A foreclosure auction is the last step of a difficult, often heartbreaking process: the homeowner has defaulted on his mortgage, his lender has finalized proceedings to reclaim the home, and the property is sold to the highest bidder, often on the courthouse steps. The rules can vary considerably by state, but in most jurisdictions, anyone at all can bid just by showing up and participating.
By definition, a foreclosure involves an unpaid, outstanding home loan – and the lender wants its money. It will almost invariably send an agent or representative to the auction to ensure that no other bidder walks away with ownership in exchange for a negligible sum. If this were to happen, the lender would lose its collateral and have nothing to show for it, such as if the outstanding mortgage were $200,000 and the winning bid were $500. The lender is not going to risk losing $199,500, so it will typically have someone in place to bid the property up to an amount that it is willing to accept. Some states, such as Hawaii, allow lenders to avoid this process by simply establishing the minimum bid ahead of time. If no one bids more than the lender, it retains ownership of the property and typically attempts to sell it through a real estate broker.
Many states allow the homeowner himself to show up and bid on his home, but this has a few disadvantages. If the lender opens the bidding at the amount of the outstanding loan, or has its representative drive the bidding up to this price, the homeowner could end up paying more than the original loan balance the lender foreclosed on. Even if the property sells for less than the loan balance, in some states the homeowner might still find himself on the hook for the difference because he was the original owner. For example, if he bids $150,000 and the outstanding mortgage is $200,000, he'd owe the $150,000 plus the $50,000 difference. He'd reclaim his home, but with the same indebtedness that he was unable to pay in the first place. This doesn't always happen – in some states lenders are permitted to forgive or cancel the deficiency – but it's a risk that should be taken into consideration. Other states disallow this practice, particularly those that recognize deeds of trust to secure home loans rather than mortgages.
Foreclosures have a reputation for selling for less than their fair market value, and this attracts a fair amount of investors to auctions. These individuals tend to be savvy with the auction rules in their particular jurisdictions and they typically have an edge over novice bidders. They also usually have ready cash to invest and this sometimes translates to paying an additional $5,000 or $10,000 to ensure getting the winning bid, still well below value.
With the exception of the lender or its representative, whoever shows up at a foreclosure auction to bid must be prepared to make at least some payment immediately. Some states, such as Hawaii and New York, require the winning bidder to pay only 10 percent of the purchase price the day of the auction, but it must usually be by certified check or cash and he must then finance for the remaining balance within 30 days or so or risk losing his down payment. Other jurisdictions require that the high bidder pay the entire bid at the time of the auction.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.