A home foreclosure is a process in which a lending institution tries to recover a portion of an outstanding mortgage balance from a homeowner who has defaulted on their loan. It’s typical for a lending institution to sell a foreclosed home at a discount. Buying a foreclosed home, therefore, offers real estate investors, property flippers, and those building rental portfolios a great opportunity. However, it’s hard to find and finance a foreclosed home when compared to a traditional property; it’s also harder to identify a good opportunity when buying a foreclosed home. There are many pitfalls when buying foreclosures that don’t arise when purchasing a home normally.
In this article, we’ll cover the following:
- What Are Foreclosed Homes?
- Where Can I Find Foreclosures For Sale?
- How to Finance a Foreclosure
- What Makes a Good Foreclosure Opportunity?
- Potential Problems with Foreclosures
- Checklist for Buying a Foreclosed Home
Our thanks to LendingHome for sponsoring this article. LendingHome can fund the purchase and renovation of your foreclosure and they can get you funded fast. Rates start at just 7%. Get preapproved online in minutes.
What Are Foreclosed Homes?
Foreclosed homes are generally 1-4 unit residential properties that have been repossessed by a lender because of nonpayment by the previous owner. The lending institution forecloses on the home and then tries to sell the property in an attempt to recoup as much as it can. It’s typical for lenders to sell foreclosures at a discount.
A foreclosure has several steps before a property is actually sold. First, the lender must file a public notice with the county recorder’s office, most often referred to as a notice of default (NOD). In many cases, the lender is also required to post a foreclosure notice on the front door of the property.
Once the NOD is issued, a grace period – also known as pre-foreclosure – goes into effect for one month or more. During this time, owners have an opportunity to settle the debt, either by paying it off or by selling the property through a short sale.
If the owner can’t settle or sell the property, it will be offered at a foreclosure auction. The pending sale is recorded with the county and often reported in the legal notices section of the local newspaper. Real estate auctions are typically held either on the courthouse steps, at the subject property, or at an auction house. The property is then sold to the highest bidder.
If the foreclosed home doesn’t sell at auction, the lender takes possession of the property, at which time it becomes real estate owned (REO). The lender will attempt to sell REO properties by listing them for sale with a local real estate agent or at a liquidation auction.
Where Can I Find Foreclosures for Sale?
Real estate investors can find foreclosed homes a number of ways. Banks and mortgage lenders typically make their foreclosure auctions and REO listings public. Specifically, there are five ways in which you can find a foreclosed property for sale:
- Find Foreclosures with Real Estate Agents
- Find Foreclosures in Newspapers
- Find Foreclosures with Online Sources
- Find Foreclosures through Government Agencies
- Find Foreclosures at Banks & Mortgage Lenders
Each of these options has their own benefits and downsides, which we outline below.
1. Find Foreclosures with Real Estate Agents
In addition to helping you in the buying process, real estate agents can also be excellent sources for finding foreclosed homes. Their connections to other sellers, agents, and lenders mean they will typically have the best sense of the foreclosure market.
- Leverage their time and expertise (it’s their full-time job)
- Multiple listing service (MLS) give agents access to a large number of foreclosures
- Banks often list properties with agents
- Agents can help with price negotiations
- Inexperienced agents can waste your time
- Most realtors are seller’s agents, which means they must represent the interests of the property seller
- Agents are motivated to sell, not necessarily get you the best deal
2. Find Foreclosures in Newspapers
Local newspapers can be the best sources of properties early in the foreclosure process, such as when NODs are issued, or when properties are going to be offered in public auctions.
- Source of distressed properties before they reach the general market
- Can get a steeper discount by working with the homeowner, or with the lender before they take possession
- Good early source for FHA and VA properties (discussed further below)
- Lots of competition from the most sophisticated investors
- Properties found at this stage may need to be purchased as an all-cash deal
3. Find Foreclosures with Online Sources
- Ease of access
- Expand your search nationally
- Set specific search criteria
- These websites often offer helpful tips, tools, and calculators
- Heavy competition
- The best deals will be snapped up quickly
- County public records searches can be tedious and recordings may be outdated
4. Find Foreclosures through Government Agencies
Government agencies can include foreclosures for non-payment, but may also be related to property seizures for violations. Primary sources of government foreclosures include Fannie Mae, Freddie Mac, and HUD’s interagency listings (including FHA, VA, IRS, etc.).
