How Foreclosures Work

When you are in the market for a new home, buying a foreclosure may be an excellent way to save money and get a better home than you might otherwise have been able to purchase.  Many people receive advertisements every day claiming that it is possible to buy foreclosed homes for a few hundred dollars, or for pennies on the dollar.  While this may be true in some cases, it is quite rare.  Usually, when you purchase a piece of property for a few hundred dollars, there are many outstanding liens or associated costs.  Other properties are condemned and require significant investment to make them livable.  Buying a foreclosure is a matter of balancing the investment amount with the expected returns.

That being said, let’s take a look at how most foreclosure sales work.

A foreclosure occurs when the borrower defaults on his or her mortgage loan repeatedly and for an extended period of time.  In such cases, the lender has the right and option to foreclose, or to assume the rights of occupancy for a particular property.  However, most of the time lenders do not want the responsibility and expenses of maintaining such properties.  Therefore, the properties are almost always auctioned off to agencies that specialized in reselling foreclosed properties.

In other situations, the original mortgage is secured by VA or FHA funding or by some other program that guarantees the lender’s security when extending financing to a buyer.  When a borrower defaults on this type of mortgage, the guaranteeing agency reimburses the lender for it losses and assumes ownership of the property.  Because most of these guaranteeing agencies are federal, they have resources through which they can sell the foreclosed homes.

Yes, these foreclosed homes are offered at a discount in many cases. However, sometimes the discount does little more than offset the costs that the buyer will incur in making the necessary updates or repairs.  Nevertheless, depending on the price range in which you are looking, the low cost of purchasing a foreclosed home may make the investment a sound decision.

Here are some tips on how to buy a foreclosure and to save some money at the same time.

Pre-Foreclosures
Many lenders publish a list of homes that are approaching foreclosure.  Those buyers looking to save money on a home purchase may be able to buy a home for about 30% below its market value by approaching the owner and offering to purchase the home before its goes into foreclosure.  Most owners want to avoid having a foreclosure on their credit report and are willing to sell their home and make some quick cash.

Auctions
Often lenders auction foreclosed homes publicly.  The downside to purchasing a home at an auction is that you usually have to pay cash. The good news is that auctioned homes are usually much less expensive than homes sold in other ways.  Properties to be auctioned are listed in advance so that potential buyers can investigate the property, its need for repairs, and its outstanding liens before making a bid.  Unfortunately, these listings are rarely available far in advance of the auction, leaving little time for interested buyers to thoroughly research the property.

Buyers who want to buy a foreclosed home with the intention of living there usually have first access.  Most investors are interested in purchasing the homes to convert them into rental properties or to update and resell them for a profit...

REO Sales
An REO (real estate owned) sale occurs when a lender decides to sell a foreclosed property directly.  Unfortunately, these sales don’t offer as much of a bargain as do auctions. The lender needs to ensure that the title of the home is clear prior to sale.   Buyers are able to finance the purchase, which generally occurs in the same way as does a traditional home purchase, with realtors and a standard closing process.

Additional Information
Buyers who want to buy a foreclosed home with the intention of living there usually have first access.  Most investors are interested in purchasing the homes to convert them into rental properties or to update and resell them for a profit.  In order to make the homes available to people who are interested in living in them, government agencies that sell foreclosed upon homes have an introductory offer period during which only owner-occupants are permitted to make offers.

When you find a foreclosed home that is being sold through a government agency, you will not need to meet and specific income or other guidelines unless you plan to apply for mortgage financing.  However, you cannot submit a bid alone.  You need to submit your bid through a licensed government broker in order to have your offer considered.  The benefit to this is that someone else knows the process inside and out and will handle all the paperwork, making the process easier for you.

If you purchase a home through a government agency that requires you to use a broker to place a bid, assume that the government agency will pay the broker’s commissions.

In many areas, special programs are available for specific types of buyers, including public employees such as teachers, firefighters and police officers.  Also, individuals affiliated with non-profit organizations may have access to special buying programs.

What to Watch Out For with Foreclosures
Banks do not want to own homes, nor do they want to make significant investments in the homes that they are trying to sell.  Therefore, almost all foreclosed homes need significant repairs.

In general, foreclosed homes are not well maintained or updated.  Many things may need to be brought up to code to make the home livable.  These could include the electrical, plumbing or HVAC systems.  Keep in mind that the cost of making these updates can be significant.

When you purchase a foreclosed home, you will receive disclosures that contain critical information.  These disclosures need to be supplemented by a certified home inspection, which will determine whether there is any critical damage to the home as a result of insects, water, age, weather, wear, etc.  As a homeowner, you need to know these things as soon as possible, preferably before purchase.

Financing and Foreclosures
When you want to purchase a foreclosed home, you may or may not be eligible for traditional mortgage programs depending on the home and your financial circumstances.  Because many foreclosures do not met lenders’ minimum property standards, you may need to seek alternative financing or even pay cash for lower-end properties. 

If you are purchasing a foreclosed home from a government agency, you may be eligible to purchase the home through a specialty mortgage program that makes allowances for property condition and sometimes even offers latitude for improvement funds.