How to Buy a Foreclosed Home

At the end of a foreclosure, in most cases, the home is sold to a new owner at a foreclosure auction. Buying a foreclosure property might allow you to get a home for a potentially low price. However, there are some risks involved when buying a foreclosed home. Wise buyers will consider such things as the neighborhood in which the home is located, how the home has been maintained, and whether any existing tenants who rented from the prior owner will remain after the purchase.

Instead of buying a property at a foreclosure auction, you might also consider buying a foreclosure property while it's in preforeclosure or after a foreclosure is over when the home is bank-owned.

How to Buy a Foreclosed Home

You can buy a foreclosure property while it's in the preforeclosure stage, through a short sale, at a foreclosure auction, or when the property is bank-owned ("real estate owned" or "REO") after a foreclosure sale.

Buying a Preforeclosure Home

If you buy a home in preforeclosure ("preforeclosure" is the period before a foreclosure sale takes place), you'll negotiate a deal with the homeowner and their real estate agent. If you find a homeowner who is, in fact, ready to sell, you can negotiate just as you would any other home-sale transaction.

Generally, in a preforeclosure sale, the homeowner sells the property for more than they owe on the mortgage loan but less than the property's fair market value. This way, the buyer gets a bargain, and the seller is able to pay off the mortgage in full and possibly walk away with some money in their pocket.

Buying a Short Sale Home

While in the preforeclosure stage, a homeowner might decide to try to sell their home in a short sale. With a short sale, the lender agrees to let the homeowner sell the property for less than they owe on their mortgage loan. Typically, in a short sale, the home is underwater (worth less than what's owed on the mortgage debt).

Like in a regular preforeclosure sale, you'll deal with the homeowner and their broker in a short sale transaction. Because short sales homes are often advertised as "pending lender approval," you'll probably also have to negotiate with the lender. And because you'll be dealing with a financial institution—a bank's asset management department—you might face challenges. Don't expect a quick turnaround and individual attention from people who have the authority to make decisions. Also, you might find yourself dealing with a department that stops answering the phone at 5 p.m. sharp.

Buying a Property at a Foreclosure Auction

At the end of the foreclosure process, a home is sold at a foreclosure sale, which is a public auction. Here's a summary of how foreclosure auctions work, with more details below: Anyone, including the foreclosing lender, can attend a foreclosure auction and bid on the home. The lender bids on the property using a "credit bid." Other people, such as real estate investors, who bid on a property at a foreclosure sale must bid cash or cash equivalent, such as a cashier's check. If a third party is the high bidder at the sale, the sale proceeds repay the borrowers' debt. But if the foreclosing lender is the highest bidder, the property reverts to the lender and becomes REO.

Buying an REO (Bank-Owned) Property

If the lender's credit bid is the highest bid at the foreclosure sale, the lender gets the property, and it becomes REO (part of the foreclosing lender's inventory). The lender will then put the property up for sale. Once the property is on the market, anyone can make an offer to purchase it.

How Does a Foreclosure Auction Work?

With judicial foreclosures, the foreclosure auction is often a "sheriff's sale." This means that local law enforcement handles the auction. A "trustee's sale" is basically the same as a sheriff's sale, but it is the final step in a nonjudicial foreclosure. The foreclosure trustee handles the foreclosure auction. And, in some places, a "special master" (a person the court appoints) or another party conducts foreclosure sales.

The foreclosure auction process differs from place to place. Sometimes, state law governs the timing and bidding process, but not always.

In almost all home foreclosure auctions, the foreclosing lender bids first at the auction, usually submitting the bid before the sale starts. Again, the bid will be a credit bid, which means the lender gets a credit in the amount of the mortgage debt. So, the lender bids the amount it's owed on the loan rather than bidding with cash. The lender may bid the full debt amount of the debt, including foreclosure fees and costs, but it might bid less.

Sometimes, state law requires the lender's bid to be at least as much as the property's fair market value. But the bid doesn't have to exceed the total amount the borrower owes. After the foreclosing lender bids, third parties, such as investors and the public, may make a higher bid at the foreclosure auction. A third-party bidder must pay a higher cash price to win a foreclosure auction. While lenders often start with a lower bid, they might increase it if other bidders are present, potentially up to the full amount they're owed.

Because of the risky nature of buying a foreclosed home (and the fact that they're often in poor condition), foreclosure sales usually have a limited number of potential bidders. In fact, at many foreclosure auctions, the only bidder is the foreclosing lender. But if the property has a lot of potential, you might face interest and competition from other investors and house flippers.

Where Do Foreclosure Sales Take Place?

The foreclosure auction might be held in the sheriff's office or at the county courthouse, typically on the front steps. Sometimes, foreclosure auctions happen on the internet. More and more foreclosure sales are taking place online.

