Buying a Foreclosed Home: The Ultimate Guide
If you were to buy a foreclosed home, would you consider it? Purchasing a foreclosed home requires an understanding of what you're looking for and how to shop for one. The purpose of this article is to examine what foreclosure means in greater detail. Additionally, we'll discuss the advantages, disadvantages, and steps of purchasing a foreclosure.
Foreclosure: What Does It Mean?
The foreclosure process occurs when a lender seizes the property. Foreclosed homes are owned by the lender when they appear on the market.
Liens are attached to your property as a result of mortgage contracts. A lien gives your lender the right to take your house if you stop paying your mortgage. Foreclosure is usually the result of a homeowner not being able to make payments on their mortgage.
In the case of foreclosed homes, purchasing one is a little different from buying one owned by a homeowner.
How Does Foreclosure Work?
Potential buyers should understand that foreclosure has several stages, which are crucial to grasp when considering buying a foreclosed home.
- Payment default and notice of default: In the case of payment default and notice of default, the homeowner has missed at least one payment, and after several months of missed payments, their entire mortgage will be default.
In most cases, this initiates the preforeclosure phase of the foreclosure process. Missed payments for 90 days will usually result in a default notice from the lender. It is possible for lenders to contact you prior to this to learn more about your situation and to see if they can assist you.
- Notice of trustee’s sale: The lender must record the impending trustee's sale with the county and publish news of it in the local paper. A foreclosure can be found this way, but an online search is generally more effective.
- Trustee’s sale: In a trustee's sale, the lender attempts to sell the property at public auction.
- Real estate-owned: The bank takes ownership of the property if it is not sold in auction. Afterwards, they will attempt to sell the house. For most people looking to buy a foreclosed home, especially those with a Veteran's Administration loan, this is the stage of foreclosure where they can purchase the home.
How To Buy A Foreclosed Home
You might feel intimidated by the idea of buying a foreclosed home. There isn't much difference between buying a foreclosure and buying a traditional home. However, it does require additional research. You'll need to be comfortable taking on some risk when buying a foreclosure.
Nevertheless, if you work with a real estate agent who understands your local foreclosure market, the stress should be lesser than when buying a traditional home.
These are the steps you should follow in order to successfully buy a foreclosed home.
1. Find out what the different methods are for buying a foreclosure
The first step in purchasing a foreclosed house is to do your research. Because there are several ways to buy a foreclosure, the best method for you may vary depending on your needs.
Listed below are the most common purchase paths.
Buying From The Homeowner
A pre-foreclosure, also known as a short sale, can occur when the homeowner still owns the property and knows there’s a possibility for foreclosure. Homeowners want to sell their homes before they go into foreclosure. Therefore, short sales aren't foreclosure sales.
It can also be challenging to complete a short sale. Short sales allow homeowners to sell their homes for less than they owe on their mortgages. Owners who owe $180,000 on their mortgage might still list the home at $160,000 even though such a sale leaves them $20,000 short of paying off their loan in full.
Often, the owners' bank agrees to take a loss in a short sale so they can sell the home and get their mortgage (which might otherwise default) off their books.
In order to avoid falling behind on their monthly payments, the owners want to offer their home at a low enough price to ensure a quick sale. Even so, buying at this stage can be challenging. In spite of the sellers agreeing to your offer, their bank or lending company may reject it if it is too low.
Buying At An Auction
A real estate auction is the traditional way to buy a foreclosed home. Auctions are sales of homes that banks and lenders have taken ownership of after homeowners default on their mortgage loans.
An auction is an excellent way for buyers to acquire a home quickly (often for a low price). However, there are also hurdles to overcome. An auction, for instance, typically requires buyers to have cash on hand.
There are also plenty of risks which include the following:
- A home you purchase at an auction might have a lien on its title from a government agency, especially if the previous owner stopped paying property taxes.
- It is possible for a home bought at auction to require expensive repairs.
- There is a possibility that you won't be able to order an appraisal. A real estate appraiser determines a home's current market value during an appraisal. You run the risk of paying too much for a home even if you buy it at auction without an appraisal.
Buying From The Bank
Alternatively, you can purchase a foreclosed home directly from a bank or lender.
You might come across the term "REO" when looking for real estate listings. It stands for “real estate owned,” and refers to a foreclosed property owned by a bank. As soon as the property becomes an REO, the bank will clear any liens on it and evict the previous owner before selling it, so you do not have to do anything.
The bank has secured the home at auction and is now selling it to recoup what's owed. Putting it on the market will likely be handled by a local real estate agent.
Buying A Government-Owned Property
You might also want to consider buying government-owned foreclosures. The properties are similar to those owned by banks or lenders. In most cases, government agencies take over homes when owners default on mortgage loans insured by the federal government.
For instance, if an owner stops making payments on an FHA loan , the U.S. Department of Housing and Urban Development (HUD) takes possession of the property. Foreclosures owned by the government are usually sold "as-is," which means you are responsible for any repairs. There are some cases where the government will repair structural needs before selling, or you can request a repair. Before viewing or inspecting the home, you might have to place an offer or bid.
2. Find out how much you can afford for a home
Buying a foreclosed home requires a budget. There is a possibility that you can get your new home at a lower price. However, foreclosed homes are not free. Foreclosed properties cannot also be purchased for $1, regardless of what you may have heard.
You will need to craft a household budget, listing your monthly income and expenses (such as estimates for discretionary expenses like eating out and entertainment) to determine how much of a mortgage payment you can meet each month.
Even if you are shopping for a foreclosure, you may end up purchasing a home you cannot afford. You will have trouble making your mortgage payment each month if you buy a home that is beyond your budget.
