How to Buy a Foreclosed Home + Risks You Should Know

Aalto Insights Team
Sep 12, 2023

Entering the housing market in the Bay Area isn’t cheap or easy, but what if you could own a house for just a fraction of its market value? By buying a foreclosed home, you can end up with your new home without breaking the bank.

But as you can imagine, it’s easier said than done. Home foreclosures are hard to navigate, and without a well-informed strategy and a little help from a team of experts, things can get really stressful. 

Whether you’re a real estate whiz or a first-time homebuyer, we’re here to demystify the process of how to buy a foreclosed home. We’ll cover what foreclosures are, how they work, the types of foreclosures to look for, and the risks you should know about. 

What Is a Foreclosure?

A house enters foreclosure when a mortgage lender seizes ownership. In other words, they become the new homeowner.

When you initially sign a contract with your lender, you also agree to have a lien on your home. This lien grants the lender the ability to take control of your home. Without this protection, lenders have no safety nets if borrowers stop making mortgage payments.

How Does the Foreclosure Process Work?

Learning how to buy a foreclosed home requires you to understand the stages of the foreclosure process. Here’s how it works.

Step 1: Notice of Default

If a homeowner is late on a mortgage payment here and there, they’ll probably get charged a late fee, but that’s about it. However, if they fall behind and miss several months’ worth of payments, they risk defaulting on the mortgage. This can trigger the pre-foreclosure process, and they’ll likely receive a notice of default from their lender.

A notice of default is a court-filed public document that states that the homeowner has breached their mortgage contract by missing payments on their loan. According to the U.S. Department of Housing and Urban Development (HUD), lenders will start the foreclosure process once you fall 3-6 months behind on payments.

A homeowner can get out of the pre-foreclosure process by doing one of the following:

  • Pay your outstanding loan balance
  • Ask for a loan modification
  • Request forbearance

Step 2: Notice of Trustee’s Sale

If the homeowner cannot do any of the above, their house can be repossessed after 90 days, and their lender will issue a notice of the trustee’s sale. This document states that a trustee (a neutral third party) will facilitate the foreclosure process and that the home will be auctioned.

Step 3: Foreclosure Auction

Next, the trustee operates a foreclosure auction, where the home is sold to the highest bidder based on the directives from the lender.

If they can’t sell the home via a public auction, it becomes real estate owned (REO). In other words, it becomes a bank-owned property. At this point, the lender will most likely hire a real estate agent to then list and sell the home.

How to Buy a Foreclosed Home: 5 Methods

How to buy a foreclosed home: family carrying boxes into their new house

There are two main ways to complete the buying process of a foreclosed home: during the public auction and after the foreclosure property becomes an REO property. There are also a few other types of foreclosures you should look into. Here’s a breakdown of your options.

1. Foreclosure Sales at Auctions

You can achieve homeownership at an auction almost instantaneously — and for a sales price well below market value!

However, this is easier said than done. Auctions can get competitive, especially if the house catches the eye of some real estate investors. Also, most auctions require you to pay for the home in cash, so you’ll need to have a lot of money handy. If the foreclosure auction allows you to get financing via a mortgage loan, make sure you get preapproved for a home purchase first.

Buying at auction also comes with the risk of buying the home as-is. You don’t get a home inspection first and don’t expect it to be move-in ready. Often, foreclosed properties require a lot of renovations, which can get expensive fast.

2. Foreclosures From Lenders

This is the safer bet if you’re purchasing a foreclosed home for the first time. When you buy a house from a lender’s REO inventory, they’ll usually run a title search to make sure it’s clean and evict the previous owner before you complete the home sale.

As with foreclosure auctions, the home will be sold to you as is, but you’ll at least get to see it first. You can also order a home inspection before making your down payment and paying closing costs.

3. During Pre-Foreclosure

A homeowner can sell their home while in pre-foreclosure, which can be beneficial if they believe they’ll lose it otherwise. Typically, you can find pre-foreclosures online and in courthouse buildings.

4. Short Sales

Short sales happen when a lender is willing to accept less money for a home than what’s owed on its mortgage. The borrowers aren’t necessarily in default for a short sale, but they usually need to prove that they’ll likely end up in default.

In the Multiple Listing Service (MLS), these short sales are often advertised as “pending bank approval.” Banks usually aren’t keen on losing money, so it’s not uncommon for them to take months to reply to a short sale offer.

5. Government-Owned Properties

If the foreclosed home was purchased with the help of a government agency via a Federal Housing Administration (FHA) or Department of Veterans Affairs (VA) loan, the government repossesses it. Then, it’s sold by mortgage brokers who work on behalf of these federal agencies. You can find these brokers by visiting the HUD website.

4 Risks of Buying a Foreclosed Home

How to buy a foreclosed home: portrait of colorful houses

Now that you know how to buy a foreclosed home, you should be aware of its associated risks. We’ve mentioned a few, but it’s time to dive a little deeper.

1. Hidden Costs at Auction

If you purchase a home at auction, you also take on all its financial baggage. You’ll be responsible for making the necessary repairs, fronting the costs of unpaid property taxes, and any other liens imposed by the state, creditors, or the IRS.

If you’re purchasing through the bank, you’ll be off the hook for liens, but renovations can still be costly.

2. Squatters

While the bank will evict the previous homeowners before reselling, auctioneers make no promises. When you buy a home at auction, evicting squatters becomes your responsibility. Sometimes, they may take their frustrations out on your newly purchased home, requiring you to pay for repairs.

3. Stiff Competition

Foreclosures can make excellent investment properties, and they’re a common niche for professional house flippers. Some buyers submit bids on multiple properties and hope one works out.

Bidding wars are also common, so make sure you know your ceiling before entering into one. Otherwise, you can end up being in over your head.

4. Slow, Arduous Homebuying Process

With the added complications in foreclosure purchases, there might be extra paperwork, which makes sales take longer — especially when short sales are concerned.

Be prepared for a lot of “hurry up and wait” during the process. Luckily, for the price you’re getting, it’s usually worth it in the end.

How to Buy a Foreclosed Home With Aalto

At Aalto, we’re here to help you buy your dream home. Our self-service real estate platform can equip you with the education and expertise you need to navigate the homebuying process without a traditional agent, whether you’re purchasing a brand-new house or a foreclosed home.

With Aalto, you’ll have access to hundreds of exclusive listings and the opportunity to receive up to 1.5% cash back when you buy a home. Are you ready to take control of your real estate journey? Sign up with Aalto today!

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