How To Buy a Foreclosure (REO, Foreclosed Property)
What is a Foreclosure?
A foreclosure is the legal process in which a lender takes ownership of real property (home, land, or building) from owners who fail to make payments on a loan or fail to follow through on other promises in respect to the property. The lender then sells the property to recapture the amount still owed to them.
Most foreclosures result from a nonpayment of a mortgage loan or a home equity loan, but the nonpayment of a balloon payment, not paying property taxes, not paying for insurance, or not properly maintaining a property can also result in foreclosure.
The three (3) parts of the foreclosure process:
1. Pre-foreclosure: This is the time between when the owner stops making payments and when the lender has the county court place the property for sale at an auction. The lender must prepare specific paperwork and give the owner specific notices concerning the delinquency.
It can also be the time between when the lender finds out that the owner hasn't paid the property taxes, paid for insurance, or stopped maintaining the property, and when the property is sold at auction by the county court.
The dispute can be settled at any time during the pre-foreclosure period thus stopping further actions by the lender and the court.
As a buyer (investor or potential resident owner), you can deal directly with the owner during the pre-foreclosure period. The owner has the right to sell the property during this time as long as the loan is completely paid off at the closing.
2. Auction: This is the action by which the county court seizes the property from the owner and sells it to the highest bidder, usually at the courthouse. The county sheriff or a trustee handles this process, depending on the state where it occurs.
The auction usually occurs on the courthouse steps after the home or other property is advertised in the local newspaper about a week in advance. You should have cash or a cashiers check with you and be prepared to make a substantial deposit or the pay the entire amount on the spot should you be the winning bidder. Make sure to have your financing arranged and approved in advance because you will have a limited time to close on this type of purchase.
You should be careful to do your own due diligence because this sale is "AS-IS." Whatever condition the property is in is the condition you will get. Neither the owner nor the lender will make repairs and most states don't allow a buyer to inspect the inside of the home or building before bidding begins. Where inspections are allowed they may only be scheduled for a limited time on a certain day.
Therefore you should visit the property and try to learn as much as possible from public records and neighbors and other sources. You could be buying a home or other type of property that has substantial structural problems, termites, toxic chemicals, exposed lead paint, or tax liens. You also might not obtain clear title because some liens such as IRS (federal taxes) and county taxes are not wiped out by foreclosure. Delinquent taxes will make it highly unlikely that you will be able to obtain title insurance.
You should make sure ahead of time that the auction is on schedule. Sometimes the auction doesn't occur because the owner makes the required payments or resolves the disputed matter at the last minute. Court rulings and improper paperwork can also stop or postpone the sale.
There is a statutory redemption period in some states that enables the original homeowner to repay the past-due amount on their loan plus expenses and regain ownership even after the auction is over. When this happens you are no longer the owner and out whatever expenses you incurred.
3. REO (Real Estate Owned): If the property fails to sell at the courthouse auction, or if the lender ends up as the highest bidder, the home becomes "Real Estate Owned" (REO) by the lender. If the lender is a bank or mortgage company they then will try to sell their REO properties on the open market, either by themselves, by listing them with a real estate broker, by advertising with a third-party marketing company, or by entering them into additional auctions.
Sometimes you won't know it is a foreclosure (REO) from looking at the real estate listing unless the bank's name or a government agency is shown as the seller.
Why buy a foreclosure?
The ultimate goal of almost all real estate investments is to buy low and sell high. Foreclosures can provide that opportunity. There is much advertising about the tremendous bargains available and the huge profits to be made by purchasing foreclosed properties at a large discount from market value. It is easy to get caught up in the frenzy to buy valuable real estate for pennies on the dollar or by using other people's money. But like all other types of investments they can bring you gains or loses depending on your timing and expertise. Many foreclosure deals can sound too good to be true and they probably are. The higher the potential reward the higher the actual risk.
It takes much research, knowledge, experience, time, and money to be consistently successful with any type of real estate investing and foreclosures are no exception. You should learn about the entire process and make sure you completely understand the laws and procedures before bidding on a property. It is best to begin with the least risky deals even though the return on investment can be low.
A reputable lender that is selling a foreclosed single-family home is most likely the first lien holder by a first mortgage. If there was no problem when the home was bought and financed by the previous owner, there theoretically should be no problem with your purchase. In about 9 out of 10 cases you will be able to obtain title insurance. However, you should beware of bidding on or buying a property in which the lender was a private party, a relative of the owner, or a bank with legal problems. In those cases there are numerous pitfalls waiting to happen.
Government Agency Foreclosures:
Several government and quasi-government agencies can also foreclose on homes and put them up for sale. These agencies will have financed the home directly, guaranteed the mortgage, or bought the mortgage from a lender, usually a bank, before the loan became delinquent.
Some agencies to research are: HUD (Housing and Urban Development, VA (Veteran's Administration, Fannie Mae, Freddie Mac, and USDA (U.S. Department of Agriculture). There are others that specialize in certain types of properties.
Many government auctions are conducted online under contract to a private company. You will be allowed to tour and inspect these homes in advance and most of the time these homes will qualify for title insurance. You have much less risk in government auctions so the prices will be much closer to market value. These auctions are better if you are buying a home for your own use than if you are an investor looking for a quick profit.
Finding Foreclosed Property:
Foreclosures provide the potential of turning another person's misfortune to your benefit. Basically you are trying to find a bargain without getting burned by the risks, dangers, and difficulties involved.
Take a look at educational materials and numerous foreclosure properties by clicking on any of the banners, links, or the map on this page.