The auction might be "absolute" (the highest bid wins) or with a reserve or minimum bid (the property must sell for a minimum set price; otherwise, the home's title goes to the foreclosing lender).

How Can I Find Out About Upcoming Foreclosure Auctions?

Foreclosure information is available to the public. To learn about upcoming foreclosure auctions, you can:

• Review legal notices in the newspaper. As part of the foreclosure process, upcoming foreclosure sales are published in local newspapers. These notices are frequently published online. (If you're thinking of approaching homeowners in foreclosure about selling their property, but they haven't listed the property for sale, be sensitive. Keep in mind that they're in the process of potentially losing their home.)
• Use online services. Various websites, like foreclosure.com, auction.com and RealtyTrac.com, provide information on houses in foreclosure. You might have to pay a fee to use their services.
• Check the county records. Foreclosure notices often have to be recorded in the county records, which are available to the public. You might have to go to the county office, or they might be available online.
• Look at county websites. Some counties have an online list of properties that will be sold at a foreclosure auction.

Foreclosure auctions are often postponed or canceled, so be sure to confirm the details before the scheduled sale.

Common Mistakes to Avoid When Buying a Foreclosure Home

Buying a foreclosed home is risky. Homeowners sometimes intentionally damage the property when they go into foreclosure, or a financially distressed homeowner might have put off doing repairs or routine upkeep—perhaps for years. You could end up with a house that needs expensive work and renovation. If you decide to buy a foreclosure property, be prepared to take on a property that might need significant maintenance.

Here are some common mistakes to avoid:

• skipping property research
• underestimating repair costs, and
• not understanding auction rules (and missing out on a good buy).

If you find a suitable property, do your homework, and purchase the home for below market value, a foreclosed property can end up being an incredible deal.

When considering whether or not to buy a foreclosure property, follow these tips:

Consider the Neighborhood

A foreclosed property in good condition located in a neighborhood with few other foreclosures will be a better investment than one in a neighborhood of foreclosed homes. Of course, such a property might go for a higher price at auction.

Check Out the Property (as Best as Possible) Before a Foreclosure Auction

Prospective buyers don't get to inspect the property before a foreclosure auction. Because the property still belongs to the borrower (the homeowner) until the sale is completed, a pre-sale inspection of the interior isn't allowed. You can drive by the property to take a look, but don't trespass. If the exterior is in good condition, the interior might be okay as well. Also, you can look online for basic information about the home, like how many bedrooms and square footage it has.

You should also get title work to determine the priority of the lien being foreclosed.

Investigate the Home's History

Buyers should next turn their attention to the house's history. If you're lucky, you can find out who lived there and whether the occupants were renters or owners (many foreclosed properties were bought as investments).

To learn about the house, start with the neighbors. Ask if the owners took great pride in their home and kept it in good shape. Or was the property occupied by unmonitored and malicious tenants (unsupervised by an owner already demoralized by the property's imminent loss)? Or was the home occupied by resident owners who spitefully trashed the property before moving out?

Even if the property was a rental that escaped the wrath of its last occupants, think about the extent of wear and tear suffered by this property. Often, rental properties suffer more deterioration than owner-occupied homes. Take this into consideration when deciding how much you're willing to pay.

Make Adjustments as Needed

The more you learn about the home, the more realistic you can be when deciding how much you're open to paying. If you can improve the home with a coat of paint and some landscaping, your post-purchase expenses will be small (and you can afford a higher price). But if you have to replace copper pipes, sheetrock, flooring, and appliances, you're looking at major expenses. The "bargain" you thought you had may turn into a very expensive investment.

Prepare for the Foreclosure Auction

If you plan on going to a foreclosure sale in person, contact the party holding the foreclosure auction to find out how much money you need to bring to the auction. Be sure to have your funds ready before bidding. It's also a good idea to attend a couple of foreclosure auctions in advance of the one for the property you're interested in bidding on. You can learn the procedures, observe the bidders, and find out the process requirements.

If the foreclosure sale will be held online, be sure to follow all instructions, like registering in advance if you need to. Rules for bidding at an online foreclosure auction vary depending on the site. You might have to register a certain amount of time before the auction or have to deposit a specific amount. For example, you could have to deposit 10% for each property on which you want to bid. So, in this example, depositing $10,000 would allow you to bid up to $100,000 for a property. And you might have to pay a fee to the auction website when you buy a property. Be sure to research ahead of time to learn how the process works.

How to Pay at a Foreclosure Auction

Third parties that buy properties at foreclosure sales in person must pay with certified funds, like a money order or certified check, sometimes for a percentage of the property price at the time of the sale. Requirements vary for how much you must put down and when you have to pay the full amount. Sometimes, the winning bidder must put down a certain amount, like $10,000, immediately after the sale, and the balance is due within a limited time.

