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Understanding What “Buying a Foreclosure” Means

Understanding What “Buying a Foreclosure” Means

What is Buying a Foreclosure?

Many first-time homebuyers and starting investors hear the great things about buying a foreclosure.  They hear about getting great deals and then they want to jump on the bandwagon and ask about buying a foreclosure.

When they approach me with this question the first thing I have to do in order to have clarity on their understanding of the question is to ask, “What do you mean about buying a foreclosure?” This may seem like a silly question until you actually understand the question that is being asked.

To me, this question has a few separate potentially unrelated results.

Buying a Foreclosure Means Buying a Home with Equity

When a buyer or beginning investor asks the question about buying a foreclosure, they are not actually asking me that question.  They are usually asking me about buying a home that could have a lot of equity in it.  This is usually meaning a home that may have repairs or other issues with the home.  Those issues would thus relate to purchase the home below market value.

They are wanting to buy a home that is “distressed”.  In their minds, they think a distressed home must be a home that is in financial default.  This may be true or may not be true.

The Two Main Questions A Buyer is Actually Asking

When a buyer is asking about buying a foreclosure they must understand the foreclosure process first in order to understand the question they are asking.

Let us begin by talking about the foreclosure process.

According to Wikipedia, a foreclosure is “a legal process in which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender by forcing the sale of the asset used as the collateral for the loan.”  To me, I call this home to be in foreclosure.   The procedure to purchase one of these homes is called a short sale.

The other meaning is when the bank has retaken possession of the home and it is now part of their inventory.  I call this home to be “foreclosed upon”.  The procedure to buy this type of property is the same as buying a home owned by an individual.  Thus, this procedure is a normal purchase.

In a sense, when someone asking about buying a foreclosure I need to know which side of the coin are they actually asking.  Are they wanting to purchase where the borrower is still the owner and they want to work on a potentially lengthy short sale process?  Or, are they wanting to do a typical purchase transaction where the seller is an unemotional bank?

There are pros and cons to both.

Pros and Cons for a Short Sale

When attempting to buy a home that is still in default then you must go through a short sale process.

The word short sale may seem a little misleading as this is not usually a short-in-time process.  It can take several months or even several years to complete.

The definition of a short sale means that you are buying the home at a price lower than what is actually owed on the home.  Thus, you are buying a home short of the actual note.

There are actually two types of short sales.  The terms that I use is a bank approved short sale and the other is a bank non-approved short sale.  The difference between the two is what will determine the length of time a buyer will be involved with the process.

A Brief Look into the Short Sale Process

When an owner begins to feel overwhelmed by their monthly expenses they may start to fall behind on their monthly payment.

They are also going through some type of financial hardship.  This can come from many different sources from divorce, job loss, death of a spouse, and the list can go on and on.

At some point in time, they may list the home with a REALTOR® in order to get the process started.  Usually, the bank is contacted to let them know that the borrower is trying to do something positive.  Often this will help delay the home being foreclosed upon.  The house is now “in foreclosure”.

The house is listed by the REALTOR® at a price he/she thinks is fair and the seller agrees to this price.  The bank has not approved of this price.  In my opinion, this price is completely irrelevant at this moment in time.

A buyer may come in and look at the home.  They may even give a full price offer.  Let us assume they do give a full listing price offer.

The listing agent then presents the offer to the bank.  The bank will then take the offer to a committee of people to approve, reject, or counter the offer.  This committee may take 1 – 12 months go get back to you.  This is where the delay occurs during a short sale process.

The reason it may take so long is that all liens against the property must be approved by all parties.  Thus, if there is a second mortgage, an HOA default, and any other junior lien holders they must agree to their compensation.  Any of the junior liens can hold up the process.


Let’s look at this as an example.

Assume a borrower bought a home for $500,000 and he still owes $450,000.  Let us assume that he got the first lien at $400,000 and a second mortgage lien at $50,000.  Let us also assume he missed some HOA payments that now has a lien of $10,000.

The house is offered for sale at a value of $300,000.  Obviously short of what is owed.  How is that $300,000 going to be distributed so that all parties feel they are fairly compensated?  And, let say that $25,000 of that will be going to REALTOR® commissions and closing costs.  Thus, $275,000 will have to go to all the lienholders.  Who gets what to the penny?  And, all parties have to agree separately to the amount they are getting.

Many times they will counter back at a price that may not even appraise at. This is also why many short sales fail.

The Approved Short Sale

An approved short sale occurs when an agreement on price was established with a previous buyer yet they failed to execute and close on the transaction.  In these cases, the lien holders have already agreed on what they will accept.

If the new buyer were to offer at that price then the process becomes pretty easy and you can close like any other transaction.  If the buyer offers less than the approved amount then the entire committee process must begin again, from scratch.

A Foreclosed Upon Home

When a bank takes possession of a home they may have the home repaired and then they will list with one of their approved listing agents.

Typically, these homes are listed at realistic market values.  Since the bank has already approved of the purchase price then there is no need for a committee to become involved.  All previous liens have been wiped out by the foreclosure on the home.  Those liens are no longer attached to the home.

When a buyer makes an offer at or above list then the process is pretty simple.  If an offer comes in lower than asking then the person in the loss mitigation department will make the decision on what to do.  They may accept, counter, or reject the offer.

Regardless, it is the same process as you would see when dealing with a normal buyer.

In Conclusion

When a person is looking at buying a foreclosure they must understand which side of the coin they are on.   Are they looking to try and get a good deal on a short sale or are they wanting to deal with an unemotional bank?

If they are looking to buy a home and realize a lot of equity they are most likely leaning to buying a short sale home where they are buying a home that is financially distressed and could also be physically distressed.

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Kevin A Dunlap

Kevin Dunlap is an author, podcaster, speaker and a licensed Nevada REALTOR® since September 2012. He has been involved in real estate since buying his first investment property in February 2002. He has also owned two small apartment complexes. He has specialties in creative real estate deals such as lease options and seller financing, as well as the normal purchase or sale of homes, condos, and townhouses. Kevin also has a team to help people who are employed in the Cannabis industry to buy homes, too.

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