Foreclosed properties can offer significant savings for homebuyers. But savings aren’t all these properties offer. Foreclosures can also be smart options for investors—particularly those looking to fix up properties and sell them for a profit.
It’s important to remember, though, that foreclosures aren’t without drawbacks. If you’re considering buying one, make sure you understand the full range of risks and rewards before moving forward.
What Happens During a Foreclosure?
When a homeowner fails to repay their mortgage as agreed, the lender will seize the property and attempt to sell the home to recoup its losses. The exact process for foreclosure depends on the state the house is located in, but in some cases, local courts may be involved.
Foreclosure typically starts anywhere from three to six months after the homeowner’s first missed payment.
Reasons for Foreclosure
Homeowners fall into foreclosure for various reasons. One of the most common is job or wage loss. According to a survey of homeowners facing foreclosure, 54% of respondents attributed their home’s foreclosure to a reduction of income or unemployment.
For example, in August 2020, 5,599 properties in the U.S. began the foreclosure process, just four months after unemployment hit its peak in April during the height of the COVID-19 pandemic. While this number was up 24% over July, it was still down 80% from August 2019. That may be due to the protections put in place for homeowners who were in financial trouble during the pandemic.
Other reasons homeowners fall behind on their mortgages include illness, excessive financial obligations or debts, and marital problems. The majority of homeowners in foreclosure may fall into the low- to moderate-income category, too, which may make a job loss or income reduction that much more troubling.
Pros and Cons of Buying a Foreclosure
Faster closing process
Potential investment opportunity
You may not see or inspect the home before buying
The property may need several repairs
You may need a large amount of cash
“The obvious pro of buying a foreclosure is the price,” real estate agent Yawar Charlie told The Balance in an email. “Generally speaking, foreclosures are properties that are offered below market value.”
It’s true: Foreclosures can offer serious savings. The Balance received information from real estate data aggregator ATTOM Data Solutions that showed the average price of a foreclosed home over the last five years has ranged from about $93,000 to $166,000. That’s well below the annual national average for each of those years.
Faster Closing Process
Michael Gevurtz, CEO of Bluebird Lending, told The Balance in an email that foreclosures are typically quick transactions, taking about 30 days, on average, from start to finish. That’s compared with 54 days, the average time to close in October 2020, according to Ellie Mae.
Keep in mind this may not be true during the pandemic, particularly in states where courts are involved in the process. Due to shutdowns earlier in the year, many courts are backlogged, causing delays in foreclosure processing.
Potential Investment Opportunity
Buying a foreclosure and then rehabilitating it can allow you to increase the home’s value and gain immediate equity. If you’re an investor looking to fix and flip the home, this can mean a solid return on your investment, especially with the right upgrades.
If you’re looking to live in the home for a while, a foreclosed home could also mean more in profits when you decide to sell later. In 2019, home sellers realized an average profit of 34% on their initial investment.
You May Not See or Inspect the Home Before Buying
Most foreclosures are sold on an “as-is” basis, meaning what you get is what you get. You may not be able to tour a property or have it professionally inspected before submitting your bid, which could be a dealbreaker for some buyers.
“Typically, you don’t have access to the inside of a property before buying it,” Gevurtz said. “They can only be seen via a drive-by or looking inside ground-floor windows.”
The Property May Need Several Repairs
Foreclosures often need serious work, either due to long periods of vacancy, the previous homeowner’s failure to maintain the home, or even damage by the last occupant.
“The property may have been left in disrepair, and the seller may have taken not only the appliances, but basic fixtures for some of the systems,” Charlie said. “Anyone who buys the house will have to make those repairs and adjustments on their own dime after the close of escrow.”
Before buying a foreclosed home, make sure you have the money in your budget to make those potential needed repairs. A 2020 survey of real estate investors by Auction.com found that budgeting at least 10% to 20% of the purchase price for rehab is the norm in a foreclosure sale.
According to Gevurtz, there are lots of people vying for foreclosures, so it might be hard to snag one right away. “It’s a very competitive market, which means inventory can go quickly,” he said.
With many auctions going online due to the pandemic, this is now more true than ever—two-thirds of investors say the availability of online/remote bidding increases their interest in a property.
Foreclosure moratoriums and mortgage relief efforts during the COVID-19 pandemic have also limited the number of foreclosed properties hitting the market, fueling even more competition.
You May Need a Large Amount of Cash
Rehab costs aside, you may also need a good amount of cash upfront—especially if you’re buying the foreclosure at auction. In many cases, cash bids are required at these events. However, if you’re not bidding on a foreclosed home at an auction and have good credit, you may still be able to finance it.
The Bottom Line
Foreclosures come with some definite benefits, including serious potential savings. But there are also quite a few risks to consider. If you do choose to buy one, consider the potential repair costs it might come with and research what you can about the property before moving forward. If you can’t tour or inspect the home, driving by the home and reviewing property records may be a good option.
Finally, make sure you have a reputable real estate agent or real estate attorney on your side. They can help walk you through the process and ensure that you’re protected as much as possible.