At first thought, buying a foreclosed home can seem like a cost-effective way to buy a house.
Becoming a homeowner with less money invested is ideal and certainly possible under the best circumstances. But there are huge trade-offs in securing a foreclosed home. The first and biggest trade-off is that, your bargain might not be a bargain at all!
From appraisal and inspector fees to home improvement costs, there is no guarantee your foreclosed property will be a good buy. These monetary estimates don’t consider the weeks, months, and possibly years it could take for the entire buying and closing process to cycle through—not to mention the elevated stress levels from the uncertainty of working with multiple red tape-laden institutions.
But... there are valuable real estate opportunities out there if you have the patience.
Preparing to Buy a Foreclosed Home
If there ever was a time to work with an experienced and specialized real estate broker and lender, it's during the process of buying a foreclosed home. This is especially true if you plan to use your VA loan benefit. It's also a good idea to seek recommendations for a real estate attorney who knows foreclosure laws backward and forward.
If you’ve just begun researching how to buy a foreclosed home, look at these stats from ATTOM for 2023.
- 357,062 reported home foreclosures in the U.S.
- States with the largest number of foreclosure starts: California (29,180), Texas (28,533), Florida (27,427), New York (17,330), Illinois (13,764)
It's interesting to note that the top four states have heavy military populations. Although it's disheartening to consider that military families are struggling to pay their mortgages, these statistics show that an inventory of foreclosed homes exists where other military buyers live and work and could potentially purchase a home at an attractive price.
But first, find out if you're financially prepared to buy a home. What to Know About Your Finances Before Buying a Home answers many popular questions buyers have.
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Home Foreclosure Terms to Know
A foreclosed home wasn’t always a foreclosed home. Getting to that designation includes three possibilities: a short sale, pre-foreclosure, and finally, foreclosure. Each has a difference that is important for buyers to be aware of because they can affect the final sale.
Short Sale
There are two conditions under which a homeowner can request a "short sale." If the owner owes more on their mortgage than their local market values, is delinquent, and likely cannot fulfill their loan agreement, they may ask the bank to accept a payment that is less than the mortgage's owed amount.
Why would the bank agree to a short sale? Because the bank loses even more money if the home moves into the foreclosing process. A short sale is also better for the seller’s credit report. A short sale may or may not be in pre-foreclosure; it depends on when the buyer reaches out to the lender.
Buyers beware; it's not uncommon for the closing on short sale properties to take six to twelve months, with the bank attempting to get back every dime. The bank may even derail the sale further by rejecting the offer the seller initially approved.
Pre-Foreclosure
If the property owner is 90 or more days late in payment and has not amended the situation with the lender, the foreclosure process begins by serving the owner legal notice. The owner still owns the property, and it may or may not be a short sale. The pre-foreclosure process doesn't guarantee the property will ultimately foreclose. Most banks prefer to work with homeowners rather than become the owner of another foreclosed property.
Buyers have an opportunity to purchase during the pre-foreclosure process, but at this point, it is widely regarded as the most difficult time to buy. Typical circumstances for attempting to purchase during pre-foreclosure include buying before the house is listed and writing an offer that states you’ll buy the home outright.
Types of Home Foreclosure Sales
Buying at Auction
After the pre-foreclosure process, the mortgage lender has seized the property. Buyers should note that purchasing a foreclosure differs from a traditional sale. Most houses are bought sight unseen, “as is,” during an auction where investors are prepared to buy the property in cash.
Also, consider that after the transaction, buyers purchase not only the structure but any liens and mortgages tied to the property. Plus, if people are still living at the address, the eviction process becomes the buyer’s problem.
Bank Owned or REO Properties
Bank-owned or real estate-owned (REO) properties are those that were not sold at a foreclosure auction and given back to the mortgage lender. Because the lender now owns the property, it deals with evictions, liens, and possibly some repairs.
These issues, coupled with multiple state foreclosure regulations, require a mountain of patience that few buyers have. The only hurry in this process is the one military members are familiar with: hurry up and wait.
Photo from Canva
An REO purchase is similar to a traditional home sale in that you’ll benefit from a professional appraisal and detailed home inspection. After the evaluations, many REO properties turn out to be poor purchases.
