When the market is competitive for buyers because inventory is limited like it has been for the past three years, foreclosed properties seem like a great option, especially for first-time homebuyers or real estate investors. Often the sellers are incentivized to sell quickly, meaning the price may be lower than comparable homes in the area.

But is it smart to buy a foreclosed property as your primary residence?

In this article, we will talk about what a foreclosed property is and the pros and cons of purchasing one for your family.

What is a foreclosed home?

A foreclosure occurs when a borrower fails to pay their mortgage loans and the lender exercises its right to seize the property and sell it to try to make up the money it lost. Typically, the lender puts the foreclosed property up for auction to recoup as much of its losses as possible, but doing so often means the property sells below market value. If the property fails to sell at auction, the lender may then reduce the sales price further to sell it directly and as quickly as possible.

A foreclosure differs from a short sale, which is when the lender allows the homeowner to sell the property for less than they owe on the mortgage. Lenders may agree to a short sale if they determine that the losses on the sale would actually be less than the cost of going through the foreclosure process. We won’t dig into short sales in this article but just know that while foreclosures typically sell for less money, they are often in worse condition than a short-sale property would be.

The pros and cons of buying a foreclosed home

There are many advantages and disadvantages that you need to consider when it comes to buying a foreclosed home. Work with your real estate agent and lender to fully understand how these factors affect you, but here is a summary of the pros and cons.

Relatively Lower Sales Price

As we discussed, a foreclosed home is usually sold for less than a comparable home at market value. While this is great news for buyers at face value, they must be aware that they often need to save money to clean and renovate the property between your purchase and move-in date because you are buying it as-is.

You Buy It As-Is

One of the biggest risks of buying a foreclosed property is the fact that its condition may be a mystery until after you purchase it. In other words, the property may have been vacant and/or neglected for months. While some lenders may allow you to walk through the home before you close, many do not allow you to see the property until after you’ve purchased it. Your real estate agent may be able to put home inspection contingencies in your offer, but the lender may not accept contingencies or may choose an offer that does not have such stipulations. If this is the case prepared to spend money cleaning and renovating the home before you move in.

However, if you are a DIY kind of person or have access to resources that can help you make the property livable, a foreclosed home may be a good opportunity. Lean on your real estate agent to help you find foreclosed properties on the MLS, and search through bank websites, the U.S. Department of Housing and Urban Development (HUD) lists, and on real estate listing sites.

More Competition with Real Estate Investors

Foreclosed properties are often sold below market value, which is a great deal for a home buyer - and for real estate investors looking to flip properties. Real estate investors often have access to significant credit lines and/or liquid cash, making it tougher for mortgage buyers to compete. You aren’t out of the running (and it helps if you have a fully underwritten loan like Leo Anzoleaga Group buyers do), but be aware of this as you consider making an offer.

Sales are Final at Auction

We already discussed as-is condition for foreclosure sales, and this is true if you look to buy a home at auction. You never know how many people will show up to bid on the house, so you may get a great price or you may find that bidders drive the price higher than your maximum bid. 

At this stage, though, you may have a little time to research the property before making your bid. Ask your agent to do a title search ahead of time if possible (more on this below). In some places, buyers are given a grace period to back out of a purchase in exchange for their deposit if they decide they do not want to buy the home, but in many other places, all sales are final.

Conduct a Title Search if Possible

If you have the property address, it may be possible to work with your real estate professional to run a title search. This is important because it can help you identify possible title issues associated with the property such as liens, unpaid taxes, and legal judgments.

For example, if a previous owner took out a second mortgage or home equity line of credit (HELOC), the issuers of those secondary loans might have liens on the property, which gives them the right to collect the debts once the property is sold. Liens are associated with properties, not property owners, which means the new owner of the property is responsible for clearing the liens by paying off the debts.

Title searches typically cost a few hundred dollars, but this investment upfront may save thousands in the long run if you do choose to purchase a foreclosed property.

You May Never See Them Listed Online

Once a property has failed to sell at auction, it becomes real estate-owned or REO, meaning the lender is selling it directly to the buyer. Occasionally, lenders sell REO instead of going to auction, but either way, these homes are not usually advertised publicly. To find them, you need to work with a licensed Realtor who is familiar with these types of properties (which you should be doing anyways if you are considering a foreclosed home).

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In Closing

Purchasing a foreclosed home is not the best strategy for every family. However, if you understand the risks, work with a Realtor to navigate the process, and prepare adequately, a foreclosed home might be one you reach your goal of homeownership.

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