An increasingly popular way to find an affordable home is buy one whose owners are being foreclosed upon. This means that a lender or lien holder is in the process of taking possession of the property, most likely because its owner has failed to make regular, timely mortgage payments. Foreclosure can also occur if a homeowner fails to pay property taxes, homeowners' association assessments, or contractors' bills.
Foreclosure doesn't happen overnight, but takes place in various stages. Each of these stages creates an opportunity for would-be buyers to step in and purchase the property.
Buying From a Homeowner Prior to Foreclosure
If you can communicate with a homeowner whose property is facing foreclosure, it may be possible to buy the house without any third parties getting involved. The idea would be that you give the homeowner some amount of cash (likely far less than the home is worth) in exchange for any equity built up in the house. You'd then be responsible for paying any outstanding debts or liens on the property.
If you have an opportunity to go this route, it's important to thoroughly check out any existing liens or other debts on the property, so that you know what you're getting into. If the owner was in financial trouble, the mortgage may not be the only bill left unpaid. Contractors, for example, who never received payment for their work on the house may have filed mechanics' liens, which will need to be paid off when the home is sold. You may be able to negotiate a discounted settlement with any lien holders.
You'll also want to inspect the property and estimate the costs of necessary repairs. Homes headed for foreclosure are often in poor shape, with deferred maintenance or major repair needs.
If the costs of paying off the lender, cashing out the homeowner, and making repairs are more than the fair-market value of the home, it's a bad deal.
If you decide to purchase the property directly from the homeowner, it's important to have a local real estate lawyer draft the purchase agreement.
Buying at a Foreclosure Auction
Buying at a foreclosure auction is the riskiest way to purchase foreclosed property, and shouldn't be attempted by a first-time buyer. It means that the lender has decided to foreclose, and put the home up for sale at a public auction, to go to the highest bidder for cash.
The main disadvantage to buying at auction is that you will probably not be able to inspect the property beforehand, and will likely have to come up with the entire purchase price within a short period of time (sometimes measured in hours rather than days).
If the house has been sitting empty, it may have already fallen prey to thieves or vandals. And, some unhappy homeowners facing foreclosure have been known to damage a home before moving out.
Plus, you'll still end up owing any unpaid property taxes and junior liens (debts put on the property after the debt that caused the property to kick into foreclosure).
Buying at auction also comes with the possibility that the former owner will exercise a right of redemption by coming up with the cash to buy the house back within a certain period of time. This is governed by state law and isn't an option in all states, but redemption is a possibility in, for example, New Jersey, Minnesota, and Delaware. The time periods for redemption vary—sometimes it's a mere matter of weeks, up until the date the court confirms the sale to the new owner; other times it's several months.
The IRS also has 120 days in which to redeem the property if back taxes are owed upon it.
A local real estate lawyer can fill you in on the redemption laws in your state.
If you're tempted to buy at a foreclosure auction:
- Research the condition of the property to the extent possible, by viewing the outside and searching for its address online.
- Research any existing debts such as liens, unpaid taxes, and previous construction debts, by ordering a full title search on the property.
- Scope out land use problems such as zoning or toxic waste issues.
- Find out how the auction process and rules work.
- Sit in on some other foreclosure auctions ahead of time.
- Decide what your maximum offer will be and don't go above it.
Buying From a Bank or Lender After Foreclosure
Mortgage lenders often end up owning the house themselves after a foreclosure auction. The bank will then typically pay off any other outstanding debts, such as property taxes or amounts owed to the IRS, in order to sell the house with a clear title.
The bank will also evict the tenants or former homeowners, and have the house appraised before attempting to resell it.
A bank has the flexibility to negotiate on the selling price, down payment, interest rate, and closing costs. And it usually wants to sell the property fast, rather than bearing the expense of maintenance, security, and upkeep. Added together, these factors can make a big difference in whether you can afford the home.
You can find information about homes in foreclosure from:
- local newspapers
- subscription newsletters
- county deed recorder's office, and
- lenders' websites.
Buying a HUD Home
The U.S. Department of Housing and Urban Development (HUD) often offers houses for sale to the public after HUD or FHA mortgage foreclosures.
HUD properties are sold "as is" on a cash-only basis through a conventional lender other than HUD. You can purchase HUD property only through an approved HUD broker or agent, who will submit an offer for you. Buyers can also request that HUD pay some or all of the financing and closing costs.
HUD maintains an online list of homes for sale.
Questions for Your Attorney
- Can you help me create a purchase contract for a pre-foreclosure home?
- Would you do a title search on this home that I'm considering buying at auction?
- Does our state's law create a risk that the foreclosure home I'm buying will be redeemed and reclaimed by its former owner?