When buying a foreclosed property, you can often finance it with a mortgage, the same as a conventional transaction. But that isn't always the case. The best deals usually go to buyers who can put up cash. If you are planning to finance, there are some special programs for both investors and buyers seeking a home for their own use that are worth knowing about.
Distressed properties make up a big chunk of the residential real estate market these days. According to the National Association of Realtors, 29 percent of all previously owned homes sold in February of this year were either foreclosures or short sales, mostly the former. Nearly one-third of all home sales were cash, suggesting that a big chunk of the market is getting snapped up by investors.
The best deals on foreclosed properties are at a sheriff’s auction, which is the first opportunity to buy them once they've been repossessed. However, sheriff’s auctions don’t offer opportunities to arrange financing – you have to pay cash up front. Sheriff’s auctions can also be risky for inexperienced buyers – for example, there’s little opportunity to inspect the property beforehand, so you can’t be sure what you’re getting. You may also find there are issues with liens on the property as well.
There are some investors who will offer private loans, known as hard money loans, for the purpose of purchasing foreclosures at a sheriff's auction, but they will typically look for borrowers who have some experience at this sort of thing.
That being said, there are other opportunities to buy distressed properties that allow you to arrange financing. The main one is on real estate owned properties (REOs), which are homes the bank retained after the sheriff’s sale. These are put on the market much the same as other homes, and you can obtain a standard mortgage for them. You also have the opportunity to inspect the property before purchasing.
There are some special types of financing available for foreclosed homes offered as REOs. Fannie Mae’s HomePath program offers financing on Fannie Mae-held REOs with down payments of as little as 3 percent, no mortgage insurance and no lender-required appraisal. In addition, you can borrow up to $35,000 for repairs and renovations as part of the purchase mortgage. The HomePath program is available to both investors and persons seeking to buy a home for use as a residence.
Freddie Mac's REO program, called HomeSteps, lists foreclosed properties that are available for purchase but does not provide special financing for them.
A similar program is offered by the VA for foreclosed properties it has acquired. VA Vendee Financing is available to both veterans and non-veterans and, like a standard VA mortgage, allows purchases with no down payment required for owner-occupants. Investors can put down as little as 5 percent and multiple investment purchases are allowed.
VA mortgages are also assumable, meaning a new buyer can take over a mortgage held by the previous owner. This can offer a way to get a good deal on a home that is in foreclosure, but has not yet been repossessed, by taking over the current owner's remaining mortgage debt.
The FHA does not have any special financing for its REO properties, called HUD Homes (HUD stands for the Department of Housing and Urban Development, which the FHA is part of). However, you can use a regular FHA mortgage, which allows down payments of as little as 3.5 percent, to buy a HUD home. For fixer-uppers, the FHA’s 203(k) loan program allows you to borrow additional money for renovations and repairs, up to 110 percent of the property’s projected post-improvement value.
FHA mortgages are limited to owner-occupants, but there is an opportunity for investors to purchase and rehabilitate multiunit properties of up to four units, provided that one unit is used as the borrower’s primary residence.
One other opportunity for financing the purchase of a home in foreclosure is to contact the current property owner and try to arrange a sale before the foreclosure is finalized. Called a short sale, this allows the owner to walk away from the property with no further damage to their credit and lets the bank avoid the costs associated with repossessing the property.
You can often get a better price than on an REO, although negotiating a price the bank will accept can be a drawn-out process. Even so, short sales are increasingly common and currently account for over one-third of all distressed property sales.
A short sale purchase can be financed with a regular mortgage, the same as other home purchases. However, realize that with the length of time it can take to close a short sale – often several months – you probably won’t be able to lock in an interest rate for the whole time. Also, remember that you don’t have to get your financing from the same lender that holds the current mortgage on the property – in fact, you may find it advantageous to go with a lender who is not involved in the sale itself.