How to buy a foreclosed home

Pete Gerardo
The Mortgage Reports contributor

Buying foreclosed homes: What you need to know

If you’re looking to buy a foreclosed home — for yourself or to fix and flip — you’ll want to be extra well-prepared.  

Thoroughly research your local real estate market, the purchasing process, and the players.

And above all, set your expectations to realistic.

It might be harder than you think to find a steal on a decent home. But if you keep at it you could see worthwhile savings on your purchase.  

Here’s what you should know.

Check your mortgage options (Jul 27th, 2021)

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How to find foreclosed homes

If you think foreclosed homes are underpriced “rough diamond” mines just waiting to be tapped, you’re likely to be disappointed.

In the aftermath of the housing market collapse a decade ago, many foreclosed homes sold for 18% to 59% less than comparable non-foreclosures.

Today, foreclosed homes sell for about 5% below non-foreclosures in the same market and location.

On the upside, many bank-owned homes today are in better condition than those of yesteryear. Thanks to the improved housing market, you’ll see fewer broken-down, hollowed-out shells.

So how can you spot a bargain and then buy one?

Find agents who specialize in buying foreclosed homes

To start, research people as well as properties — especially if you’re a first-time foreclosed home buyer.

Buyers often find bargains by first finding agents who know where the bargains are. Search for brokers and selling agents who’ve been hired by the banks to market foreclosed homes.

Many of these agents are specialists. All they do is sell foreclosed homes, often for discounted commissions because they sell them in volume.

At the same time, seek Realtors’ websites that feature databases of foreclosed homes, as well as local real estate sites with foreclosure property sections.

Note, foreclosed homes are also called real estate owned (REO) properties.

Don’t forget HUD foreclosures

One of the best places to find foreclosed homes is HUD’s website.

The federal Department of Housing and Urban Development lists foreclosure homes owned by HUD (FHA loans), the VA, the IRS, USDA and other agencies.

HUDHomeStore.com, for example, lets you search within your state for foreclosure properties. It gives those who want to live in their home a head start over investors, often allowing owner-occupiers to bid for a number of days before opening up bidding to other buyers.

You need to be represented by a licensed real estate agent to bid on one of these properties.

And there’s a bonus for workers in the public sector— not only do you get a (possibly) under-priced property, if you’re a first responder, teacher, or law enforcement officer, you may be able to get that home for 50% off via the Good Neighbor Next Door program.

In most cases, you will interact only with the bank’s agent, not the bank. For that reason (and others), it’s a good idea to hire a buyer’s agent to protect your interests.

Unless you have experience buying foreclosed properties, your agent should be a veteran in this market.

Check Freddie Mac HomeSteps, too

Freddie Mac’s HomeSteps site lists REO properties from lenders whose conventional loans were bought by Freddie Mac.

Freddie Mac’s database of homes works a lot like a private Realtor’s site or an aggregator such as Zillow — without the new home listings, of course.

Verfiy your home buying eligibility (Jul 27th, 2021)

Beat the competition with pre-foreclosures and short sales

Foreclosed properties don’t appear on real estate sites out of nowhere. Before a home reaches a foreclosure auction or list of REO properties, the previous owner still has some control — and some motivation to sell low.

You can find great deals by anticipating foreclosures and making an early offer. Once again, you have to know where to look.

Short sales

A homeowner who has fallen behind on mortgage payments can sometimes avoid foreclosure by conducting a short sale, which means the purchase price is lower than their current mortgage balance.

The lender must agree to the home sale, too, because it stands to lose money. And not all homeowners qualify; they must prove some kind of financial hardship exists.

A short sale doesn’t guarantee a great deal for you, the home buyer, but it is possible to find bargains this way. Many real estate sites now list short sales in your area.

As with foreclosed properties, expect to buy as-is. Make sure you get your own independent home inspection before closing on the home.

Pre-foreclosure

Once a lender begins the foreclosure process, the homeowner may still have time to sell the home before it hits a foreclosure auction.

The homeowner may be motivated to sell low because he or she still has time to avoid having the foreclosure reported to the credit bureaus.

So how do you know about pre-foreclosure? The best way is to make a habit of visiting or calling your county courthouse to monitor foreclosure filings. Look for notices of default, which are called lis pendens in some counties.

You can also find websites in your real estate market that list these properties. Of course, you’ll have a lot more competition from other home buyers after a property gets listed online.

Once again, it helps to work with an agent who has experience buying foreclosed homes.

Steps to buy a foreclosed home

Once you’ve located a property you want to buy, you need to know how to move forward with the purchase. Here are the general steps involved in buying a foreclosed home:

1.   Get pre-approved for a mortgage

Today, foreclosed homes in fairly good condition and in prime locations are rare gems. That means they usually sell fast.

