Buying a Foreclosed Home: Pros, Cons & How it Works

Published on November 6, 2017

– 5 min read

If you’re in the market for a new house, chances are you’ve considered buying a foreclosed home—even if just for a moment.

Maybe you’re hunting for an amazing bargain or relish the idea of taking on a big project. Whatever the case, we’ll cover the basics here, including how to buy a foreclosed home, and several of the pros and cons of buying a foreclosed home.

Buying a foreclosed home: How it works

When a borrower falls behind on mortgage payments, the lender can start the three-phase foreclosure process.

1. Pre-foreclosure period

The first phase is the pre-foreclosure period, which is a state-determined grace period. During this phase, the lender can reinstate the mortgage if the borrower catches up on payments.

Alternatively, the borrower can sell the home and pay off the mortgage. In this scenario, the borrower avoids the heavy blow of having a foreclosure on his or her credit profile. If the borrower is “under water” on the home—meaning the home is worth less than the amount owed on the mortgage—the borrower could apply for a “short sale.” In a short sale, the lender gets back less than the full amount remaining on the mortgage but agrees to consider the mortgage paid in full.

Buying a pre-foreclosure home

Start by monitoring pre-foreclosure homes. Once you find a home that interests you, experts recommend contacting the trustee or attorney to see if the mortgage has been reinstated before moving forward. If the home isn’t listed in mainstream directories (like MLS), you or your real estate agent can approach the homeowner directly to gauge interest in negotiating an agreement.

If the home is widely listed, it might be flagged as “subject to third-party approval” which means the lender hasn’t yet approved a short sale. The process could move slowly given the extra steps required for approval.

2. Public foreclosure auction period

If the pre-foreclosure period lapses without the loan being reinstated or the home being sold, the property will be listed at a public foreclosure auction.

Buying at a public foreclosure auction

Track auction listings and identify potentially attractive houses. Know that auction dates can change or be postponed—a homeowner could catch up on payments or make a last-minute deal to sell the home before the auction. You may or may not be able to see inside the house before bidding.

Bidding and ownership transfer procedures vary from state to state. For example, some states require bidders to have the full amount on hand at the auction in cash or cashier’s check; others only require a certain percentage due the same day as the auction. The bidding process can be intense, so be sure to check up on procedural tips beforehand.

3. Bank owned / real estate owned (REO) period

If no one bids or the lender is the highest bidder at the public foreclosure auction, the lender repossess the property and it becomes bank owned, also known as real estate owned (REO).

Buying a bank-owned home

Use popular search engines to filter for REO properties. Some lenders maintain their own web pages featuring REO properties for sale. Large lenders typically have big teams that deal specifically with selling REOs, often known as the loss mitigation department.

To buy an REO property, you’ll submit an offer directly to the lender. Each lender has its own procedure for selling an REO property; expect a lengthy process and several rounds of back-and-forth.

Lenders can also sell REO properties at auctions. Winning bidders are often required to make a cash deposit immediately, usually worth 5% to 10% of the outstanding mortgage amount. Buyers generally have 30 days to close, during which time they can finalizing financing as needed.

Buying a foreclosed home: Pros and cons

Like all financial transactions, buying a foreclosed home has potential pros and cons which you should carefully consider before moving forward.

Pros

  • Homes in foreclosure often have less competition and interest from other buyers.
  • Prices can be lower. This can happen because the risk is higher, the homeowner is in a hurry to sell, and/or the lender wants to quickly rid themselves of the headache of owning property.

Cons

  • The process can take longer because more parties are involved. Multiple levels at the bank and other investors may need to approve the purchase.
  • The condition of the property is likely unknown—and most foreclosed homes are sold as-is.
  • Buying a foreclosed home might require a lot of cash, especially if you’re bidding at an auction. Financing for a foreclosed home can be tougher to secure.

Ready to learn more about mortgages and buying a home? Clara is here to help! Chat with one of our licensed Loan Specialists or get your personalized rate quote in 3 minutes.

Steven Fung
Steven Fung is a licensed Loan Specialist at Clara with over 17 years of experience. When he doesn’t have his mortgage hat on, he enjoys repairing old cars and working on home improvement projects.
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