A recent increase in the number of homeowners defaulting on their mortgage payments has caused a corresponding spike in foreclosure rates. On the one hand, this may provide home buyers with the opportunity to purchase a good home at a low price. But on the other, that good deal comes from the misfortune of others. Purchasing a foreclosed home can also be quite risky and complicated, with possible hidden expenses that can potentially wipe out some or all of the savings.
If you are considering purchasing a home in foreclosure, there is much you need to consider. Before you jump into any “deal,” make sure you understand how the process works.
What is foreclosure?
Foreclosure is a procedure by which a lender can recover the amount owing on a defaulted loan by taking ownership of (or “repossessing’’) a home. The process begins when a mortgage holder defaults on two or three mortgage payments and the lender files a warning (a “notice of default”) that the payments must be brought up to date. The borrower typically has a 15-day grace period within which to make up the missed payments without a penalty. Some lenders will offer a “forbearance,” which means they will accept non-payment on the loan for a short period with the understanding that the account will be brought current at a later date.
From this point, a foreclosure can be settled in one of four ways:
1. Pre-foreclosure sale
If the lender permits it, sometimes the home can be sold in a pre-foreclosure sale to a third party before it goes to auction.
This is often the best time for a potential buyer to make an offer. It also enables the seller to pay off what they owe and get out from under their mortgage without further damaging their credit rating and the lender to avoid spending time and money foreclosing the property.
It’s wise to get pre-approved for a mortgage before you begin negotiating with the seller. Pre-approval assures the foreclosing lender that you are in a stable enough position to buy the property. But be careful; some lenders may be reluctant to finance foreclosure properties.
Before you buy, check with the public records office to see if there are any unpaid liens (back taxes, overdue utility bills, etc.) against the property. These sometimes run into the thousands of dollars and may cut into any savings on the purchase price. Getting a $250,000 home for just $200,000 is a bargain, but if you have to pay off $40,000 in liens, it’s significantly less of a deal. Make sure responsibility for outstanding liens is covered in your purchase agreement.
2. Short sale
You may also be able to purchase a home through a “short sale,” in which the lender agrees to let the seller sell the house (usually for less than the amount owing) in exchange for being released from the loan. Why would a lender do this? To save money: The foreclosure process can take months and cost thousands of dollars, and unloading the home quickly may be better than letting it sit, gathering neither mortgage payments nor interest.
3. Public auction
At the end of the pre-foreclosure period, the property in question may be put up for public auction.
Bidding procedures vary from state to state, so it’s wise to attend a few auctions before you intend to buy in order to familiarize yourself with them. Some states require bidders to bring cash (or a cashier’s check) in the amount they wish to bid, while others only require a percentage (usually about 10 percent) in cash with an agreement to pay the remainder at a later date.
Some states offer a “redemption period” -- typically 30 days -- within which the original owners are allowed to purchase the property back if they pay the price paid at auction, plus the necessary foreclosure fees. Do not perform any improvements or repairs during this period -- you may not be reimbursed for them if the seller comes through with the money.
4. Real Estate Owned (REO) sale
If the home is not purchased either at auction or through a pre-foreclosure sale, ownership of the home reverts to the lender and becomes a Real Estate Owned property (REO). Potential REO buyers deal directly with the lender or the lender’s agent -- the defaulting homeowner is no longer a part of the equation. These are considered good buys in that lenders will typically sell REOs for less than the amount they are owed. Homes with FHA-insured mortgages that go into default become the property of the Department of Housing and Urban Development.
Other things you should know
In many foreclosures, the buyer will be expected to purchase the property “as-is,” without a proper home inspection. Without an inspection, it will be significantly more difficult to assess the home’s true value. This can be a problem since a homeowner going through a foreclosure is less likely to have invested extra money back into the property for maintenance and improvements. If possible, make your offer contingent on the property passing a thorough inspection.
If you are unable to secure an inspection of the property, there are still some things you can do to get an understanding of its value through a search of the public record. For example, environmental hazards like radon, lead-based paint and buried storage tanks on the property can be gleaned from the local health department.
If you can’t actually enter the property yourself, consider polling neighbors for information. They may be able to provide you with data to help influence your decision on whether to purchase the home.
Some foreclosures will require you to evict the current occupants once you take ownership of the home. This can be a costly, time-consuming and unpleasant experience. In extreme cases, some former owners may intentionally damage the property in response to losing their homes.
Navigating the foreclosure process can be tricky. To protect yourself, it’s wise to retain the services of a real estate lawyer with experience in foreclosures.
Published on July 20, 2007