After huge upheavals in the housing market throughout the 2000s, the market showed signs of leveling off by late 2010 and early 2011. Still, despite hopeful economic indicators, as of 2011 a full third of all houses on the market were distressed properties -- those whose owners have defaulted or are about to default on their mortgages [source: Gibbs]. Largely because of desperation on the part of the owners of these properties, and their lenders, distressed homes can be much cheaper than comparable homes for sale. There are a few basic types of distressed properties.
In a short sale, a property is headed for foreclosure, and the owner of the home tries to sell the house for lower than what is owed on the mortgage. The lender takes a hit on the price to avoid foreclosure and cut its losses. When prices in the area have plummeted so far that it would be nearly impossible to sell the house for the value of the mortgage, short sales give lenders and homeowners a way out of the loan agreement.
At a foreclosure auction, banks and other lenders auction off properties that have been repossessed from owners who defaulted on their mortgage loans. Auctions are held at public facilities like courthouses and are best left to investors with large amounts of cash to spend. Individual buyers should usually steer clear, since all bids have to be backed up with a check in-hand for the entire sale price [source: Fulmer]. Even more frightening is the fact that houses at auction are usually purchased site unseen.
An REO (real estate owned) foreclosure is what people are usually talking about when they describe a property as a "foreclosure." This is a bank- or lender-owned home that you purchase directly from the lender in a process similar to typical home sales.
All distressed properties have the same basic advantages and disadvantages. On the plus side, a distressed home will typically be priced significantly lower than it would be sold for if it weren't distressed [source: Re/Max]. But these houses won't necessarily be dirt cheap. Widespread foreclosures drive down prices of non-distressed homes, so you might not need to seek out distressed homes to get a bargain [source: McQueen]. On the down side, distressed homes take more time and effort at virtually every stage of the process, require a large amount of paperwork and frequently need major repairs [source: Re/Max]. Read on to learn when you should go for it, and when you shouldn't, when it comes to distressed property purchases.