Most people love a bargain — and in the real estate world, great deals can sometimes be found in the form of a foreclosed home. Proponents of buying foreclosed homes love the reduced prices, but inexperienced buyers may find the risks outweigh the rewards.
What is a foreclosed home?
A foreclosed home is a property that has undergone the foreclosure process, which was initiated because the borrower defaulted, or failed to make payments, on the mortgage, and did not take alternative steps such as a deed in lieu of foreclosure or loan modification.
It’s “a home that has been taken from an owner by a financial institution typically due to nonpayment on a mortgage,” explains agent and broker Cristyle Egitto of A Perfect Location LLC Real Estate, based in Palm Beach, Florida.
Once the bank or lender takes possession of the property, it typically wants to unload it as quickly as possible, and often that can mean a significant discount for the next buyer. To recoup its investment, the lender will send the foreclosed home to auction, where it may be purchased by a buyer or investor.
However, “if the bank does not hit their reserve or target auction price, they will keep the property,” Egitto says. At that point, the home is “considered an REO or real estate owned.” REO properties are also sometimes referred to as “bank owned.”
“REO properties are then sold through a real estate agent, online auction platforms and other routes,” Egitto says.
— Competition less stiff
— Discounted prices
— Flipping opportunities
— Cash required
— Hidden issues, such as liens
— Sold as-is, often sight unseen
Advantages of buying a foreclosed home
If you’re looking to save money when purchasing or investing in a property, a foreclosed home can be one way to score a deal — but only if you’re prepared to make an all-cash offer. If you have enough to pay for the home outright (rather than financing through a mortgage), you could purchase a property in an online or in-person auction for a steal.
“Foreclosed properties often go for below market value as the bank is usually just trying to cover the outstanding mortgage and fees due,” Egitto says. “Foreclosures are great for investors, especially with cash on hand. Often they need work, which is perfect for flippers, and there can be a major upside on the resale.”
“There is less competition because all purchases require cash, which limits the potential buyer pool,” adds Cody Sperber, co-founder of 100 Million Academy, where he teaches real estate investment strategies.
“The biggest advantage is the potential of getting a discounted property (that you maybe couldn’t have afforded if it was all fixed up and sold retail) for a ridiculously good price,” says Sperber.
Disadvantages of buying a foreclosed home
If you’re set on buying or investing in a foreclosed home, there are some drawbacks to keep in mind.
For one, foreclosures are generally sold as-is, with little to no inspection time, and many have been neglected. This can come into play if you’re planning to flip the home.
“If the property is in disrepair, no conventional lenders would be willing to lend on the property until repairs are made,” says Sperber.
Competition at a foreclosure auction can also be high, which can be risky if you “get competitive and overpay for a property just to win the deal,” notes Sperber.
According to Egitto, “foreclosures can also have unknown fees associated with them, like back HOA dues and other liens, that stay with the property and aren’t forgiven through the foreclosure process.”
In addition, “these are cash-only purchases with very limited information,” says Sperber. “In some cases, it’s difficult or even impossible to see the inside of a property before the auction takes place.”
Overall, “if you are new to investing or real estate, then it’s probably not the best way to break into the business, unless you love to learn through failure,” says Sperber.
If you’ve weighed the pros and cons and are ready to buy a foreclosed home, it’s important to first assess your level of risk.
“The main factor I look at is the risk (buyers) are willing and able to take,” Egitto says. “I would not recommend foreclosures for novice buyers.”
Remember that to bid in a foreclosure auction, you need to have enough cash lined up ahead of time. It’s also smart to partner with an attorney or other experienced adviser to help you evaluate the property.
“I would recommend working with a real estate attorney who can assist with title searches to identify potential risks, expenses, etc.,” Egitto says.
Even though it isn’t required, Sperber recommends finding a good real estate agent, as well. An agent who knows how investors think will “understand the numbers and can quickly tell you whether it’s a deal or a dud,” he says, adding that it’s also important to work with an agent who has good connections with local vendors and contractors, and who is an expert negotiator.
Regardless of how you approach the foreclosure marketplace, it’s wise to have a game plan and work with an expert so that your “great deal” doesn’t ultimately turn sour.