Do foreclosed homes offer a good opportunity for potential buyers? It's important to understand the risks.
If you’re a homebuyer looking for a bargain, you might be investigating buying a home in foreclosure. It’s important to know, though, that though often discounted, buying a foreclosure can be a risky venture. Depending on what stage the foreclosure is, the home could be still in possession of the owner and in excellent shape, or it could be a property neglected by the lender for quite some time.
What Is Foreclosure?
Foreclosure is a process that allows a lender to recover outstanding debt when a borrower fails to pay their mortgage on schedule. To understand how the foreclosure process works, it helps to be clear that the borrower, in this case, is the homeowner. If a homeowner, or borrower, defaults on their loan payments each month for three to six months, the lender may file a public notice of default which marks the beginning of the pre-foreclosure process.
If you’re thinking of buying a foreclosure, it can be helpful to understand how the foreclosure process typically works. In general, foreclosures tend to play out in one of the following ways:
- The borrower can pay off a default amount to reinstate the loan during a grace period. This grace period, determined by state laws, is also known as pre-foreclosure. In this case, no foreclosure takes place.
- The borrower can sell the property to a third party during pre-foreclosure, negotiating the terms of purchase together. This approach allows both the borrower and owner to pay off the loan, and allows the homeowner to avoid having a foreclosure on their credit history.
- At the end of pre-foreclosure, a public auction (or short sale) is held, and the property is sold there.
- The lender might also decide to buy back the property at the public auction or through an agreement with the borrower during pre-foreclosure. Lenders tend to buy these bank-owned properties in order to resell them.
Buying During Pre-Foreclosure
A property in pre-foreclosure involves approaching the borrower and offering to buy the property outright. It is during this time that an investor can typically make the largest profits and can negotiate a deal that may be favorable for all parties involved including the buyer, borrower, and lender. This step-by-step list will help you navigate the pre-foreclosure process:
1. Prepare your resources.
Make sure that you have the resources in place to purchase this property. This includes securing pre-qualification for a loan and enlisting the help of a buyer’s agent, should you be uncomfortable contacting the owner and navigating the negotiations and closing process on your own
2. Confirm property status.
Check the history of notices and call the trustee listed to confirm that this property is still in pre-foreclosure. Owners in default can stop pre-foreclosure (called reinstatement) by paying off the amount owed or by selling the property. Or the property might be up for public auction if it’s been in pre-foreclosure long enough.
3. Evaluate bargain/investment potential.
Determine if this property represents a good bargain or investment opportunity. Start by subtracting the property’s outstanding liens and loans from the property’s estimated market value to determine the property’s estimated equity.
4. Contact the owner.
Unless this property is listed for sale on the MLS (in which case you can contact the listing agent), you’ll need to contact the owner in default to express your interest in the property.
5. Negotiate a purchase agreement and close the deal. If this owner is interested in selling during pre-foreclosure (which can protect the owner’s credit and allow the owner to walk away with something to show for the property equity), then you’ll need to negotiate the terms of the purchase, enter escrow and close the deal before the property is put up for auction.
Buying After Pre-Foreclosure
If the loan is not reinstated by the end of the pre-foreclosure period, potential buyers can bid on the property at a public auction. Buyers often are required to pay in cash at the auction and may not have much time to research the title and condition of the property beforehand; however, a public auction often offers some of the best bargains and avoids the unpredictability of dealing directly with the borrower/owner.
If the lender takes ownership of the property, either through an agreement with the owner during pre-foreclosure or at the public auction, the lender will usually want to re-sell the property to recover the unpaid loan amount. The lender will probably make sure the title is clear for any buyer, but the potential bargain is typically less than a pre-foreclosure or auction property.