The Pros And Cons Of Buying A Foreclosed Property

Why Are Properties Foreclosed?

Properties are foreclosed when the lender, usually a bank, regains possession of a property after the borrower fails to keep up their mortgage payments. The bank – or lender – then auctions the property to recoup their original investment.

According to official figures, in the first half of 2023, a total of 130,000 properties initiated foreclosure procedures. That’s a 15% and a 30% increase compared to 2022 and 2020, respectively. Experts agree that this is to be expected and that these numbers will likely increase soon as the Homeowner Assistance Fund (HAF) runs out.

As foreclosures increase, millions of savvy Americans look at these properties as the best chance to become homeowners – for cheap.

Here are some benefits of buying foreclosed properties and critical things you should consider.

Pros Of Buying A Foreclosed Property

Lower Prices

One of the main factors that make buying foreclosed properties so appealing is the low prices. Banks that just regained property ownership through foreclosure often sell at a discount, so they can quickly move those funds into other investments.

Properties are often sold at a 20%-30% discount compared to the median house price in the area. However, remember that foreclosures are sold at public auctions, so you may have to bid against other potential buyers.

High Renovation Potential

Foreclosed properties are often subject to damage and disrepair – intentional or not – as owners don’t have the funds for regular house maintenance. Foundational cracks, leaks, and exterior damage are some of the most common issues of foreclosed properties – and the price reflects that.

For that reason, real estate investors and professional contractors are often looking for foreclosed homes, so they can purchase, renovate, and sell off for a quick profit. This strategy is known as flipping and is one of the most successful short-term real estate investing strategies.

Figures show that in 2022 the average return on house flipping was over 25% of the initial investment on every property.

Keep in mind that this strategy is not for beginners; you will need a deep knowledge of the market and professional counseling from contractors, lawyers, and real estate agents.

Bargaining Power

Foreclosed properties are usually sold in public auctions, where potential buyers can bid. However, if there isn’t demand for the property, or if, after conducting a home inspection, you find that the property has significant damage or requires a large investment, you have some bargaining power. Banks may reconsider their asking price and settle for much less.

Remember that banks are not obligated to consent, but completing the sale is in their best interest. That’s why a home inspection early on is so important.

Financing Flexibility

If you’re looking to finance the purchase of a foreclosed home, there are several government-backed options you can check out:

• 203(k) Rehab Mortgage Insurance (Federal Housing Administration & HUD)
• HomePath ReadyBuyer program (Fannie Mae)
• The HomeSteps program (Freddie Mac Homes)

Only buyers who intend to occupy these homes as their primary residence qualify – real estate inventors and house flippers don’t qualify for these financing options.

• The 203(k) Rehab Mortgage Insurance can be used to purchase or rehabilitate a home. You can apply through an FHA-approved lender. 
• The HomePath ReadyBuyer program offers 3% of the purchase price in cost assistance for first-time homebuyers. This applies to the purchase of a HomePath property.
• The HomeSteps program offers housebuyers – not necessarily first-time homebuyers – the option to purchase HomeSteps homes without competition from real estate investors.

Cons Of Buying A Foreclosed Property

Highly Competitive Market

Buying a foreclosure can be an excellent opportunity to flip a property or secure your dream home for cheap.

However, demand for foreclosed properties has increased since 2021, when the Homeowner Assistance Fund (HAF) approved the American Rescue Plan (ARP) Act, supporting homeowners during the pandemic.

The ARP Act supported many homeowners facing foreclosure and thus reduced the number of foreclosed properties that hit the market. There will be a lot of competition, and more foreclosed properties will likely hit the market after 2025 as the HAF finishes allocating the funds.

You Might Not Have Time To Inspect The Property

As demand for foreclosed properties and the need for liquidity rises, banks and other lenders may try to accelerate the property sale. They may offer a hefty discount for buyers willing to purchase the property immediately – ‘as is.’

The main downside is that you won’t get to inspect the property – even a day of delay could mean someone else purchases it.

