategy and steps to buy a foreclosed home depend on the stage of the foreclosure process when you choose to buy.
Buying Short Sales
In the early stages of mortgage default, homeowners — and their lenders — have more flexibility. If the property is upside-down, the lender may agree to a short sale: a loan payoff lower than the balance owed.
But lenders are fickle, bureaucratic beasts, and you can expect extra red tape in the short sale process. It’s also hard to find good deals on properties offered on short sales, as lenders are loath to discount the loan payoff below the property’s market value.
Some investors find a way to make it work, but most opt to target pre-foreclosure homes instead.
Buying a Pre-Foreclosure Home
Once the lender hires an attorney and files for foreclosure in court, there’s no more Mr. Nice Guy. The borrower has had at least four months to bring their loan current, agree to a payment plan, or sell the home, and they haven’t done any of those.
Now the homeowner is under the proverbial gun, with an auction date looming. They need to sell now or lose their home at auction.
That urgency can make for motivated sellers. But it also puts you on a tight timeline to secure financing and settle.
When I first started investing in real estate, I bought pre-foreclosure homes. I found that the overwhelming majority of distressed homeowners didn’t want to sell — they wanted to stay in their homes.
You can offer to buy their home and lease it back to them, as one way to get their attention. You then enter an installment contract for them to rent the property from you and buy it back.
If you really want to get creative, keep their mortgage in place and use a wrap-around mortgage to finance your portion. That works especially well if they have a low-interest mortgage in place.
As for where to find pre-foreclosure homes, you can always go to the courthouse to look up foreclosure filings directly, but that’s a lot of work. Alternatively, just use an off-market distressed property platform like Propstream or Foreclosure.com.
Buying at Foreclosure Auctions
Anyone can show up and bid at a public foreclosure auction. You just need to provide proof of funds for the down payment — often a bank check made out to yourself, which you can later cancel.
The problem, however, is that you can’t see the inside of the property. The bank doesn’t own it at that point; it still belongs to the defaulting property owner. So you have no idea what kind of condition the property is in. It could look perfect on the outside and be a shell on the inside.
Or it could be pristine. You just don’t know.
Unless, of course, you do. If you have previously gained access to the property, for example by meeting with the homeowner there to discuss options for selling, then you have insider information.
Remember, the lender typically sets the opening bid at the total amount owed on the loan. At this point, that includes massive late fees and legal fees. Only bother bidding at foreclosure auctions where the property still has plenty of equity.
Buying Bank-Owned REO Properties
If no one buys the property at public auction, the lender buys the property themselves.
After jumping through the legal hoops to take ownership of the deed, and possibly evicting the former homeowners if they refused to leave, the bank then hires a Realtor and decides whether to sell the property as-is or do some repairs first. Then it goes on the market, listed on the multiple listing service (MLS).
At this point, anyone can walk through the property and make offers. If the property needs significant repairs, you’ll get the “Needs TLC” price, but that’s still the market price for the property. You’re bidding against every other Tom, Dick, and Harry out there.
Unless, of course, you can get a first glimpse of these bank-owned properties. While huge corporate banks follow procedures to the letter, local and regional banks are more accessible. There’s probably one person in charge of REO properties at these banks, and if you can establish a relationship with that person, you can sometimes get first access to their REO list before they go through the hassle of hiring a real estate agent.
It makes sense for the bank, too. They get to sell the property faster, without having to pay a realtor’s commission on foreclosure listings.
Read more about how to buy REO properties if you like this strategy.
Buying Government-Owned Foreclosure Properties
What happens when homeowners default on government-backed loans, such as FHA loans and VA loans?
If no one buys them at auction, the government takes them back instead of the lender.
Expect some extra steps and red tape, of course; but in exchange, you can sometimes score a great deal on government-owned foreclosed properties. You can view the list of government REOs on the Department of Housing and Urban Development (HUD) website.
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Where to Find Foreclosure Homes
When a lender files for foreclosure, it becomes public record at the local courthouse. You can go there and look up the latest filings. I did this for my boss once upon a time, in my early 20s.
But that’s an outrageously inconvenient way to find foreclosures.
For an easier option, you can check the local legal announcement publication where foreclosures are announced. It’s free, but still not very convenient.
The fastest and most convenient way to sift through foreclosure filings is an off-market property platform like Propstream or Foreclosure.com. You choose a geographical area and select which types of distressed properties you want to view, and it maps them out for you. Easy peasy. You can get a preview of how Foreclosure.com works here:
Granted, these platforms aren’t free, but they work wonders. In addition to foreclosures, you can also find tax liens, tax sales, divorces, judgments, and other distressed sellers.
How to Finance Foreclosed Properties
You can use conventional loans, hard money loans, or portfolio loans to finance foreclosure properties. The right loan type depends on the property condition and your needs as a borrower.
