You’ve seen them in the online real estate listings at prices too good to be true. Buying a foreclosed home sounds like a great idea, doesn’t it? Man, think of the deal you can get! Whether you’re a first-time homebuyer or looking to invest in real estate, the idea of buying property at a bargain is extremely tempting.
The truth is that there are deals to be found when buying a foreclosed home. But it’s not for the fainthearted. You’d better know what you’re doing!
So, what does it take to buy a foreclosed home? We’ve got you covered!
What is a foreclosed home?
A foreclosed home is a house that now belongs to a bank instead of an individual homeowner. You’ve heard of the repo man? He’s the guy who comes and takes your car when you stop paying the bills. A foreclosure is the same concept—but with houses. When a homeowner gets behind on their mortgage and can’t make payments, the bank moves to take the property back. This process, which can take anywhere from a couple of months to years depending on the location (laws vary from state-to-state), allows the bank to sell the house and try to get back some of the money it lost when the borrower stopped making their loan payments.
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Now, there are two types of foreclosed homes: Bank-Owned and Real Estate Owned (REO). It’s kind of confusing because, in both cases, the bank owns the home. The difference is what stage the foreclosure is in.
There are two types of foreclosed homes: Bank-Owned and Real Estate Owned (REO). The difference is what stage the foreclosure is in.
Bank-owned houses are in the early stage of foreclosure—the big, meaty part. This means the homeowner has stopped making payments and the lender has started the legal process to remove them from the property. This can be a long, drawn-out process in some cases. Once that part is complete, the house is put up for auction, where the bank tries to sell it for as much as possible to recover the money it lent.
If nobody buys it at auction? Then it’s REO time, and we don’t mean the band from the 1970s.
Real Estate Owned (REO)
When the bank forecloses on a home and tries to sell it at auction and nobody buys it, the bank still owns the house. The next step is to sell the property the regular way, usually through an agent who specializes in REO sales. So, an REO property is just sitting empty and, since no one bought it at auction, has the potential to be a really good deal for a smart buyer like you.
How do I get a good deal on a foreclosed home?
Okay, let’s talk little bit about how you might be able to get a good deal on a foreclosure.
When you’re investing in real estate, you make money by finding a good deal first, then selling later. This means you want to buy something below market value so when you do sell it, you make money. You can generally consider it a “good deal” if you get it for 80% of market value minus the cost of repairs.
Now this is important because you can expect that these houses will need repairs. In most cases, nobody has lived in the house while the bank has owned it. And the bank, which is trying to maximize how much it gets for the house, won’t spend a ton of money on upkeep.
You can expect that these houses will need repairs. In most cases, nobody has lived in the house while the bank has owned it. And the bank, which is trying to maximize how much it gets for the house, won’t spend a ton of money on upkeep.
That usually means the house has been sitting closed for months with no air conditioning—perfect for mold, mildew and unpleasant odors. Gross! The previous owners could have made things even worse if they were desperate because of the foreclosure and left clutter or trash as they were leaving.
Unoccupied houses can also be targets for vandalism and theft, which can mean missing appliances, removed copper piping, graffiti or delinquent teens breaking in to do heaven knows what. You name it. It could be a literal crack house. The yard will probably be overgrown and in desperate need of cleanup and landscaping.
So, what does this mean? You need a home inspection and a good bid on repairs so you can apply the formula for getting a deal on the house:
80% of the appraised value minus the cost of repairs
For example, let’s say you find a foreclosure listed at $125,000. You and your real estate agent agree this is a fair market value for the house in pristine condition. But it’s not in pristine condition because of all of the things listed above. Your contractor estimates repairs at $15,000. Now do the math: 80% of $125,000 is $100,000, minus repairs of $15,000 equals $85,000. There’s your offer. You’ve got some room to negotiate, but don’t go into debt to get the deal done.
You need a home inspection and a good bid on repairs so you can apply the formula for getting a deal on the house: 80% of the appraised value minus the cost of repairs.
Times (x) 80%
Minus (-) Repair Costs
Another option is to buy a home from the owners before the foreclosure. The owners have the right to sell the house at any point before the auction. Even better, they’re probably highly motivated and you could get a great deal by helping them prevent a foreclosure.
Contact the homeowners and make an offer. The transaction will have to happen quickly, though. Good thing you’ve got cash! And remember to buy title insurance to protect yourself from liens or other hiccups down the road.
Okay, so what if you’re not an investor? Is it a good idea to look at a foreclosed home as a first-time homebuyer? Maybe. You’ll want to apply the same formula for getting a good deal. But you’ll also want to make sure that you:
Are out of debt
Have an emergency fund of 3–6 months expenses
Have a down payment of at least 10–20% for a 15-year fixed-rate mortgage
Have enough cash saved above that amount to cover the cost of any repairs
If you’re looking for a move-in ready home in great shape, then a foreclosure isn’t for you because it’ll take considerable work. Not to mention that you’ll need to carefully examine the structure of the home. But if you’re willing to be patient and look past a little neglect, you can score a deal sometimes. Just know what you’re getting into up front. Talk to our friends at Churchill Mortgage about getting preapproved before you start your home search.
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So, now you’re the proud owner of a foreclosure! You got an awesome deal, you’ve got a schedule for all the repairs you need to make, and you know how much they’re going to cost.
You’re all set to move in (or have some renters move in), right?
Pump the breaks! Some states have what’s called “right of redemption,” which means a homeowner who has been foreclosed on has a period of time to redeem or buy back the property. That means that if you worked hard to buy our example property for $85,000, the previous owner has the right to buy it back from you for $85,000 plus some interest. The period of time varies and can be up to one year.
You don’t want to fix up someone’s house for free, so wait to make any improvements until after the period expires. Check out the laws in your state to see if this applies to you. It’s always good to get the advice of a trusted real estate agent.
Ready to buy a home?
If you’re ready to buy a home, foreclosure or otherwise, you need a real estate agent to help you find and negotiate the best deal possible. Our real estate Endorsed Local Providers (ELPs) are experts in their local market and they’re here to guide you through the process. Just make sure when you conduct interviews that you ask if they have experience buying foreclosed houses.