Looking to purchase a new home but concerned about your ability to afford the monthly mortgage payment? Or perhaps you want to buy in a popular neighbourhood but believe the homes are out of your price range. Buying a foreclosed home could be the answer.
A foreclosed house is typically owned by a bank or lender. Lenders can foreclose on a home when homeowners fail to make their regular monthly mortgage payments, which means they take ownership of the property.
Banks and mortgage lenders will then attempt to resell these homes, frequently at lower prices or with a smaller down payment. That is the primary advantage of purchasing a foreclosed home: You might get a house that would have been out of your price range otherwise.
Although there are risks associated with purchasing a foreclosure, the process isn’t much more complicated than the typical home-buying experience, and purchasing the right foreclosed property can get you a home at a bargain price.
Here’s a closer look at how to buy a foreclosure, as well as the information you’ll need to make the process as easy as possible.
How To Buy A Foreclosed Home
The prospect of purchasing a foreclosed home may frighten you. However, the process of purchasing a foreclosure home is not dissimilar to the traditional method of purchasing a home. Purchasing a foreclosure does necessitate additional research, and you must be willing to accept a higher level of risk.
However, if you work with a real estate agent who is familiar with your local foreclosure market, the stress level should be comparable to that of a traditional home purchase.
Here are the steps you must take in order to successfully purchase a foreclosed home.
Research The Different Methods For Buying A Foreclosure
The first step in purchasing a foreclosed house, as with any major purchase, is research. This is because there are several methods for purchasing a foreclosure, and the best method for you may differ depending on your needs.
The following are the most common purchasing paths to consider.
Buying From The Homeowner
A pre-foreclosure, also known as a short sale, occurs when the homeowner still owns the property but is aware of the possibility of foreclosure. Owners want to sell their house before it goes into foreclosure. As a result, short sales are not technically foreclosure sales.
Short sales can be difficult as well. In a short sale, homeowners obtain permission from their lender to sell their homes for less than the amount owed on their mortgage. If the owners owe $180,000 on their mortgage, they may still list the home at $160,000, even if such a sale falls $20,000 short of paying off the entire loan.
In some short sales, the owners’ bank agrees to take this loss in order to get the house sold and the mortgage (which would otherwise be in default) off their books.
The owners’ goal is to offer their home at a low enough price to ensure a quick sale before they fall behind on their monthly payments. Buying at this stage, however, can be difficult. Even if the sellers accept your offer, if it is too low, their bank or lender may reject it.
Buying At An Auction
A real estate auction is the traditional method of purchasing a foreclosed home. Third-party trustees conduct auctions to sell homes that banks or lenders have taken ownership of after the original homeowners defaulted on their mortgage loans.
At an auction, buyers can get a house quickly (and often for a low price). But there are also obstacles. An auction, for example, typically requires buyers to have cash on hand.
There are also numerous dangers:
- A home purchased at an auction may have a lien from a government agency on its title, especially if the previous owners stopped paying property taxes on it.
- A home purchased at auction may necessitate costly repairs.
- You may not be able to order an appraisal on the property. A real estate appraiser determines the value of a home in the current housing market during an appraisal. Even if you buy a house at auction, you risk paying too much without an appraisal.
Buying From The Bank
On the open market, you can also purchase a foreclosed home directly from a bank or lender.
While looking for home listings, you may come across the term “REO.” This is an abbreviation for “real estate owned,” and it refers to a foreclosed property that is now owned by a bank or lender. When a property becomes an REO, the bank will typically clear any liens on the property and evict the previous homeowner before selling the home, so you won’t have to.
At this point, the bank has secured the property through an auction and is now selling it to recoup what is owed on the property. The bank will most likely hire a local real estate agent to market the property.
Buying A Government-Owned Property
You could also look into purchasing government-owned foreclosure properties. These are similar to the properties owned by banks or lenders. Government agencies typically take possession of homes after the owners’ default on federally insured mortgage loans.
Consider the following example. When owners stop making payments on a home they financed with an FHA loan, the U.S. Department of Housing and Urban Development (HUD) seizes possession. Government-owned foreclosures are typically sold “as-is,” which means you are responsible for any repairs. In some cases, the government may repair any structural issues before selling, or you may request one. You may be required to make an offer or bid before viewing or inspecting the property.
Determine How Much Home You Can Afford
When purchasing a foreclosed home, budgeting is essential. Yes, you might be able to get a better deal on your new home. However, foreclosed homes are not free. And, contrary to popular belief, you cannot purchase a foreclosed property for $1.
To determine how much of a mortgage payment you can afford each month, create a household budget that includes your monthly income and expenses (including estimates for discretionary expenses like eating out and entertainment).
If you do not do this, you may end up buying a home that you cannot afford, even if you are looking for foreclosure. You will struggle to make your own mortgage payment each month if you buy a home that is out of your price range.
As with any home purchase, you should calculate your debt-to-income (DTI) ratio ahead of time. This ratio, as the name implies, examines how much of your gross monthly income your monthly expenses (including your estimated new mortgage payment) will consume.
Most lenders prefer that your monthly debts do not exceed 43% of your gross monthly income. If your debt-to-income ratio is higher, you will have difficulty qualifying for a home loan.
