In a hot housing market with sky-high prices, foreclosed homes offer an opportunity to get a deal if you’re willing to take on the risk of repairs they may need.
Lenders offering foreclosed homes often want to sell them quickly, but can you finance a foreclosure to take such a home off their hands? Financing a foreclosure might actually be easier than you think because you have several loan options available.
Let’s explore the steps you may need to take to buy a foreclosed home and what you should keep in mind to have a chance at buying your next home for less than you might expect.
What is a foreclosure?
Most people take out a mortgage loan to purchase a home. A part of the loan agreement usually states that if you default on the mortgage — typically by missing payments — the lender could take ownership of the home through foreclosure.
The foreclosure’s goal is to allow the lender to make up some or all of its losses on the defaulted mortgage loan. Each state has different rules governing the foreclosure process. However, the process often requires the bank to get court approval to take ownership of a home.
Once the foreclosure is approved, banks often get foreclosed homes ready to go on the market to sell them and recoverthe money lost when the previous owner defaulted on their loan. This is when you could enter the picture to potentially buy a foreclosed home.
Financing a foreclosure purchase follows steps similar to financing a regular home purchase with the added layer of potentially dealing directly with a bank or a lender.
Know who is selling the foreclosed home
The first thing to do when you’re financing a foreclosure is to understand who is selling the foreclosure property.
In most cases, you might buy the property from a bank. However, in some cases, a previous owner might act as the lender, to which the new owner makes payments. This is known as owner financing. If the new owner defaults and the home forecloses, the old owner might put it up as a foreclosure sale.
Knowing what process you go through when buying a foreclosed home is also essential. In some cases, the home might be sold to the highest bidder through a foreclosure auction.
In other cases, the foreclosed home might be listed on the market like a regular home. The home's current owner — often a bank — may accept offers rather than go through a public auction.
Find out the mortgage you can afford
It’s wise to figure out how much mortgage you can afford before you decide to finance a foreclosure.
Consider using a mortgage calculator to determine the size of the mortgage you might afford based on your financial situation. These calculators may allow you to enter the monthly mortgage payment you’re comfortable with to get the total mortgage value.
Alternatively, you could enter different mortgage loan amounts until you get a monthly payment that feels affordable.
Hire a real estate agent
Once you understand your budget, you may decide to work with a real estate agent. A real estate agent would help you with many factors, such as loan eligibility, purchase price, closing costs, and property tax.
Your real estate agent can guide you through the home buying process and ensure all deadlines are met so the purchase process goes smoothly.
Working with a real estate agent typically wouldn’t add extra cost to your home purchase transaction because the seller usually pays the agent’s fee.
Before you make an offer on any home, including a foreclosure, it makes sense to get pre-approved for a mortgage. Some platforms, such as Zillow Home Loans, could help you search for a home and pre-qualify for financing in one place.
Having a pre-approval in hand lets the buyer know that a lender has taken a preliminary look at your finances and credit history and found that you appear to be a qualified borrower. It also means the lender is more likely to approve you and back up the sale once you complete the official purchase process.
You could finance a foreclosure using several types of loans. You could, for example, get your mortgage through a:
- Conventional loan: You could go the conventional route if you want a straightforward process when figuring out how to get a loan. Keep in mind that this loan may require a significant down payment.
- Federal Housing Administration (FHA) loan: Individuals who have debt or a low credit score might qualify for FHA loans. It allows you to put a down payment as small as 3.5% of your loan value. However, it requires you to pay for private mortgage insurance to protect the loan.
- FHA 203(k) loan: This renovation loan allows you to purchase and rehabilitate a home with a single loan, which may be helpful if the foreclosed home needs serious repairs.
- USDA loan: This loan might be an option if you’re purchasing a home in an area marked by the U.S. Department of Agriculture (USDA) as a rural area. These loans are designed for low-income residents and might offer a 0% down payment.
- Veterans Affairs (VA) loan: Qualified veterans might be able to get VA loans with a 0% down payment. If you qualify, you wouldn’t need private mortgage insurance either.
Get the home inspected
In a heated housing market, many buyers waive inspection clauses to have a better chance of getting their contract accepted. However, performing an inspection might be essential for foreclosed homes.