Alternatively, you might have to pay at least the amount of the opening bid with some additional time to get the rest of the balance. Or you might have to pay the total amount of the winning bid at the sale. And the rules might be different for an online foreclosure auction.

If you don't make the full payment of the bid amount when due, the next highest bidder who timely tenders the total amount of that bidder's bid is deemed the successful bidder.

What Happens After a Foreclosure Auction?

After the auction, the winning bidder gets a deed that gets recorded in the land records. The purchaser gets the property in "as is" condition.

The proceeds of the sale are then distributed to pay the sale expenses and to the foreclosing party to pay off the mortgage debt. However, if the foreclosing lender was the high bidder and gets title to the home, the property is considered REO. Usually, the foreclosing lender is the highest bidder at a foreclosure auction.

What Happens to Surplus Funds?

When a foreclosure sale results in surplus funds (say because a third party wins the foreclosure auction by bidding more than the foreclosing lender is owed), those funds go toward paying off junior lienholders in their order of priority. Generally, lien priority follows the rule of first-in-time, first-in-right.

So, the first lienholder that "perfected" its lien by making the necessary legal filings (or automatically in some cases) gets paid before subsequently perfected (or unperfected) liens. But the first-in-time, first-in-right rule has some exceptions.

Any surplus funds that remain after paying off the lienholders will then paid to the foreclosed homeowner—so long as they follow the correct procedures to get the money. However, if property sells at a foreclosure auction for less than the mortgage debt, the lender might be able to get a deficiency judgment against the foreclosed homeowner if permitted by state law.

Dealing With Current Tenants After You Buy a Property at a Foreclosure Sale

The house you're considering buying at a foreclosure auction might come with resident tenants who had been renting from the prior owners.

Protecting Tenants at Foreclosure Act

Until 2009, most tenants lost their leases when a rental property was foreclosed on, which gave the new owners the option to keep the tenants (under a new lease) or evict them. But that changed on May 20, 2009, when President Obama signed the Helping Families Save their Homes Act of 2009 (HELP Act), which also contained protections for tenants. (See Sections 701 to 704 of the HELP Act, which are called the "Protecting Tenants at Foreclosure Act of 2009.") Although the law expired in 2014, on May 24, 2018, President Trump signed the Economic Growth, Regulatory Relief, and Consumer Protection Act (Senate Bill 2155), which restored it.

This law specifies that all leases will survive a foreclosure, except when new owners intend to personally occupy the premises (in that case the current tenant's lease may be terminated with 90 days' notice). Month-to-month tenants may be terminated with 90 days' notice (which is longer or as long as any notice period required by the states).

According to the law, if you are buying a home that you intend to use as a rental, and it comes with a lease-holding tenant, you must honor the lease. You can terminate month-to-month tenants with 90 days' notice.

Other Laws Protecting Tenants

If the home is subject to local rent control that requires landlords to have a "just cause," or good reason, to terminate a tenant or state "just cause" eviction laws, you can't just give the tenant a notice to vacate the property. You'll be stuck with these tenants if you use the property as a rental, or until you fit within one of the allowable reasons for termination under state law or a rent control ordinance.

If you're inheriting month-to-month tenants in a non-rent controlled city or place without just cause laws, should you allow them to stay? Evaluate these tenants as you would any set of prospects. If they have been paying rent on time (admittedly, it might be hard to get the facts unless you can talk to the prior owner), and have been taking reasonable care of the property, you might decide to keep them and negotiate your own, new rental agreement or lease (after giving the tenants 90 days' notice).

But if you sense trouble, particularly if the property comes with tenants who have a long time left on a lease, think twice about purchasing this property in the first place. You don't want to be saddled with tenants whom you would never have rented to in the first place. And if you purchase the property, counting on evicting the residents, understand that if these tenants refuse to leave, you'll need to begin an expensive and drawn-out eviction.

How to Buy an REO Property

After a property becomes REO (bank owned), the bank lists it for sale. Online sources, such as RealtyTrac.com, auction.com, and foreclosure.com have listings of REO properties. You can search by city, state, or ZIP code. REO properties held by Fannie Mae, Freddie Mac, FHA, and homes where the VA guaranteed the loan are listed at, respectively:

• HomePath.FannieMae.com
• HomeSteps.com
• HUD Home Store, and
• VRM Properties.

The process of buying a bank-owned property is the same as any other real estate listing. You can make an offer (and so can anyone else) and the homebuying process goes ahead as if you were buying from a homeowner who listed the property themself. If you and the bank settle on a price and close the deal, you'll become the property's new owner.

Getting Help With Buying a Foreclosure Property

If you have questions about buying a property at a foreclosure auction or need help with the process of buying a home in foreclosure, consider working with an experienced real estate agent or talking to a qualified real estate attorney.

If you want to learn more about how foreclosure works, consider talking to a foreclosure lawyer.