If you’re scanning real estate websites, you’ve likely noticed homes listed as foreclosures or bank-owned properties. Sometimes the prices on these homes can seem like a dream come true, but should you really consider buying a foreclosed home?
Buying a house in foreclosure might seem like a smart way to jump into the real estate market for cheap, but buying a foreclosed home could come with some serious pitfalls. Here are some things to know about buying a foreclosed home.
What is foreclosure?
At its most basic, foreclosure is what happens when a home loan borrower is unable to make the required payments on their loan and eventually goes into default, which forfeits the right to their home or property.
When a buyer borrows money to buy a house, they are entering into a loan agreement for the cost of the house minus any down payment.
Mortgages are “secured loans,” which means that the mortgage is recorded against the property itself through a lien. If a borrower fails to make a certain number of payments, the lender who issued the mortgage can try to recover some of the debt owed by seizing and selling the property that is the subject of the lien.
The foreclosure process
The specific foreclosure process varies under different state laws but follows the same general path. The main differences depend on whether your state generally uses a judicial foreclosure process or a non-judicial foreclosure process. In a judicial foreclosure, the foreclosure may require an order from a judge.
In a non-judicial foreclosure process, which is also known as “power of sale,” the courts may not be involved at all. Regardless of if a foreclosure is judicial or non-judicial, it can follow the same general process.
The first step of a foreclosure is when the borrower stops making payments on their mortgage. This is often caused by financial hardships like unemployment, illness, or other unexpected financial obligations.
Once a borrower has missed three to six months of payment, depending on state law, the lender will post a public notice, sometimes known as a Notice of Default (NOD) or “lis pendens,” which means pending suit.
In some states, they also post this notice on the door of the property that is at risk of foreclosure. This notice is a public alert to the borrower that the loan is in default.
After a borrower receives a Notice of Default, they have 30 to 120 days (again dependant on state law) to attempt to avoid foreclosure. This period is called a pre-foreclosure.
During this time, the borrower may work with their lender on various options, such as applying for a loan modification, deed in lieu of foreclosure, to pay the amount owed or even enter into what is known as a “short sale.”
A short sale is when the borrower sells the property and the net sale proceeds are “short” of the amount owed on the mortgage. A short sale needs to be approved by the lender.
If the borrower is able to pay the amount owed or sell the property through a short sale, the pre-foreclosure process ends without progressing to full-blown foreclosure.
If the borrower isn’t able to pay off the amount owed or get approval and sell the home through a short sale, the foreclosure process will continue. It is good to note that there could be tax consequences as a result of a short sale.
At this stage, the lender has the option to sell the foreclosed property at auction. These auctions are sometimes referred to as trustee sales, and notice of the auction must be given at the County Recorder and in the newspaper.
In some cases, the borrower has the opportunity to come up with the money owed until the property is actually auctioned off. This is known as the “right of redemption” and can stop the foreclosure process entirely.
If the borrower isn’t able to exercise the right of redemption, the property is auctioned off to the highest cash bidder. If no one buys the property at auction, the lender takes ownership of the property.
Some lenders will also forgo auction and instead accept the deed to the property back known as a “deed in lieu of foreclosure” or the lender will buy the property back at the auction itself. If the lender takes ownership, the home becomes a bank or real estate owned property (REO).
These properties are then either sold in the traditional real estate market or sold in bulk to investors at liquidation auctions. In some states under the judicial foreclosure process, homeowners may have the right to redeem their property after the sale.
Whether a redemption period is offered at this stage and how long of a period is given can vary based on several factors including but not limited to state law.
In some states the homeowner who was foreclosed on may be able to stay in the property during the redemption period, in other states whoever purchases the home at foreclosure has the right to live there, then if the homeowners cure the default, they get the property back.
Buying a foreclosed home
As you can see, the foreclosure process is complicated, and it is governed by many different state and federal laws. This can make buying a foreclosure a little more complex than a traditional home purchase.
If you’re interested in buying a foreclosure, you can find listings on many different websites that aggregate bank-owned properties. When checking out the listings you like, take note of the real estate agent’s name.
Banks usually outsource the job of selling foreclosed homes to real estate agents. One important thing to remember when you’re scrolling through listings is that most foreclosed homes are sold “as-is,” which means that there are no explicit or implied warranties as to the condition of the house.
This means that you may face challenges when it comes to financing a foreclosed home with health or safety issues present. Many foreclosed homes have fallen into disrepair and may need significant updates in order to be habitable.
You may be allowed time for a home inspection to be completed as part of the sale but this may depend upon the entity selling the property and the channel in which the property is sold.
Purchasing a property at auction, for instance, would not allow for a home inspection or even for the bidder to see the inside of the house. And just because a foreclosed home might have potential problems, don’t expect it to necessarily be priced below market value.
Many people, especially first-time home buyers, believe that foreclosures are offered at a deep discount, but it is important to remember that even low-priced homes might get multiple offers above the asking price from buyers eager to snap up a fixer-upper.
Multiple offers can raise the bidding and in turn the selling price.
Because the foreclosure market moves fast, you will also likely need your financing worked out in advance. If you’re a cash buyer you might have a firm budget in mind, and if you’re planning on taking out a mortgage to buy a foreclosure, you may want to consider getting pre-qualified or even better, pre-approved.
Mortgage pre-approval tells you how much money you are eligible to borrow and lays out the terms of final approval on a mortgage in a pre-approval letter.
Pre-approval may also help expedite the buying process because it shows the seller that your credit, income and assets have been reviewed by a lender and approved for a mortgage up to a specified amount pending certain conditions such as locating an eligible property.
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