Should I buy a foreclosure for my first home?
Whether you should buy a foreclosure or not for your first home depends on a few different variables and your risk tolerance. Time it right, though, and it can be a great financial move for many reasons.
Should I buy a foreclosure for my first home? is an interesting question. Obviously the answer is going to be different for everyone, but there are some definite perks worth considering (as well as a few drawbacks).
Below we go into all of that, and we also talk about which websites are the best sites to find foreclosures in your area.
Why buying a foreclosure can be a GREAT financial move:
Equity is the name of the game when it comes to purchasing a foreclosure. Should you buy a foreclosure for your first home, that immediate equity is useful for a lot of things.
Equity, in case you don’t know, is the part of the home that you own. When you take out a mortgage to purchase a home, you make monthly payments to your lender. Should you sell before your home is paid off, you must first pay off your mortgage. Any amount leftover is yours to keep.
When you purchase a home below market value, you’re not only setting yourself up for a future financial windfall should you decide to sell, but you’re also opening the door to immediate equity.
Equity is great for a few reasons besides profit when you go to sell. For example, did you know that the average American pays between $1,000 and $2,000 a year in mortgage insurance? Buy a foreclosure at a low enough price with a conventional loan, and you may not even have to pay mortgage insurance.
Homeowners with conventional mortgages must pay mortgage insurance until they reach 20% equity. Buy a foreclosure with a low enough loan-to-value ratio, and you may not even ever have to pay it. This is one of the biggest reasons why the answer to should I buy a foreclosure for my first home is a yes for us.
The next thing to consider is the loan potential you get soon after closing. Home equity loans have some of the best rates on the market, and you could potentially qualify for one within six to 12 months after closing. You can use home equity loans for a variety of things, but savvy investors use home equity loans to purchase additional properties for future income potential. HELOCs (home equity lines of credit) are even more interesting in that they only require interest payments during the draw period.
Needless to say, there’s a lot of potential with home equity loans. Just make sure that whatever you decide to do with your home equity loan (should you decide to pursue one) improves your financial position.
Why buying a foreclosure may be too much of a hassle:
Let’s break this down by the various stages of foreclosure a house may be in. The term ‘foreclosure’ can actually mean a few different things.
There are essentially three categories of foreclosures you may see on sites like foreclosure.com. They are pre-foreclosure, auction foreclosures, and REOs.
Let’s discuss them one at a time. Once you understand the difficulties of each, you may very well discover your personal answer to should I buy a foreclosure for my first home.
Pre-foreclosures:
Pre-foreclosures have not technically been put into foreclosure yet. This bit may be obvious, but the key thing to remember is that the home is not up for sale yet. Should you have your agent contact the current homeowner, it’s essentially a cold call. This means you may get some pushback, or the exact opposite: the current homeowner may think you’re their knight in shining armor.
Another thing to consider is that any offer you make to the homeowner must be approved by their lender. Therefore, negotiations won’t be normal by any means.
You also may be working on a strict time limit. Approach the homeowner too late, and you may be told when and where the home is going to be at an auction.
Auction Foreclosures
Auction foreclosures usually require cash bids— meaning, you can’t usually use a home loan to buy an auction foreclosure. However, there are exceptions.
Should you find an auction house that allows financing, there are still some significant challenges you have to solve. Those challenges are:
Finding a lender that will finance an auction foreclosure: Most lenders are not willing to finance a foreclosure bought at an auction, and you may discover that finding one on your own is beyond your capabilities. However, if you find an auction house selling foreclosures in your desired purchase area that is willing to accept financing, you may ask them and see if they know of any local banks or credit unions that are willing to finance auction foreclosures. Chances are, they probably know of a few. Should I buy a foreclosure for my first home may be answered very quickly here.
Closing within the required amount of time in accordance with the auction company’s rules: Auction houses that allow financing typically still require full payment within a few business days. The time limit may make things logistically impossible, but it depends on your lender and chosen mortgage.
Proving the house meets livability standards: If you use either an FHA, VA, or USDA loan, all of these mortgages require the home to be at a certain condition. You will need to talk with both the auction house and your lender about how you’re going to establish the house qualifies for a government insured loan.
Paying the winning bid fee: The winning bid fee can be a significant amount. Amounts vary, but some auction companies charge up to 10% of the winning bid amount. Unfortunately, this amount cannot usually be financed into the loan.
Paying the required deposit amount to secure the home: The minimum deposit to secure the home is often 20-30% of the winning bid amount, but here’s the real kicker: If you are unable to close with your lender by the time full payment is due, you are at risk of losing your entire deposit with little to no legal recourse to recoup your funds.
Should I buy a foreclosure for my first home? Depends on whether you want to buy a foreclosure at an auction. All of the above may make things seem impossible, but, believe it or not, it has been done, and has been done a fair amount of times. In the real estate world, though, we lovingly refer to these people as unicorns. It’s the equivalent of winning the superbowl with a team full of rookies.
REOs
Real estate owned foreclosures are foreclosures that failed to sell at an auction and are now on the open market. This means that using a mortgage to purchase an REO should be much easier than an auction-foreclosure. However, there is often a reason REOs didn’t sell at an auction:REOs tend to need a lot of work. The homeowner either didn’t have the funds to keep up with repairs and routine maintenance, or they purposefully mistreated the home before the lender kicked them out. It is in no way a guarantee that this is true, but it is, unfortunately, often true.
So this is something to keep in mind if you buy an REO. You may have to spend a lot of your weekends going to and from your local hardware store. If this ends up being the case, the good news is that you will very quickly build up sweat equity. Easy sweat equity is definitely a check mark in the yes column for should I buy a foreclosure for my first home.
