What is a Foreclosure Investment?

A foreclosure investment is the purchase of a property where the homeowner has defaulted on a mortgage. This creates the potential opportunity for the investor to buy a property at below current market prices and sell at a profit. There are several different ways to make a foreclosure investment, depending on what stage the foreclosure process has reached.

Despite the name, a foreclosure investment can be made before foreclosure, the formal point at which the mortgage lender takes control of the outstanding equity in the property, has taken place. This covers the time between the lender issuing a formal notice of non-payment and the court granting a foreclosure. Usually, the proposed foreclosure will be listed in publicly available papers. Until the foreclosure takes place, a third party can make an offer to buy the property from the owner.

It may seem that such a pre-foreclosure sale will be an opportunity for a bargain with an owner desperate to sale, but it's important to note that the lender may be able to block any sale that would not produce enough money for the borrower to pay off the outstanding mortgage amount. There are other risks as well — the buyer may take on responsibility for unpaid utility bills and taxes on the property. It's also possible that such a sale will not be valid if the homeowner has gone into bankruptcy.

The second stage where a foreclosure investment could take place is at auction. After foreclosure, the home will be advertised for auction, usually with a reserve price equivalent to the outstanding mortgage amount. In many cases, there will be no bidders and thus the lender takes ownership of the property. One risk in buying in such a situation is that the sale will usually be on the basis that the buyer — who has not inspected the home — has no guarantee about the condition of the home. Another risk is that if the home is in negative equity, the amount needed to win the auction may be more than the market value of the house.

The final opportunity for foreclosure investment is when the mortgage lender has taken control of the property and offers it for sale. The house is then known as a real estate-owned property. This is arguably the safest opportunity for foreclosure investment, as a full inspection will be possible, and there will be fewer risks of legal challenges to the sale. It is also more likely that the house will sell for a low price, as by this stage the lender may be willing to cut its losses and simply get as much as possible for the house, rather than risk having to hold on to it for a long time.