What Is a Foreclosure?

What Is a Foreclosure and How Does It Work?

A home in foreclosure.
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Homebuyers who want a good deal in real estate often think about buying a foreclosure. Unfortunately, their thinking is clouded by misconceptions. They think, with a little work, they'll get a cheap price on a nice home. In other cases, they might believe banks are desperate to dump an awful home. Neither assumption plays out exactly this way. The real scenario is often ugly and complicated.

A foreclosure is a home that belongs to the bank, which once belonged to a homeowner.

The homeowner either abandoned the home or voluntarily deeded the home to the bank. You may have heard the idea of a bank "taking the property back," but the bank never owned the property in the first place, so the bank can't take back something it did not own. Instead, the bank foreclosed on the mortgage or trust deed and seized the home. There is a difference.

Why Sellers Go Into Foreclosure

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Sellers stop making payments for a variety of reasons. Few choose to go into foreclosure voluntarily. It's often an unpredictable result from something like:

  • Being laid-off, fired, or quitting a job
  • An inability to continue working due to medical conditions
  • Excessive debt and mounting bill obligations
  • Squabbles with co-owner or divorce
  • A job transfer to another state
  • Maintenance issues they can no longer afford

During the market crash from 2005 through 2011, many homeowners simply walked away from their homes because the values had fallen and they owed more than their homes were worth. This was not the best solution, in most cases, but it provided some immediate relief for homeowners.

Negotiating Directly With Sellers in Foreclosure

Investors who specialize in buying foreclosures often prefer to purchase these homes before the foreclosure proceedings are final. Before approaching a seller in distress, there are factors you want to consider.

Foreclosure proceedings vary from state to state. In states where mortgages are used, homeowners can end up staying in the property for almost a year. In states where trust deeds are used, a seller has less than four months before the trustee's sale.

Almost every state provides for some period of redemption. This means the seller has an irrevocable right during a certain length of time to cure the default—including paying all foreclosure costs, back interest, and missed principal payments—to regain control of the property. For more information, consult a real estate lawyer.

Many states also require that buyers give to sellers certain disclosures regarding equity purchases. Failure to provide those notices and to prepare offers on the required paperwork can result in fines, lawsuits, or even revocation of sale.

Finally, determine whether you're the type of person who can easily take advantage of a seller's misfortune under these circumstances and/or put a family out on the street. Critics will argue it's just business and sellers deserve what they get, even if it's five cents on the dollar. Others tell themselves they are "helping" the homeowners avoid further embarrassment. However you think about it, it's important to prepare for the emotional situations that can come with dealing in foreclosures.

Buying a Home at the Trustee's Sale

Check with your local county office to find out how sales in your area are handled. As an example, factors in Sacramento, California that are also common throughout the U.S. include:

Sometimes buyers are not allowed to inspect the house before making an offer. On top of that, you may need to evict the tenant or owner from the premises after you receive the title, and eviction processes can be costly.

The problem with buying a house sight unseen is you can't calculate how much it will cost to improve the structure or bring it up to habitable standards. Nor do you know if the occupant will retaliate and destroy the interior.

Another drawback could be liens recorded against the property that will become your problem after title transfer. Some investors who buy at trustee sales pay for a title search in advance to avoid this problem. The people who show up to bid on the courthouse steps are professionals, and they buy foreclosures at auction as a business. They hope to buy the foreclosure at a low price to make a nice profit when they later flip the home. You do not need to hire a real estate agent to buy a foreclosure at the auction, but you do need to prepare to compete with the pros.

Buying a Foreclosure From the Bank

Many banks do not sell homes directly to investors or homebuyers. If a bank is willing to sell homes individually and not in bulk sales, the bank will generally list the home through a real estate agent. There are REO agents who specialize in foreclosure listings.

It is more common to buy a foreclosure directly from the bank in a bulk sale purchase. In bulk sales, the banks will package a bunch of properties into one transaction and sell them all at once to one entity. That is the best way to buy a foreclosure—if you can afford it—because the discounts are typically the steepest.