When purchasing a foreclosed home, exercise extreme caution. You might be tempted to buy a foreclosure at the very top of your price range.
The issue with this is that the foreclosed home may require costly repairs. If you bought a home at the top of your budget, you might not be able to afford the necessary repairs.
Are you having trouble determining how much house you can afford? Make use of a Home Affordability Calculator. It can give you the information you need to make an informed purchasing decision.
Hire An Experienced Real Estate Agent
If you decide to buy a foreclosure, you should look for an experienced real estate agent who has access to a local multiple listing service and is familiar with the local market.
This agent can assist you in determining when a foreclosed home is being offered at a low price or when it is being listed at a price that is excessive for the risk involved. An agent can also assist you in locating foreclosed properties that other buyers may overlook.
A good real estate agent can also discuss potential problems with a foreclosed property. Keep in mind that each state has its own set of foreclosure laws and regulations. It is critical to work with an expert who is familiar with these laws.
Get Preapproved For A Mortgage
Getting pre-approved for a mortgage is a wise decision regardless of the type of home you purchase. A lender will run your credit and verify your income and debts at no cost during the preapproval process. This lender will then determine how much of a mortgage you are eligible for.
You’ll know exactly how much you can spend on a home once you receive a preapproval letter from a lender. If a bank approves you for a $200,000 mortgage, you won’t waste time looking at $300,000 homes.
Having a preapproval letter makes you a more appealing buyer. Sellers (banks or government agencies in the case of foreclosures) prefer to work with buyers they know can qualify for a mortgage. They are not concerned that you will be unable to obtain a loan, delaying the sale of their home. If a home receives multiple bids, sellers are more likely to work with buyers who have already been preapproved for a mortgage.
In foreclosure situations, banks and lenders can be especially sensitive to credit issues, so a good credit score will be especially important during the preapproval process.
It is prudent to shop around for mortgage lenders. Don’t just go with the first mortgage lender you come across. Instead, look for the lender with the lowest interest rate and loan fees.
If you get preapproved from one lender and want to buy a bank-owned property, the bank or lender may require you to get preapproved through them as well. Typically, this is done to confirm your eligibility or to look for a selling opportunity. Understand that you are not obligated to use that lender. You can still use your original company’s preapproval to qualify for the bank-owned home.
You apply for full approval after you find your dream home and make an offer that is accepted by the seller. If you already have a preapproval letter from a mortgage lender, it’s often easier to apply for full approval from the same lender who has already reviewed your income and credit. However, before granting you full or final approval, this lender may still require you to submit copies of your most recent pay stubs, tax returns, and W-2s.
Your lender will want to ensure that nothing has changed financially for you since you received your preapproval.
Make A Competitive Purchase Offer
If the house is in pre-foreclosure, your real estate agent will need to present the offer to the current owner.
If you’re interested in a foreclosed home that’s going to auction, you’ll need to contact the trustee or attorney in charge of the auction to ask any questions about the property before the auction.
A trustee is an independent third party who conducts a foreclosure auction on behalf of a lender or government agency. During an auction, this official accepts bids.
If the house is an REO, your agent will present your offer to the bank’s listing agent directly.
A buyer’s agent will never speak with the bank directly. For government-owned listings, the process is similar: your real estate agent will present your offer directly to the government agency listing the home.
You may be tempted to make a lowball offer on a foreclosed property. True, foreclosed properties frequently sell for less than traditional homes. However, if you make an offer that is significantly below market value, the sellers (whether a federal government agency, a bank or a lender) may reject it.
It is therefore critical to collaborate with your real estate agent in order to make a competitive offer. Your agent will advise you on the appropriate figure.
You should also include a home inspection contingency in your offer. (Note: If you’re buying a foreclosed home at auction, you won’t be able to do this.) This condition states that the home sale cannot be finalized until you have scheduled a home inspection.
Get A Home Inspection
Remember that you are purchasing a foreclosed home “as-is.” This means that no one on the selling side (whether you’re buying from a bank, lender, or government agency) will pay for any repairs that are required. You are responsible for these repairs.
As a result, it’s critical that you inspect the property as part of the offer process. And if the home inspection reveals too many problems or problems that will cost too much to fix, you may want to reconsider purchasing the home.
As part of an offer, banks or government agencies will usually include an inspection contingency. This means you can order a home inspection after your offer is accepted but before the sale is finalized. Your home inspector will walk through the house looking for everything from roof leaks to evidence of a shifting foundation.
Following the inspection, you will be given a written report outlining the inspector’s findings. If there are too many problems, you can back out of the deal. Regardless of what the inspection reveals, foreclosed homes typically offer little to no room for negotiation.
Expect to pay more money for repairs on a foreclosed home. Determine how long the house has been unoccupied and whether the previous owner performed routine maintenance on the home to get a better sense of its current state.
It’s also a good idea to check with your local building department to see if there are any open building permits that could cause problems after the sale.
The process of purchasing a foreclosed home at auction differs greatly because you will not be able to schedule a home inspection. You may not even have the opportunity to enter the house.
This makes purchasing a home at auction particularly risky. Yes, prices may be lower. However, without a home inspection, you will not know what problems exist until after you have purchased the home.