If purchasing an REO, buyers might run into the possibility that the bank insists that they work with the bank’s broker. They are attempting to save money and time by avoiding paying a buyer’s agent and the bank’s broker commission.
Related: Comparing Conventional and VA Home Loans for Military Homebuyers.
Sometimes, first-time buyers assume the bank that owns the property will also lend money to buy the property as part of one big deal. This is not the case. REO brokers don’t approve home loans. Their concentration is ridding the bank of bad assets.
A benefit of buying an REO instead of through an auction is the ability to spend time researching a property. Carefully investigating the property's details requires a lot of time. If the home is too far gone into disrepair, getting any type of mortgage approval will be difficult.
It's possible to write inspection contingencies within the offer in order to retrieve any deposit money if a home inspection goes badly, but it's not common for banks to consider these types of clauses during a foreclosure purchase.
Photo from iStock.com/Simplyphotos
Uncovering how long the property was unoccupied and uncared for helps establish how much money is needed for repairs. An experienced home inspector who works with foreclosed homes is a strong ally. They’ll point out indicators ranging from major cash investments to normal wear and tear issues.
A title search is another must-do for considering buying a foreclosed home. These searches dig up all kinds of stressful problems. When the bank owns the property, they don’t necessarily have to clean up any issues with liens and back property taxes. The IRS considers the owner, potentially you, to be on the hook to pay up.
If you’re a buyer with the time and patience for REOs, you can search for homes online through several options:
- Lenders list their REOs on the Multiple Listing Service (MLS). Any real estate agent has access to this inventory.
- Many bank websites have dedicated REO listings, which are available for public viewing.
- There are other online foreclosure listing services available, but they charge users a fee.
Can Military Members Use a VA Loan to Purchase a Foreclosed Home?
Yes. VA loans can be used to buy a short sale or foreclosed home, but there are many factors to seriously consider before hunting for your property diamond in the rough. The VA allows the purchase, but the required features of the property remain the same as any house purchased with a VA loan, including an appraisal that will detail the home's condition and determine the value.
Your chosen property must undergo an appraisal to ensure the Minimum Property Requirements (MPRs) are in good standing. If the property fails the appraisal, the financing will not be approved. The appraiser will examine the MRPs in several areas: the roof's condition (it must not have significant defects), mechanical systems (heating, electrical, plumbing), windows, and the removal of all lead paint.
Remember, foreclosed properties likely have damage and disrepair from lack of upkeep. If you want to meet the MRPs and have the appraisal go through, you must pay for the fixes.
Talk with your real estate agent about the option of the seller/bank paying for the updates needed to make the MPRs. Although uncommon, these seller fixes could simplify the process and move the VA loan approval along faster.
Photo from Canva
A VA guaranteed loan will not be issued for a property not appraised for its sale price. Expect value issues if the property is located in an area with very few bank-owned properties because the comparable properties drive up the foreclosed home’s price, but not the value—according to the VA appraiser. Your real estate agent might advise you to request a Reconsideration of Value if the gap between value and sale price is out of sync with your market.
Auctions are typically the first stop for a foreclosure sale, which makes VA financing difficult because auctions require a large cash payment, are sold “as is,” and sold to the highest bidder. Most service members utilize a VA loan because a down payment is not required.
If the home doesn’t sell at auction and changes to an REO, you’ll have a better opportunity to become a homeowner because when the VA is ready to sell foreclosed homes, they list them through a property management service called Vendor Resource Management (VRM). The home will also be listed on the MLS, and your real estate agent can help navigate a process that is more similar to a traditional sale.
A foreclosed home purchase is not for everyone. In fact, most military members don’t have the time or cash on hand to make the process worthwhile. Deployments, TDYs, and family obligations strain the free time to babysit the foreclosure process.
Keep in mind purchasing the first foreclosed home that captures your interest doesn’t often happen. Part of this process is choosing home after home because your offers have been refused for a multitude of reasons. It's not uncommon to write several offers before one sticks.
Need more information on buying a home? See our free guide below.
