Investing in Foreclosure: Know the Risks

Investing Basics, Real Estate, Retirement & Investing
on April 9, 2013

Investing in a foreclosed house may seem like a quick way to make a lot of profit in real estate selling. However, it’s a complicated process that comes with a number of different risks.


A foreclosure involves the lender taking over a property or home that was financed with a loan and the borrower failed to make timely payments. The term foreclosure technically represents the court order turning the property over to the lender as collateral for the unpaid loan balance. The lender can then sell the property to satisfy the outstanding loan. In some cases a house can be sold to satisfy other debts when ordered by a court.

Foreclosure sales regularly happen one of two ways: the lender takes control of the home and sells it to a new buyer, or the court sells the home at a court auction. Because of the legal technicalities, new real estate investors should practice with regular home sales first before trying a foreclosure flip.


Foreclosure can seem attractive because homes involved often sell for prices below what their market value is worth. If a home is in good condition and in a good neighborhood, it can then be cleaned up and resold for a profit, in theory. Buying a foreclosure can occur during a legal process or before it. A pre-foreclosure sale is known as a short-sale, which involves both the lender and the owner trying to sell the home at a less-then-market value just to get it sold. That way neither party gets stuck with foreclosure or a home that won’t sell. Short sales often happen in markets glutted with other foreclosures or heavy inventory of homes for sale. The other two ways, as discussed earlier, involve buying the home from the lender or at auction.

Investing Risks

Lender-owned homes are better known as real-estate owned properties or REOs. These are the safer of the two foreclosures. The same real estate selling rules on a new home apply to REOs. While in some states disclosure of damage is not required, new owners do retain the right to sue a lender to fix those damages if they weren’t disclosed during a sale.

Foreclosure in a bankruptcy should be avoided. If the bankruptcy claim isn’t finalized, any deed for a sale could be nullified by the court deciding the bankruptcy and who should get the property. That could leave a buyer out of money paid and property.

Auction foreclosures require non-refundable deposits without any inspection of the property. It’s a cash up-front situation where a party can get stuck with a bad property. Worse, a former homeowner could still sue to reverse the sale, so further legal costs can be involved. Many investors avoid auctions altogether.

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