If the property is in move-in condition, you can use a conventional loan such as a Freddie Mac or Fannie Mae loan for investment properties. These work especially well if you plan to house hack and move into the property for at least a year. Try Credible to compare interest rates and find the best conventional mortgage loan.
Fannie Mae offers a HomePath ReadyBuyer program designed to help first-time homebuyers buy a foreclosed home owned by Fannie Mae with up to 3% assistance towards closing costs. But there’s no free lunch, and you have to jump through some hoops such as a mandatory online homebuying course.
If the property needs significant renovations, you could use a 203K loan if you plan to move in yourself. But if you plan to buy a fixer-upper as an investment property, you’ll need a hard money loan — a short-term purchase-rehab loan. Try Kiavi, LendingOne, or New Silver as reputable options for purchase-renovation loans.
Once you complete renovations, you can sell the property as a flip or refinance it as a BRRRR deal. You may even be able to pull out your original down payment when you refinance and score infinite returns. Good long-term lenders for rental property loans include Visio, Kiavi, New Silver, and LendingOne.
Portfolio lenders and hard money lenders often allow you to borrow the down payment as well, unlike conventional lenders. You can open unsecured business lines of credit through services like Fund&Grow, and tap into these credit lines and cards to help cover your down payment or renovation costs.
Pros of Buying Foreclosed Homes
Why do people buy foreclosures?
In a word, bargains. You can often score great deals if you learn how to buy foreclosure properties.
The best deals tend to come from pre-foreclosure properties, but they’re also more work. You have to set up outreach campaigns such as direct mail, which costs money and effort. And homeowners in foreclosure are notoriously difficult to work with.
It’s far easier to buy bank-owned REO properties. You can still often find decent deals on REO homes, especially if you build relationships with REO managers at local and regional banks. Just don’t expect the kinds of discounts you might be able to score buying preforeclosures.
Cons of Buying Foreclosures
Foreclosures come with more headaches than buying homes from “normal” sellers.
As outlined above, it takes work to reach homeowners in pre-foreclosure. And even once you establish contact with them, they can prove fickle and fearful, prone to changing their mind a half dozen times in a week.
Bank-owned REOs are easier, but banks don’t make ideal sellers either. Expect plenty of red tape and a slower sales process.
Government-owned foreclosed homes come with even more bureaucracy. You’ll need to provide more documentation, and you can expect delays from start to finish.
While not a con per se, many foreclosures are fixer-uppers. That can add to the discount, but it also adds labor and risk. You need to understand the exact condition of the property, and precisely what repairs are needed. And, of course, you need to budget accurately.
FAQs About Buying Foreclosed Homes
Still have questions?
Here are a few of the more common questions about how to buy foreclosed homes.
Is there special financing available to buy a foreclosure home?
Sort of. The closest is Fannie Mae’s HomePath ReadyBuyer program, outlined above.
Freddie Mac offers a similar program through HomeSteps to sell off its REO properties. The program only operates in a handful of states, but it waives mortgage insurance even for down payments lower than 20%.
Otherwise, you can use FHA 203K loans or Fannie Mae HomeStyle loans for fixer-uppers, or any conventional loan for habitable properties. For investment properties, use a hard money loan or portfolio loan.
Can you buy a foreclosure with a VA loan?
Yes. If you qualify for a VA loan, that is.
Do I need good credit to buy a foreclosed house?
No more so than any other house. Better credit scores typically mean better interest rates and lower points and fees.
Who should buy foreclosure properties?
Anyone looking for a bargain on a property, who doesn’t mind the extra headaches involved. Bear in mind that many foreclosure homes have deferred maintenance and need some TLC, as real estate agents call it. After all, if the previous owners couldn’t afford the mortgage payment, they probably couldn’t afford the cost of repairs and maintenance.
Should You Buy Foreclosed Homes?
Buying home foreclosures isn’t for everyone.
Many of them need extensive repairs, in which case you need to feel comfortable working with contractors or doing home improvements yourself. And whether you buy pre-foreclosures directly from the homeowner, from the bank, or from a government agency, expect more hassles than a traditional home purchase.
For your trouble, you can often score a lower purchase price than you’d find among the broader real estate market listings. Just make sure that the juice is worth the squeeze and you don’t find yourself in over your head.♦
Have you ever bought a foreclosure property at auction? What about preforeclosures or REO properties? Tell us about your experiences.
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About the Author
G. Brian Davis is a real estate investor and cofounder of SparkRental who spends 10 months of the year in South America. His mission: to help 5,000 people reach financial independence with passive income from real estate. If you want to be one of them, join Brian and Deni for a free class on How to Earn 15-30% on Fractional Real Estate Investments.