Should You Buy a Foreclosure?

Written by
Kirk Haverkamp
Read Time: 3 minutes

Should you buy a foreclosed home? The savings can be huge, but so can the hassles and pitfalls. Here are a few tips for first-time foreclosure buyers to make sure the experience is a rewarding one.

How much can you save?

According to the National Association of Realtors (NAR), foreclosures sell for about a 20 percent discount compared to conventional sales. But that's an average - many sell for much bigger discounts, and some sell for close to market value. Expect smaller discounts on homes that are in good condition and have not been on the market long.

What's the biggest downside?

The biggest problem with buying a foreclosed property is that it may not be in very good shape. For one thing, they've often been standing empty for a long time - perhaps a couple of years or more - so they deteriorate.

Necessary maintenance may have been neglected even while the home was occupied because the owners were in financial difficulty. Furthermore, some foreclosed properties may have been stripped or vandalized by their departing owners, to extract what value they can or out of anger over the foreclosure itself.

Should you buy at auction?

The biggest savings are found by buying a home at a foreclosure auction, also known as a sheriff's sale. However, this is also where the risks and hazards are greatest for the first-time foreclosure buyer.

First, you can't inspect the interior of the property beforehand - you're buying it largely unseen, except for what you can determine from the outside. Second, you could get stuck with title problems - there's no title insurance on properties bought at a sheriff's sale and tax liens are a common problem with foreclosures. Third, foreclosure auctions require that you pay cash - so you can't finance the sale with a regular mortgage loan.

Most of the buyers at foreclosure auctions are experienced investors or real estate types who know how to spot the best deals and avoid potential title problems. It's a risky place for neophytes to tread.

Buying an REO

If a property doesn't sell at a foreclosure auction, it reverts to the bank or other lender than holds the mortgage, which then tries to sell it like a conventional home listing. These are known as REOs or real-estate-owned properties.

With an REO, you can get both a title search and title insurance when you buy the property, eliminating lien problems. You can also get mortgage financing to buy an REO, though it probably won't be through the same bank that's selling you the property. Finally, you can inspect the home before buying.

The savings usually aren't as great on an REO as buying at a foreclosure auction, but you can maximize your discount by looking for homes that have been listed for sale for a long time. Lenders usually offer minimal discounts when they first list an REO for sale, then mark it down further if it doesn't move. These days, about one-quarter of REOs are on the market for at least a year before selling, according to CoreLogic, so those are the ones that will offer the biggest discounts.

Special programs for buying foreclosures

The vast majority of U.S. residential mortgages are guaranteed by Fannie Mae, Freddie Mac, the FHA or VA. Not surprisingly, these agencies end up with a lot of foreclosures. As a result, all have special programs for selling these properties.

These programs may offer special financing, minimal down payments, or other perks for purchasers. Fannie Mae's Homepath and the FHA's 203(k) mortgage programs can provide additional loans for limited improvements and repairs to foreclosed properties. Freddie Mac's Homesteps offers a 2-year home warranty., while the VA Home Loan Financing for Foreclosures is available to both veterans and non-veterans. Many of these programs are also available to investors and second-home buyers, as well as to those buying a home for a primary residence.

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