Should I Buy a Foreclosed Home?

How Does Buying a Foreclosed Home Work?

When a homeowner defaults on their mortgage payments, the home will eventually be foreclosed on. When exactly the lender will take possession of the property varies by state according to real estate law. When a home is foreclosed upon, the lender will want to cut their losses and resell the home as quickly as possible. They generally do this in one of two ways:

• Auction: The lender will likely sell the home as is for less than the market value. Buyers are typically required to pay in cash and forgo an appraisal or home inspection. Auctions are public events that may be listed on county or city websites.
• Real estate-owned (REO) sales: If a property fails to sell at public auction, the lender may sell it directly to an interested buyer. These properties might be listed on the lender's website or on real estate sites like Zillow or Trulia.

Pre-foreclosed homes may also be available through short sales. This is when the lender allows the homeowner to sell the home for less than what they owe on their mortgage. All proceeds of the sale go to the lender. They might go this route if a short sale would cost them less than pursuing a foreclosure. Short sale properties are often listed on real estate sites like Realtor.com and Zillow.

Benefits and Risks of Buying a Foreclosed Home

Purchasing a foreclosed home has some potential benefits and drawbacks. Understanding how it works can help you decide if it's the right path for you.

Pros

• You could realize significant savings. On average, foreclosed homes sell for roughly 15% less than the home's actual value, according to NAR. That's because most lenders are aiming to offload these properties quickly in order to recoup their losses. You might even be able to negotiate an offer that's below the asking price.
• The process may not be that different from buying a non-foreclosure. If you have an adequate down payment, reliable income and healthy credit, you'll probably be able to finance a foreclosed property that's not being sold at auction. That begins with getting preapproved and choosing the type of mortgage that works best for your situation.
• The lender might be more motivated to push the sale through. If it's an uncomplicated sale and your financing has been approved, the process might move quicker than a non-foreclosure sale. It typically takes 45 to 60 days to close on a home sale, but regular sellers could drag things out if they decide to renegotiate. Again, lenders that own foreclosures usually want to button up the deal swiftly, assuming everything's in order.

Cons

• You might need more cash. If you want to purchase a foreclosed home through an auction, you'll likely need to make a cash offer. You'll avoid mortgage fees and can close the deal quickly, but not everyone has that kind of money on hand.
• It can be competitive. If there's a home that's listed for below market value, other interested buyers could pounce. You might need to up your offer to stand out from the competition. Getting preapproved for a mortgage beforehand can show sellers you're ready to go.
• You might be assuming more risk. Foreclosures are often available as-is. While you could get a great deal, you might also be opening yourself up to a lot of risk, especially if there are any serious issues with the home. Even if buying directly from a lender, they may be unwilling to make repairs ahead of the sale.

Should I Buy a Foreclosed Home?

Whether or not a foreclosed home is right for you depends on several different factors. It might be worth considering if:

• You find a foreclosure property that meets your criteria and the price is right
• You're positioned to make a cash offer if you're bidding at an auction
• You're comfortable assuming more risk, especially if you're waiving any contingencies—like foregoing an inspection or appraisal
• You have no problem buying the property as is, which may result in repairs down the road
• You've gotten preapproved for a mortgage and have your down payment ready to go

When a Foreclosed Home Might Not Make Sense

On the other end of the spectrum, this type of property might not be for you if:

• You have a low appetite for risk
• You don't want to deal with potential competition or getting into a bidding war with other buyers
• Buying the home would put your financial health in jeopardy, which might be the case if you're making a cash bid or upping your offer to outbid other interested parties

How to Purchase a Foreclosed Home

Take the following steps if you decide a foreclosed home is right for you.

1. Save for Your Down Payment and Closing Costs

Just like buying a non-foreclosed home, you'll need a sufficient down payment to get approved for a mortgage. How much you'll need will depend on the type of mortgage you choose. Putting down 20% is often the goal, but it's possible to qualify for a conventional loan with as little as 3% if you're a creditworthy borrower with strong finances. FHA loans, which are backed by the federal government, require just 3.5% for eligible borrowers.

Just don't forget about closing costs. These are fees, taxes and other expenses you'll have to pay when finalizing a mortgage. Closing costs typically add up to 2% to 5% of the home's purchase price.

2. Get Preapproved for a Mortgage

Unless you're making a cash offer, you'll need to finance your home sale. Preapproval is when a mortgage lender looks at your financial information to see if you are likely to get approved for a mortgage. If so, you'll receive a preapproval letter clarifying your expected loan amount and interest rate.

Preapproval typically requires a hard credit inquiry, which can temporarily lower your credit score by a few points. You'll still need to complete a formal mortgage application when the time comes, but the preapproval process can give you a sense of your buying power and help sellers take your offer more seriously. Once you're preapproved, you can shop around for a home and look for properties that are within your price range.

3. Look for Foreclosure Properties

You can start hunting for foreclosed homes by:

• Searching for auction information on county and city websites
• Checking lender websites for foreclosure listings
• Searching for foreclosures on real estate listing websites
• Telling your real estate agent to prioritize foreclosed homes

4. Make an Offer

If you find a foreclosed property you like, and it fits your budget, you can go ahead and make an offer. Your real estate agent can do this on your behalf and negotiate with the seller from there. (Again, things will be different if you're buying at auction.) If you're making the purchase directly from the lender that owns the home, you can request an inspection to ensure the home is up to your standards.

Your mortgage lender will also order an appraisal to confirm that the home's value isn't less than your bid. If it is, you'll likely need to come up with extra cash to cover the gap—or you might decide to walk away from the deal if you have an appraisal contingency in your contract.

5. Close on Your Home

If all goes smoothly and your mortgage application is approved, the last step is to finalize your home loan. This is when you'll provide the rest of your down payment and cover your closing costs. That can include prepaying a portion of your property taxes and homeowners insurance premiums.

The Bottom Line

Buying a foreclosed property could be a great way to save money on your home purchase. Just know that you might be taking on more risk—and if you purchase a home via auction, you'll likely need to make a cash offer. Either way, you can expect to buy the home as-is.

If you're financing your home with a mortgage, you'll want your credit to be as strong as it can be. That can help you qualify for a home loan with the best rates and terms. You can get your credit report and FICO^® Score^☉ for free from Experian.