If you have the cash, a steady job and the desire to become a homeowner, you may be tempted by the thought of buying a foreclosure. While there are some bargains to be found, you do need some education and some professional guidance before you jump into making an offer.
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Types of Foreclosure Purchases
The term "foreclosure" gets tossed around a lot, and generally refers to properties that have been repossessed by the lender because the homeowners were unable to pay their mortgage. Some foreclosures are owned directly by a bank, but others are owned by Fannie Mae, Freddie Mac and HUD. Some foreclosures are sold through real estate agents, while others are sold at auction.
The first step you should take if you want to buy a foreclosure is to consult with a lender. No matter which method you use to buy a foreclosure, or who you buy it from, you will need financing. Be prepared to document your income and assets, and to have your debt-to-income ratio and your credit history reviewed. If you are purchasing the home as an owner-occupant, you may have more financing options than if you are purchasing as an investor, since there are some special financing incentives from government agencies to encourage buyers to purchase a foreclosure and live in it. Investors generally need to make a higher down payment when purchasing a home, often as much as 25% or more.
You can buy a foreclosure with FHA, VA or conventional loans provided the home meets the loan guidelines for condition. One option that many foreclosure buyers have taken advantage of is an FHA 203(k) loan that allows you to wrap renovation costs into the mortgage.
Of course, if you can pay cash, you'll find it much easier to buy a foreclosure. (For related reading, see Avoiding Foreclosure Scams.)
Many buyers assume that buying a foreclosure means you are getting a bargain, but this is not always the case. Banks that are selling foreclosures are hoping to recoup as much of their costs as possible, so, if the property is in good condition, it may be listed at market value or just below market value. Homes that are priced extremely low may be in terrible condition or the bank may also be hoping to encourage a bidding war. Foreclosures in some markets receive multiple offers and can end up selling far above the list price.
If you become involved in a bidding war, or are purchasing a home at an auction, make sure you know your comfort level with your mortgage payment and have worked with a real estate agent to evaluate the market value of homes in your area so that you don't overpay.
Foreclosures are sold as is, which means that while you can have a home inspection for knowledge of the property, the owner (the bank or government agency) is under no obligation to fix anything. Some foreclosures have been vandalized and will lack appliances and even kitchen cabinets, while others have been vacant for so long, that they have issues with mold or other damage. On the other hand, some foreclosures have been maintained or even improved with some new appliances, fresh paint and new carpet. Just make sure you are aware of the condition and understand the costs you may incur if you have to make repairs. A bargain isn't such a bargain if you need to spend thousands of dollars to bring the home to a livable condition.
Fannie Mae offers special financing and incentives to buyers of its foreclosures through its HomePath program, including closing cost assistance up to 3.5% for owner-occupants and low down payment loans.
Freddie Mac offers its First Look program to owner-occupants that allows them the first chance at buying one of its foreclosures before investors are allowed to make an offer. The Freddie Mac HomeSteps program includes a home warranty and savings on new appliances.
HUD foreclosures located in areas that need revitalization are available at bargain prices for law enforcement officers, teachers, firefighters and EMTs. The HUD Home Store offers details about HUD-owned homes in every state.
The Bottom Line
Purchasing a foreclosure can be a great way to become a homeowner, but you need to work with a Realtor with experience in foreclosure purchases and plenty of local knowledge to make sure the home you buy is truly a bargain rather than a money pit. (For related reading, see Investing In Foreclosures Not A Get-Rich Quick Venture.)