Buying a Foreclosed Home: Good Deal or Risky Business?

After the real estate bubble burst in 2008, it seemed like foreclosed houses could be found in almost every neighborhood across the country. The number of foreclosed homes reached an all-time high in 2010 but has steadily decreased each year since. Nevertheless, as long as there have been mortgages, there have been people unable to pay them. Buyers can get a bargain buying a foreclosed home. But if they’re not cautious, they can get more than they bargained for.

Although we use the term “owning a home” all the time, if you have a mortgage, the bank holds the title. Until you pay off the mortgage in full, the bank has a claim to the property.

When someone fails to pay their mortgage payments, the lender has the right to start foreclosure proceedings. Foreclosure is a legal process where the property is claimed by the lender. They resell it to someone else to recoup the losses they suffered when the mortgage payments stopped.

Banks are in the business of lending—not homeownership. It is in their best interest to sell foreclosed properties quickly. When houses stay in their inventory, they are responsible for property taxes and insurance. The longer they are on the bank’s books, the more these vacant homes cost them money. This scenario leads to advantages for many investors and homebuyers.

Banks typically ask a lower price for a foreclosure than for a comparable property in the area. At the height of the real estate crisis, banks had so many homes that asking prices were often 15% to 20% below the market. In more recent years, that percentage has stabilized, but finding something 5% below the market price is still common. 

This is obviously attractive to investors, as well as home buyers looking for a good deal. Buyers looking to buy their first home may be tempted by the price of a foreclosure. They may be able to purchase in a neighborhood that they thought was out of their reach. Certain upgrades like high-end finishes or additional space might be affordable. They may get “more house for the money.”

A bank selling foreclosed homes is the epitome of a motivated seller. In addition to a low asking price, they may offer incentives to finance the purchase with them. Better financing deals could further lower the price and closing costs. FHA or VA loans can also be used to finance a foreclosure, although they may impose certain restrictions. FHA stands for Federal Housing Administration and is part of the U.S. Department of Housing and Urban Development (HUD). The HUD website provides details about who is eligible for an FHA loan. The U.S. Department of Veterans Affairs offers VA loans to current and past military service members and their spouses.

In most cases, mortgage payments aren’t the only bills that get neglected when a homeowner is struggling financially. Property tax liens or other debts might be attached to the title of the property. The foreclosure process removes these obligations, meaning the buyer is purchasing a clear title to the home. This is not always the case when buying directly from a home seller.

Buyers of foreclosed homes need to proceed with caution. Just as there are two sides to a coin, the home that seems like a great deal can have its drawbacks. As with any financial transaction, it’s wise to know exactly what you’re getting into.

Failure to make mortgage payments can happen for a number of reasons including losing a job, medical issues, conflict due to a divorce, and mounting debt. When owners are unable or unwilling to pay the mortgage, upkeep usually suffers too. Routine maintenance and repairs might be skipped.

This neglect can leave a house in bad shape. It can range from stained carpet and an overgrown yard to severe roof leaks and broken windows. And once foreclosure proceedings start, the owner may abandon the home completely, or even intentionally cause damage.

All of these things can be fixed—at a cost. And that falls to the buyer. Homes in foreclosure are typically sold as-is. The price of repairing or replacing the things can add up quickly, making the low asking price less enticing. 

For the right buyer, the house may still be worth it. If the repairs needed are within the buyer's budget, or if the home has other desirable features, such as a sought-after neighborhood, the pros may outweigh the cons.

Another thing to consider is that where they once stood firm about selling homes as-is, banks may be changing their stance on repairs. As the market has improved, most banks do not have as many foreclosed properties in their inventory as they did a decade ago. They may be less desperate to recoup their losses and more willing to negotiate on making improvements if it can get them a better price. 

The location of a foreclosed home may make it a bad investment at any price. In fact, the location could have a direct correlation to the owner's financial hardships.

In parts of the country that have fallen on hard times, foreclosures will follow. If a failed factory has been the primary employer in a small town, laid-off workers will need to relocate, possibly walking away from their mortgages. Banks will have a difficult time selling foreclosed properties in such an economically depressed community.

A buyer of a foreclosed home in one of these places could find themselves living in a virtual ghost town. If they have a reliable source of income and are willing to wait for what could be a slow rejuvenation of the area, it could be a good move. If they are looking for a quick resale as an investment opportunity, they’re probably better off continuing their search elsewhere.

Depending on the market, there can be a lot of competition from real estate investors for foreclosed properties. And unlike dealing with a typical home seller, a financial institution will be making the decision of which offer to accept. Homebuyers sometimes make personal appeals to a homeowner. A well-timed letter professing their love for the home can sway someone who wants their house to go to a nice family with whom they connect emotionally.

Not so with a bank. They are interested in their financial statements. A foreclosed home will go to the highest bidder. Potential buyers hoping to come out on top must be ready to strike early with the best possible offer. 

For those interested in the possibilities that foreclosed homes offer, it is best to find a reputable real estate agent with knowledge of the foreclosure process. He or she can help potential buyers navigate the market and avoid the pitfalls. (And if you’re looking to buy in the St. Louis area, we hope that you’ll try us out here at BHHS Select Properties!)

Buying a foreclosed home can offer investors and first-time buyers great opportunities, provided they’re cautious. Finding a trustworthy agent and knowing what you’re getting into is the key to finding a hidden gem.