How to Buy A Foreclosed Home

A foreclosure modern American home with an overgrown lawn

Buying a foreclosed home can be a smart way to get a bargain on a new house or investment property to rent or resell. In many ways, purchasing a foreclosed home is comparable to buying any other property, but since it comes with some potential pitfalls, it's not for the faint of heart. Here's how to buy a foreclosed home, and some tips to help you navigate the process.

What Is a Foreclosed Home?

A foreclosed home is one that has been seized by a mortgage lender (typically a bank, credit union or financing company) after a borrower failed to make required payments on their home loan.

Because lenders typically don't want to own these homes long term, it's possible to scoop up a foreclosed home at a bargain. It's important to remember, however, that foreclosed properties are sold "as is," and can have cosmetic and structural problems and financial encumbrances, such as back taxes, that typically aren't concerns when you're buying a home from a builder or private owner. A foreclosure may have been sitting vacant for a period of time, its yards may be overgrown, and the previous owner may have left items behind that'll need to be dealt with. Sometimes, an angry owner even vandalizes a property or strips out expensive wiring or piping before they depart. These issues shouldn't stop you from taking advantage of the potential savings, but it's important to prepare for the hazards.

Foreclosed properties available for sale fall into two broad categories: bank-owned properties and real estate-owned (REO) properties.

Bank-owned properties are in the process of being reclaimed by the lender and put up for auction. It's possible to make an offer for a property before it goes to auction, when the lender may still be working to evict the previous owners, and liens for back taxes or unpaid bills are still attached to the property. Typically by the time a property goes to auction, the lender has settled any liens, but it's wise to double-check the title and factor any such encumbrances into the price you're willing to pay.

REO properties are typically still owned by the lender, but only after they have failed to sell at auction. These properties may be in a more distressed state than those that sold readily at auction. While they may not be accessible for walk-throughs, it is often possible to do a cursory external inspection to spot issues that can help you narrow your search or adjust your offer price.

How Do You Buy a Foreclosed Home?

  1. Find representation. Look for a mortgage broker or real estate agent with foreclosure experience. If you're new to the foreclosure game, it'll be well worth your while (and the commission) to have the guidance of a seasoned professional. A good agent can help you spot quality bargains, help you avoid buying in neighborhoods with falling property values and point out red flags you might not see.
  2. Learn the ropes. Taking cues from your broker or agent, get familiar with the foreclosure-buying process by following these steps:
    • Acquaint yourself with resources that list foreclosed properties for sale at the bank-owned and REO phases of foreclosure (more on this below).
    • Attend a few local foreclosure auctions to watch and learn so you understand the procedures and customs participants follow.
    • Learn about title searches, how to identify liens and other financial encumbrances, and the process of inspecting properties to quantify potential repair costs.
    • Consider seeking referrals for professional title searchers and home inspectors who can help you.
    • Connect with contractors who can assist you with home repairs, painting and landscape. The foreclosed home you buy might need a lot of work to get it move-in ready. If you're into DIY, you can take classes to sharpen your home improvement skills.
    • Contact an attorney with real estate experience who can offer advice and assist with drafting and reviewing offer letters, sales contracts and other documents.
  3. Get preapproved for a mortgage. Full-time real estate investors often pay cash for foreclosed homes, making the foreclosure market very competitive. Cash buyers have an advantage, so if you're in a position to use cash, that's great. Financing a foreclosure purchase is also viable, but if you plan to go that route, your purchase offer should include proof that you can pay in short order. It's essential, therefore, that you work with a lender to get prequalified for a loan and have your lender spell out how much you're able to spend.
  4. Shop around. Check out homes comparable to the one you'd like to buy. Properties offered at foreclosure auctions often have not been advertised for sale ahead of time, so all you may have to go on at the time of purchase could be a description, floor plan and a few photos. It's helpful to get an idea of what your budget should be getting you. If you can inspect the properties you're considering (sometimes possible with REO homes), try to estimate the cost of repairs or improvements that might be required.
  5. Make your offer. Make a bid at an auction or work with your broker to negotiate a purchase directly from the lender that holds the title. Note that you may need a sizable cash deposit or cashier's check to secure the purchase. Understand that a foreclosure sale may lack some of the terms common in standard home-sale contracts, such as contingencies for voiding the sale if the property fails an inspection. Craft your offer letter accordingly (too many conditions can bring rejection, even if the price is right) and be sure to factor potential repair costs into your offer price.
  6. Close the deal. Once your offer is accepted, schedule an inspection, work with your experts on any final negotiations and set a closing date.

Resources for Finding Foreclosed Homes

To scout foreclosed properties for potential purchase, check out the following resources.

  • Bank websites. Many bank websites provide lists of foreclosed properties for sale.
  • The U.S. Department of Housing and Urban Development (HUD) provides listings of homes for sale by government agencies, including foreclosures and properties otherwise seized by law enforcement agencies.
  • Foreclosure listings at online real estate listing services such as Zillow and RealtyTrac.
  • The multiple listing service (MLS), typically available only to licensed real estate professionals, lists foreclosed properties along with typical home sales. Your agent or mortgage broker can help you tap this resource for properties in your area.

Do I Need Good Credit to Buy a Foreclosed Home?

If you plan to finance your foreclosure purchase, you'll need to qualify for a mortgage just as though you were buying from a homeowner. As with any home loan, the lender will likely want to see evidence that you can afford the monthly mortgage payments, and they'll probably run a credit check as well.

Your credit scores will likely play a role in a lender's decision to issue you a loan and may also factor into the interest rate and fees they'll charge you. Whether you're financing a foreclosure or a more traditional home purchase, higher credit scores generally lead to better borrowing terms.

Before applying for foreclosure financing, it's always a good idea to review your credit report and check your credit scores to know where you stand. If you can wait and your credit score has room for improvement, focus on raising your credit score for a year or so before applying for a loan.

Foreclosed homes can be a great launching pad for real estate investment, or even a path to a more affordable home for you and your family. If you understand what you're getting into and how to size up foreclosure properties, you could get a terrific bargain.