- Buy properties before they reach the general market
- Large selection & low prices in general
- Often have time to obtain financing
- Some agencies, like FHA, may provide financing
- Buying process is more paperwork-intensive
- Buying process can be slow
- All cash purchases required on certain properties
5. Find Foreclosures at Banks & Mortgage Lenders
Banks and mortgage lenders can be excellent sources of foreclosed homes that either didn’t immediately sell at auction or are REO properties. These are properties that lenders are selling themselves and most major lenders like Bank of America, Chase, and Wells Fargo will have their REO homes listed online.
- Process is most similar to purchasing non-foreclosure homes
- No auctions
- Can use financing to make the purchase
- Can order inspections and searches prior to closing
- Heavy competition
- Prices are less heavily discounted
- Property must be purchased “as is”
- Banks may attempt to wait for better offers
How to Finance a Foreclosure
Cash is the preferred way to purchase foreclosed properties since it enables the sale to move quickly. This is because cash deals aren’t subject to lender requirements, which are strict when it comes to the purchase of foreclosed properties.
However, if you’re not paying cash for a foreclosed property, there are three types of loans that will work. We summarize them in the table below and will discuss in more detail later.
|Hard Money||Conventional Mortgage||FHLMC HomeSteps|
|Best Use||Short Term Financing|
Rehab / Renovation
Compete with All-Cash Buyers
|Permanent Mortgage||Permanent Mortgage|
|Minimum Down Payment||10% - 20%||15 - 25% investment||15 - 25% investment|
|Minimum Credit Score||550||640 investors||640 investors|
|Occupancy||Investment||Owner-occupied or investment||Owner-occupied or investment|
|Property Type||1 - 4 or more family||1 - 4 or more family||1 - 4 or more family|
|Loan Term||12 months||Up to 30 years||Up to 30 years|
|Interest Rates||7% - 12%||4% - 6%||4% - 6%|
|Points||1.5 - 3 points||0 - 1 points||0 - 1 points|
|Approval Time||10 - 15 days||30 - 45 days||30 - 45 days|
|Mortgage Insurance Required?||Not required||Required if down payment is under 20%||Not required|
|Visit LendingHome||Read More||Read More|
Hard Money Loans
Hard money loans are offered by a wide variety of lenders and are available to investors who wish to fix and flip houses, properties with more than 4 units, or who are looking for bridge financing. Bridge loans allow borrowers to buy a foreclosure and complete major repairs, then refinance when the house is more likely to qualify for permanent financing.
While exact terms vary significantly from lender to lender, LendingHome’s competitive terms serve as a great example of Hard Money loans for foreclosures:
|Hard Money Loans for Foreclosures|
|Minimum Down Payment||10 - 20%|
|Minimum Credit Score||550+
(check yours here for free)
|Loan Term||12 Months|
|Interest Rates||7 - 13%|
|Points||1.5 - 3|
|Funding Time||10 - 15 days|
Conventional Mortgage Financing
Conventional mortgages include permanent mortgages for investment properties. They’re available through nearly all major banks, mortgage providers, and mortgage brokers. Requirements vary for each of the three loan types. For example, while conventional mortgages are available for investors, FHA and VA loans are for owner-occupied properties only.
More significantly, all conventional mortgages for foreclosed properties are “end loans.” That means the subject property must be in move-in condition, there can’t be major deficiencies or safety violations. Unlike rehab loans, the conventional mortgage aren’t available for renovations in the event that the property needs major repairs, which is common with foreclosures.
|Conventional Mortgages for Foreclosed Homes|
|Minimum Down Payment||Single Family Investment: 15%
2-4 Unit Investment: 25%
|Minimum Credit Score||Investor: 640|
|Loan Term||10 - 30 Years|
|Interest Rates||4% - 6%|
|Points||0 - 1|
|PMI||Required with less than 20% down|
|Funding Time||30 - 45 days|
HomeSteps by Freddie Mac is a loan program available specifically for the purchase of foreclosed properties held by the Federal Home Loan Mortgage Corporation (FHLMC). Two major advantages of the program are that appraisals and mortgage insurance both aren’t required for these loans, which can save a buyer thousands of dollars. They are suitable for both investment properties and primary residences.
- Not recommended for properties that require extensive repair or renovation
- Available through three lenders: BB&T Home Mortgages, Nationstar Mortgage, and Regions Bank
- Special note on condominiums: Project eligibility requirements may be waived
The program is available in just 10 states – Alabama, Florida, Georgia, Illinois, Kentucky, North Carolina, South Carolina, Tennessee, Texas, and Virginia.
|HomeSteps for Foreclosed Homes|
|Minimum Down Payment||Investor Single Family: 15%
Investor 2-4 Units: 25%
|Minimum Credit Score||620 - 640
(check yours here for free)
|Loan Term||10 - 30 Years|
|Interest Rates||4 - 6%|
|Points||0 - 1|
|Funding Time||30 - 45 Days|
What Makes a Good Foreclosure Opportunity?
