The benefits and drawbacks of purchasing a foreclosed property depend on the foreclosure phase the home is in. You can buy a home at a foreclosure auction or trustee sale. Or you can buy the home as real estate owned, an REO, which results when a home fails to sell at auction and the foreclosing lender takes over ownership to sell. Purchasing a home at an auction is typically for seasoned investors who have the cash in-hand and can close quickly. REOs cater more to the average homebuyer who may need a mortgage and time to inspect the home.
Auctions Provide a Steal of a Deal
You can get a foreclosed home for a low price at an auction because the foreclosing lender is looking to recover the outstanding balance it's owed and not necessarily the home's fair market value. For example, if the homeowner was unable to make payments on a mortgage with a remaining balance of $100,000, yet comparable homes in the area sell for $200,000, you can potentially score the home at a great price. The lender would be looking to recoup the mortgage balance plus legal fees incurred in the foreclosure process, which may total far less than $200,000.
Property Problems Add Up
The disclosure rules that apply to a traditional home purchase don't apply to auctions. Therefore, buyer beware: In exchange for a low price, you may end up paying big bucks to bring the home up to par. Disgruntled homeowners may have wrecked the home before moving out, and the lender doesn't have to disclose property condition. Other drawbacks to bidding on an auction include:
- They are usually all-cash deals with no financing allowed.
- You must pay in full on auction day.
- They are sold as-is; thus you can't inspect before buying.
- You're responsible for any unpaid liens on the title for taxes and junior mortgages.
- The lender doesn't pay buyer's agent commissions or attorney fees.
The Pros of REOs
An REO sale resembles traditional sales. The lender that owns the home wants to unload it quickly to recover its losses. Because the lender is motivated, it's usually willing to negotiate more reasonable terms regarding financing, down payments, inspections, time frames and closing costs. REOs have other advantages:
- The home usually has a clear title free of liens.
- The property is vacant, clean and may include repairs and improvements.
- The lender often pays buyer's agent commissions.
- The sale is subject to traditional closing timelines and conditions.
REO Property Pitfalls
Like a foreclosed home sold at auction, an REO may not be in the best condition, and the lender isn't obligated to disclose this. You'll have to rely on your own inspections and documentation on the property's history to uncover the facts. Because the lender, like any home seller, wants to know that you can close, it may ask for a lot of paperwork upfront. Offer acceptance may require a mortgage preapproval letter from your lender and proof of funds for your down payment. An REO lender may also require you to sign legal documents or addendums to the contract to protect its interests. Consult a real estate attorney about contract terms before signing.