Distressed house in the country.

Distressed Property: Everything You Need To Know

Jamie Johnson5-minute read

September 22, 2020

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Prospective home buyers are often looking for bargains, particularly in seller’s markets. Why pay full price for a home when there are so many deals you can take advantage of?


And one of the biggest opportunities to find a deal is by purchasing a distressed property. This happens when you buy a home below market value, usually intending to fix it up.

Distressed properties do come with a significant amount of risk, but they can be an excellent investment when done correctly.

What Is A Distressed Property?

A distressed property is a home on the brink of foreclosure or already owned by the bank. Investors often seek these properties out because of the opportunity to buy a home at a discount.

However, they’re taking a risk that the property might need significant repairs. There are three primary reasons for a distressed sale. Let’s look at each scenario in more detail.

Foreclosures

Many distressed houses are the result of foreclosures. This happens when a home buyer stops being able to make their monthly mortgage payments.

The bank forecloses on the home and repossesses the property. Occasionally, the lender may accept a deed in lieu of foreclosure to assume ownership.

In the case of a foreclosure, lenders are often anxious to sell these homes quickly, in accordance with state laws. They will typically sell the home via  foreclosure sale or at auction.

REO Properties

Properties that don’t sell at foreclosure auctions are known as real estate owned property, or REO properties. These homes are considered distressed property.

Lenders don’t typically want the responsibility of maintaining or repairing these properties and may be willing to sell them at a discount. So, if you know where to look, you might be able to snag a good deal by purchasing REO property.

Short Sales

And finally, homeowners facing foreclosure may be willing to do something called a short sale.

This typically happens when a homeowner becomes “underwater” on their home.

That means they owe more on the mortgage than the home is currently worth. In this situation, short sales are a more attractive option for the owner.

A short sale happens when a buyer purchases the distressed property for less than what the current owner owes on the mortgage. This allows the current owner to avoid foreclosure, and short sales usually result in a good deal for home buyers and investors.

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How Can I Find Distressed Properties?

If you’re a real estate investor, distressed properties can be a great investment opportunity. Not only will you purchase the property at a more attractive price point, but there’s usually less competition for these types of homes.

If you’re interested in exploring this option, here are a couple of ways you can find distressed properties that are available to purchase.

Real Estate Agents

The easiest way to find distressed homes is by working with a real estate agent specializing in these properties. The right real estate agent will be able to guide you through the process of finding distressed properties.

They may have more information about the home's condition and any risks you should be aware of. You can also ask them for recommendations on financing options.

Do-It-Yourself

However, you don’t have to work with a real estate to purchase a distressed property. If you have some experience in this area, you can do the legwork yourself.

To get started, identify a few different neighborhoods you’re interested in. From there, you can begin looking for homes that have fallen into disrepair. Then you can research the homeowners and find out if there is a potential buying opportunity.

Can I Finance My Purchase Of Distressed Houses?

Unfortunately, it can be challenging to finance a distressed property because the value is difficult for an appraiser to assess. And in many states, all-cash payments are a requirement for distressed properties sold at auction.

If you find a distressed property close to foreclosure, consider approaching the seller with a very lowball offer. Many lenders are motivated to move forward with the sale to avoid the foreclosure process.

What Are The Risks Of Buying Distressed Properties?

There are many potential benefits to buying a distressed property, but these purchases can be risky. If you’re a first-time home buyer, you should consider whether the risks are worth the potential rewards.

The house may seem like an incredible bargain. But you need to consider whether you’re ready to handle the delays, disappointment, and expensive repairs that often come with distressed properties.

Here are a few of the most significant risks that come with buying a distressed property.

Buying A Property As-Is

The biggest risk of buying a distressed property is that the home is often sold as-is. It’s hard to inspect distressed properties before the sale, particularly if they’re sold at auction.

And even if you do get the opportunity to explore the property, the seller doesn’t have any money. So, there’s no room to negotiate for repairs.

Being Outbid At Auction

When you buy a home at auction, you can either attend online or in-person. And online auctions are becoming increasingly commonplace.

But regardless of which path you choose to take, there’s always the possibility that you could be outbid at auction. There’s no guarantee you’ll be able to purchase the property until the sale has been finalized.

Purchasing Delays

If you’ve never bought a distressed property before, you may be surprised by how long the process actually takes. The sale is not as straightforward as buying a home from someone who’s current on their mortgage.

While it takes 6 – 8 weeks to close on a traditional home, it can take 6 months to a year to close on a distressed property. That’s because you’re usually dealing with the lender, and they don’t always care how long the process takes. Plus, there may be a lot of hoops you have to jump through to finalize the sale.

If It’s So Risky, Why Do People Buy Distressed Properties?

Now that you understand the risks that come with buying distressed properties, you may wonder why anyone would choose to go this route. Well, buying a distressed property does come with certain advantages.

Real estate investors, particularly those with contracting experience, often seek out these properties. That’s because they can get a good deal on the sale, and these individuals are well-equipped to handle any problems they discover on the property.

Many investors buy distressed properties and fix them up, only to either flip the house or rent it out. In general, most people don’t buy distressed properties planning to live in the home.

Summary: Distressed Property Can Be More Than You Bargained For

Distressed homes offer a unique buying opportunity for real investors, but the average home buyer should probably look elsewhere. You may end up biting off more than you can chew and would be better off taking a traditional route to purchasing a home.

If you’re interested in becoming a real estate investor yourself, you can get started online with Rocket Mortgage® by Quicken Loans®.

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Jamie Johnson

Jamie Johnson is a Kansas City-based freelance writer who writes about a variety of personal finance topics, including loans, building credit, and paying down debt. She currently writes for clients like the U.S. Chamber of Commerce, Business Insider, and Bankrate.