Foreclosure is the process of a lender seizing and selling a property to a new buyer when the owner fails to make their mortgage payments as agreed. It enables the lender to recover at least some of the mortgage balance that is left.
The timeline and legal process for foreclosure can vary from state to state, but the end result is the same: The mortgage borrower loses their home.
What Is a Foreclosure?
A mortgage forms a lien against a property, giving the lender the legal right to move in and take ownership if the borrower defaults. Once they have taken control of the home, the lender will then almost always sell the property to recoup their losses. This process is called "foreclosure." Investors and other buyers can then purchase these homes, often at auctions or right from the bank or government agency that owns them.
How Does Foreclosure Work?
Foreclosures are likely to occur when the homeowner has failed to make agreed-upon payments on the mortgage. However, the reasons behind nonpayment can vary. Sometimes job or income loss is the culprit. Other times, medical bills or credit card debt may make it impossible for you to stay afloat. Foreclosure can also be the result of bankruptcy, divorce, or disability.
In some states, there must be a legal process in court before the home can be taken. Other states offer options that don't require a court to get involved.
A lender can't legally foreclose on a home until the person who owns it is at least 120 days behind on their mortgage payments.
Pros and Cons of Buying Foreclosed Property
Many buyers who consider buying a foreclosed property do so to save money. Not all bank-owned and foreclosed homes are a bargain, but many are priced at less than market value due to their state of repair. They also might be priced to sell quickly because of the lender’s need to recoup their losses.
The U.S. Department of Housing and Urban Development (HUD) even has some homes listed at $1.
Buying a foreclosed home can help you to buy a home that is out of your price range. Perhaps the house is in a high-demand area or has more square footage than your budget allows. You might not be able to afford it, except that it is being foreclosed, which brings the price down within reach.
That might be where the perks end, though. Foreclosed homes are often in poor shape. Many will need repairs that the seller does not want to make or cannot. Most foreclosed homes are sold as-is. Most home auctions require cash in order to buy, so you might not be able to finance the purchase via a normal mortgage loan.
May be priced lower than other homes on the market
Homes often in disrepair
Sellers often won't, or can't, make repairs
Previous owner might be able to take the home back in some cases
Could require large amounts of cash if purchased at auction
No record of home repairs and maintenance
Finally, there are concerns regarding the previous homeowners:
- Many states have what is called “right of redemption” time frames that allow the owner to catch up on payments and take back their home.
- The previous homeowner might "squat" in the home, staying even after it's sold, and it could be hard to remove them.
- The prior homeowner isn't involved with the sale, so it can be tough to know what repairs have been done to the house before you move in. Banks don’t have a record of this type of upkeep.
You’re typically buying from a large bank or a private lender when you buy a foreclosure, so offers usually require more than one approval. It also might take longer to move the sale through the pipeline.
You can mostly expect negotiations to be slower and more difficult than they would be with a traditional seller. Banks are looking to recoup as much of their losses as they can, so they will likely present a counteroffer during the talks, which must be approved by many people.
You can include a home inspection clause and negotiate on repairs and pricing based on the report's findings when you purchase in a traditional home sale. However, these sorts of requests and deals aren't allowed when buying a foreclosed home at auction.
- Foreclosures occur when the owner of a home stops paying their mortgage and falls more than 120 days behind on the loan.
- Banks and government agencies claim these homes and then sell them to try to recoup their money.
- You can buy foreclosed homes at auction or straight from the bank or agency.
- It’s often harder to deal with a foreclosure purchase when big banks are involved, but you'll probably pay less.