Home foreclosures provide unique opportunities when compared to traditional home ownership. Specifically, foreclosures allow buyers to purchase property at a discount, they can be found at all price points and luxury levels, sometimes only require minor repairs, and they close quicker than with typical home purchases.
What this means is that when you’re considering a foreclosure, make sure it meets the following criteria:
- Sale Price Below Market Value
- Located in a Desireable Neighborhood
- Good Condition and Upkeep
- All-Cash Offer
Let’s discuss each of these four elements of a good foreclosure opportunity in depth.
1. Sale Price Below Market Value
The best opportunity when it comes to real estate foreclosures is that they often sell at a discount. It’s sometimes possible to find homes that sell for as little as half of their fair market value at auction. When you’re assessing potential foreclosure purchases, the most important thing to check is its sale price (or starting bid price) versus the value given by real estate websites such as Zillow or Trulia.
If the REO price or the auction price rises above the fair market value, it’s probably not a good investment. If the sale price is below market value, however, it could be a great opportunity and should be explored further. While there’s no hard rule, you should aim to buy foreclosed homes at least 30% less than market price.
2. Located in a Desirable Neighborhood
Another benefit of purchasing a foreclosed home is that there are typically a lot of foreclosures on the market, giving you the chance to pick and choose. It’s possible to find home foreclosures in almost any neighborhood and at almost any price point. Even homes in affluent neighborhoods are susceptible to foreclosure.
What this means for you is that you can find foreclosure opportunities in growing neighborhoods that offer a great investment. Don’t think that just because you’re looking for a foreclosure that it has to be a beat up house in a run down neighborhood. On the contrary, foreclosure opportunities can be found in almost every neighborhood. Make sure that the foreclosures you’re looking at are located in a neighborhood that attracts tenants and home buyers. Zillow and Trulia can help you better understand how vibrant a neighborhood is in terms of population growth, public goods, and price appreciation
3. Good Condition and Upkeep
One of the downsides of foreclosures is that sometimes a foreclosed home is in extreme disrepair. In situations with a home in need of improvements, home buyers sometimes spend more money than they expected and end up in over their heads. However, even though it might be normal to find foreclosed homes in disrepair, it’s also normal to find homes with little to no damage.
When you’re seeking out foreclosure opportunities, remember that any repairs will cut into your finances. You’ll therefore want to find a foreclosed home that is in good condition. If you can, pay for a detailed home inspection prior to purchasing a foreclosed home. Unfortunately, this isn’t always possible, as many foreclosures are sold at auction or site unseen. If this is the case, you might want to forgo purchasing the property. Instead, look for a foreclosure where you can verify it’s condition. If there are a lot of repairs, you’ll want to negotiate with the lender or bid low for the sale price, since you’ll have to spend additional cash getting it ready to live in.
4. All-Cash Offer
The final element of a good foreclosure opportunity is actually on the homebuyer. Coming in with an all-cash offer is a great way to entice a lender to accept your deal and close fast. One of the major benefits of foreclosures is that cash offers can close as fast as in 15 days.
The faster you can take over ownership of a home, get it ready for sale, and then either sell it or rent it out to tenants, the faster you can capitalize on your new investment.
If you don’t have sufficient cash savings to afford to make an all cash offer, that’s okay. There are financing companies that can help get you the capital you need so you can close quickly. LendingHome, can prequalify you in minutes with an online application and have you funded in as little as 10 days.
Potential Problems with Foreclosures
There are eight common problems you’re likely to encounter when buying a foreclosed home. To help you avoid these pitfalls, we’ve outlined each one below
- Auctions – Auction sales can occur on the courthouse steps, at an auction house, or the property itself. While buyers can often buy auctioned properties at a significant discount, they can be tough for novice investors. That’s because you’re typically not allowed to inspect the property before buying it. Additionally, auction-style bidding has the potential to push the price of the properties to unprofitable levels. Buying a house at auction, especially foreclosures, is best left to those who have significant experience buying foreclosed properties or who are working with trusted mentors.
- Damaged & Unmaintained – When the property owner can’t afford to make the monthly house payments, there are usually financial problems that also limit repair and maintenance. In an act of revenge, the owner might even intentionally damage the property. If the house has been sitting vacant, there is also the risk of vandalism. Anything of value – appliances, carpeting, and copper piping – may be removed from the property.