We don’t recommend purchasing a property without having it professionally inspected. Still, the more daring inventors may find a good deal.

Not Move-In Ready

Foreclosed properties are often neglected and require urgent maintenance and repairs. If you want to move in immediately, there may be better options than foreclosed properties. Here are some of the most common issues arising from foreclosed properties:

• Intentional neglect by previous owners
• Damage and disrepair
• Foundational cracks, exterior damage, and leaks
• Problems with the water heating, electricity, or mechanical systems

Whether you purchase a property ‘as is’ or have the time to inspect it, you’ll need to invest in making it habitable. Make sure you have some money left over after you make a purchase.

Lengthy Timeframes

Depending on your state, even after you purchase a foreclosed property, you may not have immediate access to it. In some cases, foreclosed properties are sold occupied by previous owners or tenants, and the eviction process can take 2 to 12 weeks.

The process is slightly different depending on who is occupying the property. Suppose the occupant is a former tenant renting from the previous owner. In that case, the process is more complicated, as there are laws in place protecting tenants. In this case, expecting the tenants to remain for at least 60 days is more realistic.

If the occupant is the previous owner that defaulted on their mortgage loan, you’ll need to go through the ‘formal’ eviction process.

As always, we recommend getting qualified legal advice from a local real estate attorney.

You May Need A Large Amount Of Cash To Secure A Property

Many government agencies will finance a foreclosure if you use it as your primary residence. However, it’s rare for private lenders to do the same with foreclosures – even for a primary residence.

Real estate investors and contractors looking to flip foreclosed properties without cash on hand might find it hard to locate a private lender and close a deal – especially considering how fast some foreclosed properties are sold.

That’s why when it comes to buying a foreclosure, cash is king.

Bidders that offer an all-cash bid – cash, checks, or money orders – are more likely to secure the property. Plus, banks are more likely to accept a lower bid for the foreclosure if it’s an all-cash offer.

Purchasing a foreclosure can be very difficult if you don’t have that kind of liquidity.

FAQs

What Is A Disadvantage Of A Deed Acquired In Foreclosure?

A Deed in Lieu of Foreclosure may sound like a good idea; you don’t have to go through a lengthy foreclosure, and you become the property owner immediately.

However, you shouldn’t always accept it. You shouldn’t accept a Deed in Lieu of Foreclosure if:

• The entire mortgage debt is not released (you may face title problems)
• There are outstanding subordinate liens (you may have to foreclose that mortgage)
• The homeowner offers a partial conveyance of the property (you may face title problems)

Does A Foreclosure Hurt Your Credit?

Yes – a foreclosure can have a long-lasting effect on your credit history. Foreclosures can drop your credit score by 100-160 points, depending on your current score. Additionally, you will lose points for missing payments before getting foreclosed.

Foreclosures remain on your credit report for seven years.

How To Buy A Foreclosure In My State?

• One of the requirements to start a foreclosure process is to file a document at the county courthouse or county public records. Foreclosure auctions are public sales accessible to any buyers. 

What Makes Buying A Foreclosed Property Risky?

The four main risks of buying a foreclosed property are:

• Neglect from previous owners
• Unpaid liens
• Lengthy foreclosure process
• Damage and disrepair

When you purchase a property, sellers must disclose information about the property’s condition. Sometimes, sellers may be legally liable if they conceal or fail to disclose information – even after completing the sale.

This is not the case for foreclosures. A foreclosed property is always sold ‘as is,’ so it’s up to the buyer to conduct a home inspection and ensure there are no underlying issues.

What Is The Number One Reason For Foreclosure

The number one reason for foreclosure in the US is unexpected medical expenses, accounting for more than 65% of all foreclosures. Some of the other most common reasons are:

• Job loss or unemployment
• Natural disasters or major house damage
• Increased home expenses
• Divorce

How Many Months Can You Fall Behind On Mortgage?

You can fall behind on your mortgage 120 days before the lender can begin foreclosure. After foreclosure starts, it can take months or years before eviction, depending on your state’s and local laws.