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Updated September 18, 2020: The complexity of foreclosures may intimidate prospective buyers. Can you get financing if the house is run-down and in disrepair? Do you have to pay cash? Can you only get a mortgage from the bank that is selling the house?
People who don’t have a ton of money may be deterred from looking into distressed properties by the sheer complexity of financing. In reality, mortgages are used to buy a lot of short sales and foreclosures. You might even be able to use one loan to pay for both the purchase price and the cost of renovations.
Don’t you have to pay cash for a foreclosure?
First, let’s clear one thing up.
No, not always. Depending on the foreclosure stage the property is in, whether it is in preforeclosure, auction, or bank-owned A short sale is a method of selling a house that is in the preforeclosure stage. When the lender has taken possession of the property and is attempting to sell it, that stage is known as “bank-owned.”
You can use a mortgage to purchase short sales or bank-owned (also known as real-estate-owned or REO) properties. In fact, it’s common to do so. According to Wells Fargo, about 60% of its foreclosed homes were bought using financing.
Getting a mortgage can sometimes be trickier with foreclosures. Short sales, which occur when a home is sold for less than is owed on the mortgage, can be laborious to complete. They demand the mortgage lender’s consent to accept less than the amount owed on the mortgage. Waiting for a bank to approve a short sale could take months. Meanwhile, your interest rate lock could expire. The transaction might also fail if the owner manages to gather their debt and halt the foreclosure process.
At foreclosure auctions, paying with cash is typically required.
According to Philip Boroda, director of REOs and foreclosures for Coldwell Banker in Los Angeles, “If a consumer wants to bid on a house that appraised at $400,000, they’ll have to bring cashier’s checks in increments of $100,000.” Seasoned investors who purchase multiple properties might get different treatment. According to Boroda, he has observed that investors who place the winning bid occasionally have more time to raise funds.
The rules for auctions vary by state and county. For instance, if you are the successful bidder for a $100,000 home in Lorain County, Ohio, you must deliver a cashier’s check for $5,000 right away. After that, you would have 30 days to bring a bank check for the final $95,000.
The balance would begin to accrue interest at a fairly high rate of 10% annually if you missed the deadline. Worse, you could be held in contempt of court.
Fortunately, with foreclosure auctions, you only need to be concerned about these strict guidelines for cash purchases. Here are six options for financing a foreclosure for buyers who are considering bank-owned properties or short sales but don’t have a ton of cash on hand.
Buying a bank-owned home with a conventional mortgage
Foreclosed homes are often in terrible condition. Mortgage approval for a property that has been abandoned, damaged by the previous owners, or vandalized and stripped of its copper plumbing can be challenging. Banks typically won’t lend on a home with a missing furnace or a hole in the roof.
Homeowner’s insurance, which is necessary to close on a mortgage, can be expensive for an REO property in poor condition. Homes that are older or in poor condition carry more risk, so insurance companies typically charge higher premiums for them. This is often the case with foreclosed homes.
However, REO homes that are essentially habitable—even if they need some work—can be bought with a conventional mortgage from a bank, credit union, or mortgage lender. Like with conventional homes, lenders assess borrowers’ credit, income, and capacity to pay back loans in accordance with guidelines established by government-sponsored mortgage giants Fannie Mae and Freddie Mac.
Loan amounts go up to $484,350 in 2019. Some expensive locales have higher allowances.
Early preapproval for a mortgage is particularly crucial when financing the purchase of a foreclosure. By doing so, you’ll be better equipped to submit a serious offer as soon as you discover a desirable property, before wealthy investors buy it.
You can compare mortgage offers with the assistance of our partner ConsumersAdvocate. Note: If you click on the link below, we might get paid.
Get preapproved for a mortgage from the bank or lender selling the REO, according to experts.
“It’s against the law for them to make you use their lender,” They want to run you through their internal system because they do trust their lender and don’t want to waste time with an unqualified buyer, according to Orange County, California real estate agent and short sale expert Keith Watts.
You are free to compare prices and terms from various mortgage lenders, but it is worthwhile to learn what rate they are offering.
They might prefer that you obtain a mortgage from them as well, but Watts said they cannot imply that if you do not use them, you will not receive the deal.
Buying a foreclosure with a renovation loan
A renovation mortgage, which combines the purchase price and the construction costs into a single loan, can be used to finance a foreclosed home that requires extensive renovation. One popular program is Fannie Mae’s HomeStyle renovation mortgage.
Typically, a good credit score of at least 620 is required to be eligible. Borrowers with high incomes and excellent credit may be permitted to make a down payment as low as 5% of the purchase price.
