Foreclosures are often thought of as the backbone of a successful real estate investing career. Whether your real estate strategy is to buy and hold (rent) or buy and flip (sell), foreclosures have the potential to make you money – potentially lots of it.
In this post, I’m going to attempt to give you a thorough overview of how to find and buy foreclosures, so take a deep breath, find a comfy chair, pour yourself a cup of coffee and let’s dive in.
What is a foreclosure?
When a property carries the label “foreclosure” this means the property owner took out a loan against the property (mortgage) and has missed multiple consecutive payments (usually 3-6).
As a result, the lienholder (usually a bank) forces the sale of the property in an attempt to recover the loan balance. Foreclosures are often referred to as “REO properties.” REO stands for “Real Estate Owned.”
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Different kinds of foreclosures
Before I go into how to find and buy a foreclosure, I’d like to talk a bit about the different kinds of foreclosures. A common misconception is that all foreclosures are bank-owned properties, but that’s not the case.
Usually, foreclosures will fall under one of two categories: bank foreclosures & government foreclosures. Let’s discuss each of these in a bit more detail.
A bank foreclosure happens when a bank forces the sale of a property to recover the balance of a loan (mortgage) that the borrower has stopped making payments on.
Other times, mortgages are backed (insured) by the Federal government as in the case with FHA, VA and USDA mortgage loans.
If a mortgage has been sold to or insured by the Federal government, and the property gets foreclosed on, ownership of the property transfers to the government.
There are four main types of government foreclosures: HUD Homes (FHA foreclosures), VA Foreclosures, USDA Foreclosures and Fannie Mae foreclosures.
Let’s dig deeper into each of these.
HUD stands for the Department of Housing & Urban Development. The Federal Housing Administration (FHA) is a division of HUD, and offers mortgage loans with down payments as low as 3.5%.
When a borrower takes out a FHA loan on their property and later forecloses, HUD takes possession of the property, and the property is then considered a HUD Home.
VA (Veterans Affairs) loans offer 100% financing and are available to current or past US military service members who meet certain income, credit and other eligibility requirements.
When a property with a VA loan forecloses, the property goes back to the VA and becomes a VA foreclosure.
USDA stands for the United States Department of Agriculture. USDA loans offer 100% financing to qualified borrowers to purchase a home within a USDA-eligible area.
USDA loans are typically reserved for properties located in rural areas. When a property with a USDA loan forecloses, ownership is transferred to the USDA.
Fannie Mae Foreclosures
When a lender sells a mortgage loan to Fannie Mae, then Fannie Mae takes ownership of the property in the event of a foreclosure.
The foreclosure process
As I mentioned earlier, the foreclosure process starts by a borrower not making their mortgage payments for multiple consecutive months (usually 3-6).
From a legal perspective, there are two types of foreclosures: judicial foreclosures & non-judicial foreclosures. The main difference between the two is that judicial foreclosures require the lienholder to file a lawsuit in court to initiate a foreclosure; non-judicial foreclosures do not require the court’s involvement.
Since non-judicial foreclosures don’t involve the courts, they typically move much faster. Judicial foreclosures can take up to several years to finalize while non-judicial foreclosures can be completed in just over a month in some cases.
Whether a foreclosure is judicial or non-judicial, there are three phases that make up the foreclosure process: pre-foreclosure, auction & post-foreclosure. Let’s explore each one.
Phase #1: Pre-foreclosure
The pre-foreclosure phase is kicked off by the lender notifying the borrower that he/she is in default (behind on their mortgage).
In non-judicial states, this notice is referred to as a Notice of Default (NOD) and may be accompanied by a Notice of Sale. In judicial states, this notice is called a Lis Pendens.
This notice informs the borrower that they have so much time (grace period) to pay what’s owed and become current with the lender. If the borrower fails to meet the lender’s demands, within the grace period allowed, the lender will force the sale of the property (foreclose).
Since the borrower likely won’t be able to meet the demands to avoid foreclosure, they are often very motivated to sell to avoid having a foreclosure damage their credit, so you stand a chance to purchase pre-foreclosures at a steep discount.
Next, let’s look at some ways you can find pre-foreclosures.
There are a number of free and paid websites you can use to find pre-foreclosures. Here are a few of them:
Check with your county court
In judicial foreclosure states (remember these are the ones that have to go through the courts), the county court should have foreclosure notices on file.
Ask the court if you can search these files to uncover pre-foreclosure opportunities.
Have your real estate agent pull pre-foreclosure listings from MLS
Real estate agents have access to a real estate database called MLS. MLS stands for Multiple Listing Service. Ask your agent to provide you with a list of properties that have “pre foreclosure” or “short sale” mentioned in the listing.
A short sale is when a lender is willing to sell a property for less than what the borrower owes.
Phase #2: Auction
If the borrower fails to get right with the lender within the grace period allowed, the lender will attempt to sell the property at auction.
There are two types of foreclosure auctions: live (in-person) auctions & online auctions. A live auction will be held at the county courthouse steps or at the property itself. Online auctions are handled by a number of auction sites such as these:
Some auction sites require an up-front buyer’s premium while others do not.
A buyer’s premium is a certain percentage of the purchase price (or a flat fee) that the buyer must pay in addition to the purchase price for a property.
