There are few better investments than real estate; however, all investments carry some degree of risk by nature. This risk is even greater in investments such as real estate, the liquidity of which is incredibly low.

While many investors view real estate acquisition as relatively safe, this can change drastically when buying a property that has been foreclosed on by the previous owner.

In this article, we’ll take a closer look at what makes buying a foreclosed property risky and if there’s anything you can do to reduce or eliminate those risks.

Types of entries

The three most common types of foreclosures in the United States are:

• Foreclosure of power of sale
• Judicial foreclosure
• Strict lockdown

For a power of sale foreclosure, also known as a statutory foreclosure, the mortgage agreement in some states will contain a power of sale clause. This allows the lender to auction off the property to fill the foreclosure. This does not require any judicial intervention and is licensed in a total of 29 states.

A court foreclosure requires the lender to file a lawsuit to begin foreclosure proceedings. This is then communicated to the buyer, and they usually have 30 days to become current on the loan. If that fails, the property is then auctioned off either by the county sheriff or by a court.

Strict foreclosures are only allowed in Vermont and Connecticut and require a lawsuit by the lender against the defaulting borrower. The court then sets a deadline to pay off the mortgage, and if that fails, the title automatically passes to the lender.

It is the only type of foreclosure that does not require a formal sale.

5 risks of buying foreclosed homes

As with any investment, buying a foreclosed property involves certain risks that you, as a buyer, should be aware of.

1. Overpaying is easy

A common risk when buying foreclosed property is paying more than the home’s current market value. This risk can be exacerbated if you are buying at an auction, where competing buyers may “bid unwillingly” to drive up the price.

You can significantly reduce this risk by setting a maximum bid at an auction or setting yourself a firm budget when buying off-market.

2. You might need money

Financing can be nearly impossible if you are considering buying a foreclosed property, especially if you are considering using conventional financing options or an FHA loan.

You may be able to find a rehab loan with decent terms, but it can take a lot longer and can make a turnaround unprofitable. That being said, some lenders will have options available for these types of situations.

3. Your ROI may take an unexpected hit

Many newbies are unfamiliar with the potential expenses or additional costs associated with buying a foreclosure.

While most will be prepared for the price of the property and standard title fees, there may also be unexpected costs. There may be transfer duties or even liens on the property, and you may even have to pay fees related to the initial foreclosure.

4. Your rental plan may be delayed

Buying foreclosed homes risks delays caused by the foreclosure buying process.

Foreclosure sales are known to have more delays than traditional sales, especially during the escrow phase at closing. One way to minimize these delays is to make sure you’re working with an experienced real estate broker or agent.

Your agent should not only be familiar with foreclosure sales, but also with the financial institution involved in the transaction.

5. As-Is Sales Can Be Nebulous

A huge risk when buying a foreclosed home is that sellers are under no legal obligation to disclose major defects.

Homes are generally sold as is, which means that the full responsibility for due diligence rests with the buyer, and the buyer must arrange for their licensed inspector.

It is always wise to keep a reserve of funds in case the property needs extensive repairs or even major expenses like roofing or foundation work.

Advantages of buying a foreclosed home

The main advantage of buying a foreclosed home is that you can often pay considerably less than market value if the right circumstances exist.

While they don’t necessarily have a lower listing price than other homes in the area, their price is set by the lender, who wants to sell the home and take it off their books.

Can you get a mortgage to buy a foreclosed home?

It is not uncommon for a buyer to be able to obtain a mortgage for the purchase of a foreclosed home. Many lenders even specialize in loans for foreclosed properties or properties that need rehabilitation.

Loan terms vary from lender to lender, and some may require the home to be in livable condition, while others may not.

Before you start your property search, you may want to apply for a mortgage in advance to get pre-approved, which can significantly increase the chances of the seller accepting your offer.

Mortgage options for buying foreclosed homes

In many cases, even when a property is foreclosed, you can take advantage of a variety of conventional mortgage options.

As long as you’re not buying through a cash-only auction and the home is in livable condition, you may be able to get a conventional mortgage.

Other options include government-backed loan programs from the Veterans Administration, the Federal Housing Authority, or even the USDA.

Government guaranteed loans have the major advantage of making a home more affordable, although they come with certain stipulations depending on the property.

For example, if the property you are considering is unable to qualify for a loan because it is not in “habitable condition”, additional work may be required before it meets the minimum criteria. .

On the other hand, since you don’t need mortgage insurance with government guaranteed loans, you can use the money saved for other work.

Conclusion

Ultimately, while buying foreclosed properties may not be a bad investment, they come with risks and rewards unique to foreclosures.

However, knowing what you are up against when it comes to these risks can allow you to be much more adequately prepared.
One of the best ways to get into a foreclosure sale is to visit a lender today and begin the pre-approval process, so you can start looking in earnest for your next investment.