If you find an REO in the country, you may want to consider using a USDA loan to finance the purchase. If you and the house qualify, USDA loans don’t require down payments, which means you could use the money you were planning on using as a down payment to fix the home up instead. If you think you might move in a few years, you may see a significant return on your money.
One last thing to consider with REOs is that, if a particular home comes up on the market that is in good condition, you can expect a healthy amount of competition. If it’s below market value, consider offering the full asking price, if not a little more. Sometimes, just an extra $500 is all you need to have your offer accepted. If numerous things come up during the inspection (and you have an inspection clause), you can always use that information to try and talk the price down a bit.
Pros and Cons of Buying a Foreclosure for Your First Home
Should you buy a foreclosure as your first home? Here’s a quick recap of things to consider when considering a foreclosure as your first home:
Pros:
Potential for a lower purchase price compared to the property’s market value
Potential for immediate equity, which means there is the potential to:
Avoid mortgage insurance (if using a conventional mortgage)— the average homeowner pays $1,000-$2,000 a year in mortgage insurance
Take out a home equity loan or cash out refinance as soon as 6-12 months after closing (FYI: home equity loans have much lower interest rates than traditional credit cards and personal loans)
Make a much greater return when you sell
Cons:
Pre-foreclosures require negotiations with the lender, and you may be put on a time limit before the home goes to auction, which often makes the purchase logistically impossible
Plus, homeowners in pre-foreclosure have not listed their home for sale yet, and may be put off by your offer or have unreasonable expectations
Auction-foreclosures often require cash-only bids, but it is possible to find auction houses that accept financing and lenders that are willing to finance auction-foreclosures, but finding both may prove difficult
REO-foreclosures are often in need of repair and need a lot of money put into them
So, should I buy a foreclosure for my first home?
The answer to that question depends on you. One thing we might need to discuss are expectations. First houses are rarely mansions. If you’re looking at foreclosures because you want to buy a truly magnificent house, then you may be putting too much pressure on yourself. It’s not your job to impress anyone.
Once again, however, we like foreclosures because of the potential for immediate equity. Home equity loans are truly great financial products, and many savvy investors from humble origins have used them to catapult themselves to financial independence. Yes, we know how bold of a statement that is, but it’s true.
Nevertheless, don’t house hunt yourself to exhaustion. If you can’t make it work, don’t sweat it. If you are trying to save money on your house, there are many ways to do so. Buying a foreclosure is not the only way.
For example, you could:
Pursue a down payment assistance program in your area—down payment assistance programs are often forgivable loans, which means that as long as you fulfill your end of the bargain, you don’t have to pay the loan back. Those that aren’t forgivable loans are often just straight up grants. However, some are indeed loans that do have to be paid back.
Buy a mortgage point—pay 1% of your mortgage amount to lower your interest by 0.25%. The break even point before savings occur is usually just a few years.
Change your loan term— to pay less money in interest, choose a shorter loan term; to lower your monthly payment, choose a longer loan term.
Look at a different purchase area—sometimes just going down the road a few minutes lowers house prices dramatically.
If you’re hung up on immediate equity, also remember that most homes naturally appreciate every year. If you wait a few years before reselling, you will most likely make a bit of profit through natural appreciation assuming you’ve kept up with your home’s maintenance.
Where can you find foreclosures?
Where to find a foreclosure? All of the various websites you likely already know about list foreclosures. We prefer foreclosure.com because it’s super easy to differentiate between different types of foreclosures. Whether you want to try the pre-foreclosure route, the auction route, or the REO way, it’s easy to sort through exactly the type of foreclosure you want. Of course, you can also specify how many bedrooms and bathrooms you need, as well as anything else you’re looking for in a home. Just remember, the more specific you are, the fewer results you’ll likely get. However, if you see nothing but houses you want to buy, that’s a good thing.
Conclusion
Did we help answer your question: Should I buy a foreclosure for my first home?
Whether you should buy a foreclosure for your first home or not depends on the home and your needs. If you’re buying your first home, you will likely have the most success by pursuing an REO foreclosure. However, keep in mind that REOs are often foreclosures that went to auction but failed to sell, which means whatever you find may need a little bit of work.
If you want to see which foreclosures are in your area, consider visiting foreclosure.com. We like foreclosure.com because they make it easy to filter by location, listing type, property features, and price. If you’re serious about buying a foreclosure, this is the site you want to use.
Also consider taking a look at our Homebuyer’s Workbook, which is an online printable PDF. We cover a lot of topics in it, including bidding strategies for both buyer’s markets and seller’s markets, determining how much house you can truly afford, and how to locate down payment assistance programs in your area. And, of course, we also talk about foreclosures, Here’s a quick look at the Table of Contents:
FAQ
Can you buy a foreclosure with a VA loan?
Yes, you can, but certain foreclosures are easier than others. As we discussed above, REOs are the easiest to buy with a VA loan, but all of them are theoretically possible. The key thing to keep in mind is that the home must meet livability standards, and VA loans can take longer to process than conventional loans.
Can you buy a foreclosure with an FHA loan?
There is no law or regulation that stipulates you can’t buy a foreclosure with an FHA loan. However, the home must meet FHA guidelines, and, as with VA loans, FHA loans can take over a month to process. If time is of the essence, FHA loan logistics may make things impractical for any foreclosure that is not an REO foreclosure.
Can you buy a foreclosure with a USDA loan?
As with the above two loan types, there is nothing preventing you from using a USDA loan on any type of foreclosure. And, like FHAs and VA loans, USDA loans require the home to be in a certain condition, which may make things difficult if you want to buy a foreclosure at an auction. Your lender must be able to verify the condition of the home before it will approve for a loan with it.