If you’re an investor looking for fix and flip, it may be the perfect fit. But, if you're a homebuyer looking for a bargain, it's important to know the risks involved in purchasing a home in foreclosure. Depending on what stage the foreclosure is, the home could be still in possession of the owner and in excellent shape, or it could be a property neglected by the lender for quite some time. In the case of the latter, you may end up putting much more into the home than you intended to spend.
What Is Foreclosure?
When a borrower fails to pay their mortgage on regularly and on time, the lender may decide to begin the foreclosure process. Usually, the buyer/homeowner needs to default on their loan payments each month for at least three to six months for the lender to decide to foreclose the loan. The lender starts the process by filing a public notice of default, usually in the newspaper but now often on the web.
The homeowner can pay off a default amount to reinstate the loan during a grace period. This grace period, determined by state laws, is also known as pre-foreclosure. In this case, no foreclosure takes place. Or, the borrower can sell the property to a third party during pre-foreclosure, negotiating the terms of purchase together with the lender. This approach allows both the borrower and owner to pay off the loan, and allows the homeowner to avoid having a foreclosure on their credit history. It is during this time that an investor can typically make the largest profits and can negotiate a deal that may be favorable for all parties involved including the buyer, borrower, and lender.
If the loan is not reinstated or satisfied via private sale by the end of the pre-foreclosure period, the potential buyers can bid on the property at a public auction. Buyers often are required to pay in cash at the auction and may not have much time to research the title and condition of the property beforehand. It becomes a "buyer beware" purchase. However, a public auction often offers some of the best bargains and avoids the unpredictability of dealing directly with the borrower/owner.
If the lender takes ownership of the property, either through an agreement with the owner during pre-foreclosure or at the public auction, the property is referred to as "Bank Owned." The lender will usually want to re-sell the property to recover the unpaid loan amount. The lender will probably make sure the title is clear for any buyer, but the potential bargain is typically less than a pre-foreclosure or auction property.