Welmoed Sisson of Inspections by Bob in Boyds, MD, also warns of damage or deficiencies that are the result of bank repossession:
“Foreclosed properties are likely winterized by the bank. This process can wreak havoc on a structure, as modern houses are not meant to endure wide ranges of temperature and humidity. These houses also typically have their electricity and gas service shut off. If the house has a sump pump, lack of electricity can lead to basement flooding. Buyers should request that utilities be restored at least a day or two prior to a home inspection, to give the inspector the best chance of identifying issues. Doing an inspection on a winterized house means the inspector will not be able to adequately report on the condition of the house.”
Get a detailed home inspection, as well as an appraisal, to determine the extent of any damage.
- Code Violations – In order to save money, the previous owner may have performed repairs himself. It’s possible that the repair work done was not completed according to local building codes. For example, the homeowner may have installed a noncompliant hot water heater. In order to sell the property, you will have to correct those violations.
- Insect/termite damage – A foreclosed property may not have a termite bond, or even had regular treatment for pests. Since termite damage is found inside the walls, you will need to get a termite inspection to specifically check for infestations and damage.
- Lack of cooperation from the bank – Though it may seem logical that a bank will want to unload a foreclosed property as soon as possible, that’s often not the case. Banks will often delay the process, in the hope of getting a higher offer on the property.
- Competition from other buyers – This is most acute on the foreclosures that represent the best deals. Other buyers will want to purchase the same property, and that can both create a bidding war, or be a major cause for the aforementioned delays by the bank that owns the property, as they consider the offer that will provide them the greatest recovery.
- Undisclosed liens – The bank selling the property may be interested only in recovering money to satisfy their loan on the property, but there could be other liens on it. This can include tax liens, as well as mechanics liens for work performed but not paid for. You could become responsible for these liens once you own the property. Make sure that you order a title search on the property, and obtain buyer’s title insurance in order to protect you against that possibility.
- Condominiums – In some areas, the market can be flooded with foreclosed condos. Though prices may be low, selling them profitably can be difficult. In addition, getting financing on condos can be complicated. If a project contains too many unsold or foreclosed units, or too many are already owned by investors, lenders may be unwilling to finance purchases in the development.
Checklist for Buying a Foreclosed Home
Foreclosures are unique when it comes to buying property. Here are seven things that you should keep in mind when looking for a foreclosure opportunity:
- Find an agent specializing in foreclosure – A real estate agent who specializes in foreclosures is your best ally in the process. They can help narrow down the field of properties, based on specific criteria that you provide. They can also be a major asset when it comes to negotiating price and terms.
- Get preapproved for a mortgage – If you’ll require financing, get a pre-approval well in advance. Though you may not be able to get approval for financing on a specific property, you can at least make sure that you’re qualified to buy at the price point that you want. A preapproval letter can help you compete with all cash offers.
- Know how long it takes to sell a home in the market – If you’re planning to purchase, rehab, and sell a foreclosure, you’ll need to move as quickly as possible in order to maximize your return. Properties require carrying costs, such as financing, taxes, insurance, and utilities. The longer it takes to sell in a particular market, the harder it will be on your bottom line.
- Know the market value of comparable homes – This important to know in order to understand what kind of discount you’re getting the foreclosed home at. In addition, if the property will require repairs and renovations, you’ll want to make sure that you can still make a profit after all the additional expenses.
- Get a detailed home inspection – Foreclosed properties are typically sold “as is.” That means that the bank will not make any repairs to the property prior to closing. For that reason, you must know in advance what the extent of repairs will be, as well as the approximate costs to complete them. This will affect how much you are willing to pay for the property. (In the case of auctions, you may not be able to get a home inspection.)
- Have contractors lined up – Whether you plan to rent the property or fix and flip the property, you want any repairs and renovations completed asap. This will mean having contractors lined up and having a good idea of what they’ll be charging you.
- Have extra cash – Even a full home inspection can miss hidden damage. Those buying a foreclosed home will want to have extra cash (or rehab financing) available in order to cover unexpected expenses as well as the additional carrying costs caused by delays.
Buying a foreclosed home can be very profitable for real estate investors whether they plan to rent the houses out or fix and flip the properties. Similarly, foreclosed houses can present investors with unexpected expenses, be purchased at inflated auction prices, and be much harder to find. Working with trusted real estate agents, appraisers, home inspectors, and contractors can help ensure your projects are as profitable as possible and are completed on time.
When you’re ready to move forward with buying a foreclosure, make sure you have the financing you need to close on a great opportunity when it arises. Getting prequalified with LendingHome online takes just a couple of minutes.