You should predetermine your debt-to-income ratio (DTI) before buying a home. It calculates how much of your gross monthly income will be consumed by your monthly expenses (including your estimated new mortgage payment).
Lenders typically ask for no more than 43% of your gross income to be consumed by debt. A high debt-to-income ratio will make it harder for you to qualify for a mortgage.
In the case of foreclosed properties, you should be especially careful. If your budget is tight, you might be tempted to buy a foreclosure. In this case, the foreclosed home might require expensive repairs. You may not be able to afford those needed repairs if you have purchased a home at the top of your budget.
3. Consider hiring an experienced real estate agent
The best way to buy a foreclosure is to find a real estate agent who knows the local market and has access to a local multiple listing service.
You can use this agent to determine whether a foreclosed home is offered at a bargain price or if the asking price is too high for the risk involved. Agents can also help you find foreclosed properties that other buyers might miss.
You may also run into challenges with a foreclosed property if you work with a good real estate agent. Bear in mind that each state has unique laws and regulations regarding foreclosures. It's essential to work with an expert who is familiar with these laws.
4. How to get a mortgage preapproval
No matter what type of home you buy, getting preapproved for a mortgage is a smart move. A lender will run your credit and verify your income and debt as part of the preapproval process free of charge. After that, the lender will determine how much of a mortgage it can approve for you.
You will know exactly how much you can spend on a home after you get a preapproval letter from a lender. Choosing a house that costs $300,000 is pointless if you have a $200,000 mortgage.
It also makes you appear more attractive to lenders if you have a preapproval letter. Foreclosure sellers prefer to work with buyers who they know can qualify for a mortgage (e.g., banks or government agencies). It is not their concern that you will be unable to get a loan, thereby delaying the sale of their home. Among multiple bidders on a home, sellers are more likely to work with buyers who have already been preapproved for a mortgage (all else being equal).
A good credit score will be particularly important during the preapproval process since banks and lenders can be particularly sensitive to credit issues in foreclosure situations.
Shopping around for mortgage lenders is a smart move. Choosing the first mortgage lender you come across is not a good idea. Look for the lender who will offer you the lowest interest rate and fees.
A bank or lender may require you to get pre approved through them if you get pre approved from one lender and want to buy a bank-owned property. It's usually because they want to confirm your eligibility or they're looking for a sale. Remember that you are not obligated to go with that lender. Your pre approval from your original company will still work if you want to buy a bank-owned home.
A full approval can only be obtained after you have found your dream home and have made an offer that is accepted by the seller. You're more likely to get full approval from the same lender that has already evaluated your income and credit if you already have a pre approval. Before granting you final approval, this lender may still require copies of your latest pay stubs, tax returns, and W-2s.
Your lender will want to ensure nothing has changed for you financially since you first received your pre approval.
5. Provide a competitive purchase offer
If the home is in pre-foreclosure, your agent will need to present the offer to the current owner.
The trustee or attorney who is running the auction will be able to answer any questions you have about the foreclosure house before the auction begins.
Trustees run foreclosure auctions on behalf of lenders or government agencies. During an auction, this official accepts bids. If the house is REO, your agent will present your offer directly to the listing agent.
A buyer’s agent will rarely have direct contact with the bank. For government-owned listings, your real estate agent will present your offer directly to the government agency listing the property.
A foreclosed home might tempt you to make a low offer. The price of foreclosed properties tends to be lower than that of traditional properties. In contrast, if you make an offer that is too far below market value, the sellers (whether they are federal government agencies, banks, or lenders) may reject it.
To make a competitive offer, you should work with your real estate agent so they could give you advice regarding this figure.
Adding a home inspection contingency to your offer is also a good idea. (If you’re buying a foreclosed home at auction, you won’t be able to do this.) This condition states that the sale cannot be finalized until you schedule a home inspection.
6. Get a home inspection
Please keep in mind that you are buying a foreclosed home as-is. In other words, no one on the selling side will pay for any needed repairs (whether you're buying from a bank, lender, or government agency). You are responsible for these repairs.
Therefore, inspecting the property as part of the offer process is very important. You might want to pass on buying the house if the home inspection uncovers too many problems or problems that are too expensive to fix.
A bank or government agency will usually allow an inspection contingency in an offer. After your offer has been accepted, you have the option of ordering a home inspection before the sale closes. The home inspector will look for everything - from leaks in the roof to evidence of shifting foundations.
Upon completion of the inspection, you will receive a written report concerning the inspector's findings. If there are too many problems, you can walk away from the sale. It is common for foreclosure homes to offer little to no room for negotiation, regardless of the findings of the inspection.
You should expect to spend more money on repairs for a foreclosed home. Determine how long the house has been vacant and if the previous owner performed routine maintenance to get a better idea of its condition. You should also check with your local building department to see if there are any open building permits that could cause issues after closing.
When purchasing a foreclosed home at auction, you won't have the chance to schedule a home inspection. There is often no chance for you to see the inside of the house.
As a result, buying a home through the auction process is particularly risky. Yes, there may be a discount. But if you don't have a home inspection, you won't know what problems lurk until you own the home.
Foreclosed homes: Who should buy them?
This strategy could be beneficial for people willing to do significant research before making an offer and those willing to deal with lengthy delays and onerous paperwork.
Being able to pay substantial cash on short notice for repairs, overdue taxes, and liens is very helpful.
You should be eligible for one of the federal financing programs, such as the 203(k) loan, the HomePath ReadyBuyer program, or the HomeSteps mortgage program. You can use these programs to purchase a home.
If that doesn't work, you may be able to get a better deal if you offer all cash.
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