There are important differences between live and online auctions. First, online auctions typically span several days while live auctions start and finish within a few hours.
Additionally, live auctions usually require payment in full the day of the auction while online auctions typically allow a reasonable amount of time to close at a title company.
A very important fact to note about online auctions is that just because you win the auction doesn’t mean the deal is done.
Oftentimes, the seller must approve the winning bid before the property becomes yours. It may take several weeks for the seller (usually a bank) to notify you whether they’ve accepted or rejected your bid.
Phase #3: Post-foreclosure
In some cases, properties fail to sell at auction. This could be because no one showed up to bid, the highest bid was below the minimum the seller was willing to accept (known as a reserve price) or it could be that the deal fell through for some other reason between the seller and the buyer.
Regardless of the reason, when a property fails to sell at auction, it enters the post-foreclosure phase and goes back to the lienholder (usually a bank) or the government.
At this point, the owner will usually hire a special real estate agent to list the property for sale on the open market. These agents are known as REO agents, and they specialize in selling bank or government-owned properties.
Once the property is listed on the open market, the details of the property will be made publicly available on MLS and major real estate sites like Zillow, Trulia & Realtor.com.
Purchasing HUD Homes
Purchasing Fannie Mae Foreclosures
You can find and submit offers on Fannie Mae owned properties at www.homepath.com.
Be aware that Fannie Mae properties typically are part of the First Look™ Program. This program prohibits investor offers for usually the first 20 days the home is listed for sale on homepath.com.
During this “first look” period only buyers looking to purchase a primary residence (a house they will live in) are allowed to submit offers.
Other Ways to Find Foreclosures
In addition to the resources I’ve previously mentioned, here are some other sites that offer foreclosure listings:
Bank of America Foreclosures
Fifth Third Bank Foreclosures
People’s United Bank Foreclosures
Wells Fargo Foreclosures
Ways to finance the purchase & rehab of a foreclosure
In many cases, financing the purchase of a foreclosure won’t be an option. This is because banks and government agencies who own foreclosures often don’t allow for contingencies.
A contingency is essentially a condition. When a real estate sales contract has a contingency, the buyer is essentially saying, “I agree to purchase this property if this or that is true.”
For instance, if a sales contract includes a financing contingency, this means that the contract is contingent upon the buyer obtaining financing (a loan) that is of a sufficient amount to purchase the property for the agreed upon price.
If the buyer cannot obtain financing, then the deal is off without penalty to the buyer.
Furthermore, even if financing is allowed, a bank may not extend a loan to you to buy a foreclosure if the property is in rough shape.
So, purchasing a foreclosure with cash may be your only option. There are a few ways you can borrow the cash you need to purchase the property if you don’t have the funds yourself.
Personal loans and lines
Depending on how much money you need to acquire the property, unsecured personal loans and lines of credit can be a great way to get the cash you need to make the deal happen.
Below is a list of companies (some of them I’ve used personally) that offer sizable loans and lines.
Another way to get the cash you need is by taking advantage of hard money or private money loans.
Private money is simply money owned by private people. Borrowing private money is just a matter of asking people you know if you can borrow from them.
You could get private money from family, friends, people in your networking group or whoever knows and trusts you enough to lend money to you.
Hard money lenders, on the other hand, are professional money lenders (companies) who have access to lots of private money and loan it out to real estate investors at a higher interest rate than what they pay to borrow it.
Both private money and hard money loans have advantages and disadvantages.
The biggest advantage to private money is that the loan terms are usually fairly simple since you’re borrowing from people who know and trust you.
Uncle Joe agrees to loan you $10,000, and you agree to pay Uncle Joe $10,000 + $500 interest in 3 months. Pretty straightforward. Perhaps the biggest downside to private money, however, is you may not be able to get the funds you need from family and friends alone.
Hard money lenders, on the other hand, usually have access to large pools of money. They are more interested in the property itself than they are with the borrower’s financial profile, so even if your finances don’t paint a pretty picture, don’t rule hard money lenders out. Hard money lenders can easily be found by doing an internet search.
Unlike private money loans, though, hard money loans usually require an application, an appraisal and a property inspection to get the loan approved – similar process to getting a bank loan. Additionally, the interest rates on hard money loans are usually higher than borrowing private money.
Foreclosures: Pros & Cons
While foreclosures can create a great business opportunity for real estate investors, they also have their downside. Let’s look at some of the pros and cons with buying foreclosures.
Pro: potential to acquire properties below market value
Pro: in some cases, property may need little work – allowing for quick profit.
Pro: potentially less competition
Con: buyer may have to pay back-owed taxes
Con: property usually sold in “as is” condition (seller makes no repairs)
Con: may require additional paperwork and longer time to close
The advantages and disadvantages in buying foreclosures also vary depending on whether you buy a property during the pre-foreclosure, auction or post-foreclosure phase. For pros and cons to consider at each of these phases, check out this post.
Buying foreclosures can be a great way to make money and even amass wealth in real estate. Like any business, though, buying foreclosures comes with risks. Do as much research as possible before deciding whether or not to buy a foreclosure.
If you’re ready to buy a foreclosure, I recommend working with a REO agent. Remember, these are agents who specialize in foreclosures. To find REO agents in your area, click here.