Any type of renovation may be done with the funds as long as it is permanently attached to the home and can be finished in a year. To create a thorough construction budget, you must hire a licensed contractor. The renovation money doesn’t go to you directly. Instead, the money is placed in an escrow account and will only be used when necessary.
Typically, you can receive up to half of the funds right away, allowing you to pay for materials, hire architects, or obtain permits. According to a predetermined construction schedule, the remaining funds are deposited and distributed to the contractors when specific work milestones are reached. Once the work is complete, an appraiser must inspect everything.
Using an FHA loan to buy a bank-owned house
Federal Housing Administration loans might be the best option for people with less-than-perfect credit. Government-backed FHA loans are intended to help owner-occupants. They are not meant for investors or house-flippers. Almost any type of home, including bank-owned properties and short sales, may be purchased using an FHA loan.
FHA-approved mortgage lenders are prepared to offer more flexible underwriting and accept smaller down payments as a result of federal support. For a mortgage requiring a 10% down payment, a credit score of 500 is needed. If you have a score of at least 580, you might be able to submit the minimum 3 5% down.
FHA 203(k) renovation loans
Additionally, there are two distinct 203(k) renovation loan programs offered by the FHA for financing renovations.
The Limited 203(k) Mortgage allows you to add up to $35,000 to your mortgage to cover smaller projects like painting, kitchen remodeling, or fixing minor issues found by a home inspector.
A wide range of improvement projects, including structural repairs, are covered by the FHA 203(k) Rehab Mortgage. There are requirements to meet, such as the necessity of using an FHA-approved consultant. (Read more about home improvement loans. ).
The money can be used for significant tasks like roofing, plumbing, and landscaping as long as the property is at least a year old and the construction budget is at least $5,000. As long as the original foundation is still in place, they can even be used to rebuild a house that has been destroyed.
Home equity lines of credit for short-term financing
You can open a home equity line of credit, which functions somewhat like a credit card but is secured by the home you own, if there is equity in the property. Typically, lenders are willing to offer credit lines for up to 85% of home equity, which is calculated as the market value of the home less the mortgage balance. Only the amount you actually need is withdrawn, and only the money you actually use is subject to interest.
Generally speaking, using a HELOC for a down payment or long-term financing on a foreclosure purchase is viewed as a poor financial decision. Although they are lower than credit card interest rates, HELOC interest rates are typically higher than those on conventional 30-year mortgages. However, if you have a clear strategy for quickly repaying the borrowed money, a HELOC can be a source of quick cash for urgent projects. Experienced investors in foreclosures may feel secure enough to use HELOC funds for purchases, but there is always the possibility that something could go wrong and you lose your home.
Using hard money loans for real estate investments
Hard money loans are sometimes called “last resort loans. These alternatives to bank loans are frequently used by borrowers who aren’t qualified for a conventional mortgage or who require quick cash to purchase and quickly flip properties.
For sophisticated borrowers who are comfortable with risk and don’t mind paying higher fees and interest rates, hard money loans are the best option.
Good credit isn’t an issue with hard money loans. These non-bank lenders, who are typically small businesses or investors, focus more on the collateral than your past financial stability. They are worried about whether the asset used to secure the loan is valuable enough to safeguard them in the event that you default. You also have to have skin in the game. Down payment requirements can be as high as 30%.
Hard money loans can be processed in as little as a few days. When making an offer on a desirable foreclosure, speed can significantly affect the outcome. Some seasoned investors use hard money to purchase a foreclosure, renovate it, and then swiftly refinance to a more affordable conventional loan once the renovation is finished and the property passes a bank inspection.
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: Tom Rumble
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With 16 years of experience as a freelance journalist, Jeanne Lee specializes in writing about small businesses and personal finances. Fortune, Money, Fortune Small Business, and Health have all published her work. com and Financial Planning, among others.
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FAQ
What are the disadvantages of buying a foreclosed home?
- You won’t be able to inspect the interior of the home before bidding at auction.
- The process takes longer than a traditional buying process does.
- There may be expensive repairs you need to make.
- You might be forced into a situation where you must evict the previous occupants.
- You’re buying the home as is.
How long after a foreclosure can you get a conventional loan?
Conventional loans The typical waiting period before a foreclosure occurs is seven years, though it may be shortened to three years in exceptional cases.
What makes buying a foreclosed property risky select two?
As was previously mentioned, buyers of foreclosed homes run the risk of taking on the debts or liens of the prior owner. However, additional expenses that might not be apparent right away may also fall under the purview of the new buyer.
Can you borrow more than the purchase price of a house with a conventional loan?
Traditional mortgage plans do not permit borrowers to finance amounts above the sales price of a home.