What Is Foreclosure?

Definition and Example of a Foreclosure

A mortgage forms a lien against a property. It gives a lender the legal right to take ownership if the borrower defaults. The lender will then almost always sell the property to recoup its losses after it's taken control of the home. This process is called "foreclosure."

Investors and other buyers can then purchase these homes, often at auctions or directly from the bank or government agency that owns them.

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Where to Find Foreclosed Houses

The following resources can help you find foreclosed properties for purchase. Real estate professionals in your area may know of additional resources.

  • Bank websites. Many bank websites provide lists of REO properties for sale.
  • The U.S. Department of Housing and Urban Development (HUD) lists homes available for purchase from government agencies, including many foreclosures.
  • You can search for foreclosure properties on web-based real estate listing services such as RealtyTrac and Zillow.
  • Multiple listing services (MLS) list foreclosure properties. These services are available by prescription to licensed real estate professionals. A real estate agent or mortgage broker can use MLS to access foreclosures in your area.

2. Get a preapproval letter

Unless you can afford to pay cash, you’ll want a mortgage preapproval letter in hand when you make an offer on a foreclosure. “It separates the lookers from the buyers,” Soffee says.

Preapproval letters detail how much money you can borrow based on the lender’s thorough assessment of your credit score and income. Find a mortgage lender who understands your goals, and gather the necessary paperwork to obtain a preapproval letter.

“It’s always good to be prepared,” Sklar says. “Having your proof of funds will make it an easier transaction.”

You’ll also want to consider what kind of loan to get preapproved for. Foreclosed properties often require repairs or upgrades, and an FHA 203(k) loan can help. These loans allow buyers to finance up to $35,000 for repairs.

Although foreclosures tend to get scooped up by real estate investors who pay cash, don’t let that discourage you; many lenders will help you find the right financing to buy a foreclosed home.

Why Foreclosed Homes Are Cheaper

The biggest selling point of foreclosed homes is, of course, their marked-down price—often significantly lower from other similar properties in the same area (known as “comparables,” or “comps,” in broker-speak). Most foreclosures are sold at a sizable discount below market value, with the exact amount varying from region to region. Buyers may also take advantage of additional savings with perks such as reduced down payments, lower interest rates, or the elimination of appraisal fees and certain closing costs.

What makes these properties such a deal? If the residence is in the pre-foreclosure or short-sale stage, its owners are in a financial bind—and time is not on their side. They have to unload the property and get what they can while they can, before they lose possession of it. In short, these sellers aren’t negotiating from a position of strength and, while it may seem cruel to take advantage of others’ misfortune, buyers can benefit.

Buyers can benefit even more if the property has in fact been seized. The sheriff’s office isn’t interested in hanging onto a house, and banks don’t want to be in the landlord business. Financial institutions typically want to rid themselves of foreclosed properties promptly (for a reasonable price, of course—they have to answer to investors and auditors that they made every attempt to recoup as much of the original loan amount as possible). Again, buyers can take advantage of this situation. 

Finally, foreclosed homes are usually sold “as is”—if there’s damage, repairs by the owner aren’t part of the equation—and, as used-car and vintage furniture aficionados know, “as is” translates into a discount. Of course, “as is” can be a double-edged sword, as we’ll discuss below.

The Research Secret

Foreclosures are heavily regulated and different states have different rules regarding the buying process of foreclosed properties. The first secret to a successful purchase is thoroughly researching the rules of the state in which the house is located, especially if you're counting on a quick sale. Foreclosure laws primarily depend on whether a state uses deeds of trust or mortgages for real estate purchases. This determines whether the state uses judicial or non-judicial foreclosures, or a combination of both. Depending on the state, process periods for foreclosures vary from a few weeks to almost a year. Redemption periods (the time in which a homeowner can reclaim his mortgage and buy back his home following a foreclosure) also vary from one month to a full year. These fluctuating time frames can negatively affect how long it takes to complete your home buying transaction.

What Are the Different Types of Foreclosed Homes?

There are essentially two categories of foreclosed homes: bank-owned homes and real estate owned (REO) properties. Both bank-owned and REO homes are under the ownership of the lender, which, in many instances, is a bank. The only distinction is what stage the foreclosure is in.

Bank-owned homes are in the thick of foreclosure, meaning the homeowner has stopped making payments. In turn, the lender has started the legal process to remove him or her from the home. Foreclosed homes are “bank-owned properties” that eventually go to auction, where the bank tries to recoup the money for the property.

If the home doesn’t sell, it’s still bank-owned, but it is now known as an REO home. REO properties have already gone through the auction process and remain unsold. The bank or lender retains ownership and tries to sell these properties, oftentimes through REO real estate agents.

A Note About Purchasing Through Short Sale

A short sale occurs when the homeowner sells a home for less than what they owe on the mortgage because the value has declined. Foreclosure has not been completed with a home up for short sale. The homeowner still owns the home so you work through their REALTOR®.

When you buy a home in a short sale, the lender (not the homeowner) needs to approve your offer. You might spend a lot of time waiting for approval.

Understand what you’re getting into with a foreclosed home

When a homeowner is unable to make their mortgage payments the lender forecloses on—or takes back—the home. There are four general steps to the home foreclosure process:

  1. Pre-foreclosure: where the homeowner receives notice of a pending foreclosure action, but the lender hasn’t yet begun to foreclose.
  2. Lender foreclosure process: lender begins the legal process to foreclose on the home, with the length of time and exact steps varying from state to state.
  3. Lender seizes the home and evicts the homeowner: by this point the homeowner has usually abandoned the property, sometimes taking with them as much as they can carry – appliances, plumbing fixtures, light fixtures, and more.
  4. Lender sells the home as a foreclosed property or holds until the market improves: unless a real estate investor can make a deal with the bank ahead of time, the home will be sold at a foreclosure auction or held as “Real Estate Owned” until the market improves.

4. Bid higher if other foreclosures are selling quickly

There’s no exact formula on what the bank’s bottom line will be, so if foreclosed homes in your area are selling quickly, it’s important to work with your agent to craft a strong offer, backed up by your preapproval letter if obtaining a mortgage. In many instances, foreclosures are already discounted, so an offer that’s too low might be a non-starter for the bank.

Keep in mind that the type of house and location matter, and some homes might sell faster than others. In competitive markets, you might need to offer asking price (or slightly more if there are multiple bids) and keep contingencies to a minimum.

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