To beat the competition, you’ll need financing in place before you start shopping, unless you plan to make a cash offer.

If you have the money, you can pay cash now and refinance later to get (most of) your liquid cash back, if you choose.

Otherwise, start by getting a pre-approval letter from one or more mortgage lenders. Note, this is different from a pre-qualification letter. Pre-approval involves actually applying for a mortgage and submitting the documents underwriters need to commit to a mortgage approval.

Pre-qualification doesn’t require checking your credit score or documenting your income. A pre-qualification simply estimates your home buying budget based on the numbers you provide.

A pre-approval letter, on the other hand, confirms you will be able to borrow X amount based on the lender’s evaluation of your credit score, assets, and income. It gives you the power to make an offer agents and home sellers will take seriously.

Don’t assume the bank that owns the home will lend you money to buy it. Many banks will have you complete a mortgage application or otherwise evaluate your finances. (They don’t want another foreclosure on their hands.) But that doesn’t mean they’ll give you a mortgage.

A bank’s REO properties department is in charge of disposing of bad assets, not issuing mortgages. Buying a foreclosed home and financing the purchase are two separate transactions.

2.   Negotiate a purchase price

Before making an offer, you and your agent should assess the local real estate market. This is true whether you’re buying a short sale, pre-foreclosure, or a bank-owned property.

Consider the home’s condition, location and the prices for which comparable properties (“comps”) have recently sold.

In addition, you may want to determine the ‘absorption rate’ — the speed at which comps are selling. If prime properties are selling in just days, you might need to make a higher offer than you initially planned for.

Expect the bank to demand you purchase your foreclosure property “as-is.” Expect it will want to use its own title company or real estate attorney. And you’ll need to provide proof of funds and/or a mortgage pre-approval letter with your offer.

You can negotiate several other common items: price, closing costs, property inspection, and the closing date.

When making a foreclosure purchase, don’t expect a price discount for any repairs you may need to make. Unlike 10 years ago, most banks are not desperate to sell REO properties.

Instead, they are seeking to maximize sale proceeds — the ‘net.’ With your offer, your real estate agent should be able to prepare and submit a “net sheet,” which includes all closing costs, who pays what, and how much the bank will ultimately earn at closing.

You can try playing hardball if a property has been on the market for, say, 30+ days. But if a foreclosed house doesn’t sell fast, it’s probably for good reason.

3. Get a home inspection

Always get a home inspection before making an offer. When you buy a foreclosure, you’re taking the property “as is.” Also, always make your offer contingent on satisfactory results from the inspection.

This doesn’t mean the house won’t need some work. It probably will.

You just don’t want to buy a house and later discover the furnace hasn’t had any maintenance in years, or the foundation has serious structural problems.

Working with the home inspector and/or a local contractor, develop a repair estimate. Then use that figure to help formulate an offer that is both realistic and competitive.

Speaking of unpleasant surprises, title insurance is a must when buying a foreclosed home.

Don’t assume the title has been fully searched and cleared by the seller or lender. Title insurance will protect you against any outside claims to the property that could potentially come up in the future.

If the home inspection doesn’t turn up any deal-breaker issues and the home’s title is clean, you can move forward with the purchase and finalize your financing.

Financing a foreclosure: What kind of loan can I use?

If your “dream foreclosure’ is in livable condition, and lenders consider you a good risk, you may qualify for a conventional loan. Financing problem solved.

However, if the house requires heavy-duty TLC, an FHA 203k rehab loan may be your best option.

The FHA 203k loan allows you to borrow for both the home purchase and repair costs using just one loan.

Because these loans are guaranteed by the Federal Housing Administration, it’s easier to get approved, even with a credit score as low as 580. The minimum down payment is just 3.5%.

However, these relaxed financial standards are offset by strict eligibility guidelines. The house must be a primary residence, and renovations can’t include anything the FHA deems a “luxury.”

Fannie Mae offers a similar home purchase and renovation loan: the Fannie Mae HomeStyle program. Compared to the 203k loan, its eligibility and costs are more palatable. However, it has stricter down payment and credit score criteria.

Because of the paperwork involved, and a requirement that you use only licensed contractors, neither type of loan is suitable for minor repair projects.

Although foreclosed homes are not as abundant or inexpensive as they once were, good deals can still be found. You simply need to know where to look — or hire someone who does.

Just be prepared to strike the moment you uncover a real bargain.

What are today’s mortgage rates?

Mortgage interest rates are at historic lows and expected to stay there for the foreseeable future.

Super low interest rates can increase your borrowing power, but they can also increase the number of borrowers competing for deals through the foreclosure process.

Getting your pre-approval in advance and seeking guidance from a licensed Realtor will help you find quality investments below market value.

If you tread carefully and know where to look, a foreclosed home could be a smart path to homeownership.

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