When searching for a home to buy, you may come across a home for sale or a listing described as a "distressed property".  Usually the term distressed property will mean that the home is either in foreclosure or in a short sale situation.

After the 2008 recession, in many areas of the United States, the housing market had many of these types of homes for sale. Often, these homes are priced below other homes of similar size and features, making them a tempting buying possibility. But prospective home buyers should proceed with caution. There are both benefits and pitfalls to purchasing a distressed property.

Remember to consult your real estate agent and/or financial advisors to discuss the options for your individual situation.

Foreclosure

A foreclosure usually occurs at some point after the homeowner falls significantly behind on mortgage payments. When there is a mortgage on a home, the bank or financial institution holding the home loan will have a lien on the home. A lien is considered to be the collateral for the loan. The home itself acts as collateral on the mortgage loan (through the lien), which means the bank or financial institution issuing the loan has the right to seize and sell the property in order to pay-off the mortgage loan.

In foreclosure, if the home is not sold to a third party, ownership may revert back to the lien-holder. The home will then be referred to as a bank-owned property. Bank-owned properties are usually then listed with a real estate brokerage or sold by the bank at a liquidation auction.

Short Sale

A short sale on a home is sometimes used to prevent or avert a property from going into foreclosure. Depending on the lender, after a homeowner has no made several or many mortgage payments, the lender may issue an official "Notice of Default" and then initiate a “pre-foreclosure” period. During this time, the homeowner may have the option to work out an arrangement with the lien-holder called a short sale. In a short sale, the market value of the home is said to be less than the amount owed on the mortgage. So when the home is sold, the bank or mortgage lien-holder will be "short" in paying off the mortgage.

Depending on the State and/or the lien-holder, this shorted amount (the difference between what the home sold for and the mortgage) may or may not be forgiven to the homeowner. Short sales can be confusing and time consuming. Home buyers are encouraged to use the services of an experienced short sale real estate agent if they are interested in buying a short-sale home.

Should a Homebuyer Consider a Distressed Property?

Distressed properties are often tempting to buyers because they may seem like a good value for the money. While this can be true, there are also some potential pitfalls and issues with purchasing a home in foreclosure or in a short sale. Real estate professionals often see prospective home buyers become fixated and intent on getting a great bargain and deal on the home. This fixation on price may cause the homebuyer to not see or understand that the home may need quite a lot of repairs or that the process to buy may be stretched into many months of waiting. 

When buying a distressed property, it is recommended to; 

Attend the Home Inspection

Not only is it recommended that a homebuyer have a home inspection on a distressed property, its also recommended that the buyer attend the inspection if at all possible, then review the inspector’s report and talk to the inspector. They can often shed a lot of light on the condition of the home and give you an unbiased opinion.

Research the Property

Bank-owned properties often sell “as-is,” which means they will usually not pay for any repairs to the home prior to sale. And in many states and locations, the lien holder (bank) may not be obligated to disclose any problems or issues with the home. This is why a home inspection is a must. Also, using the services of a qualified real estate agent can help buyers find out more about the distressed property.

Be Realistic

Whether a home buyer is purchasing the distressed property for themselves or to use as an investment property, it's important to be realistic about the purchase price and the repairs that the home may need. Buyers purchasing a distressed property for use as a rental home (and using a mortgage to do so) should calculate whether the amount of rent they can charge is greater than the expected monthly mortgage payments. And if a homebuyer is purchasing the home as a personal residence, they should be realistic about the cost of repairs and the time that it will take to complete those repairs.

If a homebuyer chooses to go the distressed property route, using the services of a real estate professional would be a great start. Your agent will have access to the resources that can give a clearer picture of the home, and help you make informed decisions on buying a distressed property.