After a foreclosure, the home is often left vacant until sold, and it might not be looked after during this period. That’s why you’re better off getting a professional home inspection to learn about any issues with the home, even if the lender is selling the home as-is.
The inspection would help you understand what needs to be fixed and how much money you might need to spend to make it liveable. If repairs cost too much or the house is in a dangerous condition, you might be better off finding a different home to buy.
Avoid offering too little
It might be tempting to make a low offer when buying a foreclosure home. However, keep in mind that lenders know the home's value they’re trying to sell, and in a hot housing market, other buyers do, too.
If you make an offer far below market value, it might have a low chance of getting accepted. You could lose your opportunity to someone making an offer closer to the market price. Check whether your real estate agent has previously worked with foreclosures and ask them for guidance on what offer to make.
Advantages of buying foreclosed homes
There may be several advantages you could benefit from when buying a foreclosed home:
- Get a deal on the home: Foreclosed homes might present a chance to get a great deal. Banks don’t want to hold on to and pay maintenance for homes longer than they have to, so they may offer you a deal to have a short sale period
- Get a vacant home: Foreclosed homes are likely already vacant. This means you don’t have to negotiate a closing date that depends on the moving-out date of the old owners.
- Potential loan consolidation: If the home needs repairs, a 203(k) foreclosure purchase and rehab loan could allow you to turn a foreclosure into the home of your dreams using the same loan.
Things to watch for before financing a foreclosure
Before you decide to buy and finance a foreclosed property, you should be aware of some risks:
- Deteriorating or distressed properties: The home may have been sitting vacant, potentially for a long period, causing issues to appear. For example, if the home is in a cold climate and it wasn’t properly winterized, its pipes may have frozen or been damaged. Such issues could be expensive to fix.
- 203(k) loans add complexity: 203(k) loans are often considered one of the best home improvement loans. However, 203(k) loans prevent you from doing the work yourself and require you to hire a professional contractor. These loans also require additional paperwork to properly document everything, which might delay the closing process and the renovations.
- Foreclosures often sell as-is: The current owner, likely the lender, might not be willing to make any repairs. This can cause issues if you’re using a loan type that requires certain household features to be fully functional before closing. Additionally, because an as-is sale is final, you’d be stuck with the bill to fix any major issues you might find after closing.
Is financing a foreclosure right for you?
Buying a foreclosed home might present an attractive deal, but you may wonder whether financing a foreclosure is the right move for you. Ultimately, the decision depends on your specific situation and the home in question.
It could be well worth the hassle if you’re happy with the home and willing to deal with the potential complications associated with a foreclosure. You may be able to save money while getting the home of your dreams.
Buying a foreclosure isn’t for everyone, though. If the home is listed as-is but doesn’t pass inspection, you may have to decide whether to abandon the purchase or pay for the repairs yourself.
Additionally, delays in the process could impact your mortgage. If interest rates are on the rise, a delay may push you toward higher rates. You could pay to lock in your interest rate, but a delay may cause additional charges to extend your rate-locking agreement. If you don’t want to deal with risks, buying a foreclosure might not be a good fit.
FAQs about financing a foreclosure
What's the difference between in foreclosure and foreclosed?
A home in foreclosure is a home going through a pre-foreclosure process that hasn’t been completed. The lender does not yet own the home but is attempting to get ownership through the legal process required by the state.
A foreclosed home is a home owned by a lender who has already completed the foreclosure process. When buying a foreclosed home, you’d typically be buying it directly from the lender.
How high does your credit have to be to buy a foreclosed home?
There is no difference between credit requirements for a foreclosed home versus a regular house. Qualifying for a mortgage to buy a foreclosed home would have the same general credit requirements as purchasing any other home. Begin by checking with your lender about what requirements it has in place. You could also get pre-approved for your mortgage before making an offer.
Can you finance a foreclosure with a regular loan?
You can use a regular mortgage to purchase a foreclosed home as long as the seller doesn’t have specific requirements and your lender approves your application. Ask your lender before making an offer on a foreclosed property to verify.
Buying a foreclosure might get you a good deal, but it might not be for everyone. People who want a quick and smooth transaction might prefer purchasing a home that isn’t foreclosed.
However, if you’re comfortable with the risks, the potential to save money or get the home of your dreams may be worth it. Explore the best mortgage lenders, familiarize yourself with your local regulations, and get your potential future home inspected.
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