Overview of
Foreclosure Investing
A Straightforward Tutorial on
Foreclosures, Pre-Foreclosures and REOs
How Does the Foreclosure Process Work?
To start, when an individual takes out a mortgage
to buy his or her house the bank gives the individual a loan, but secures it
with the real estate in question. Th us, whenever you take out a mortgage, you
execute two documents: one is the actual note for the mortgage loan, and the
other is the security agreement specifying that, in the case that you default on
your mortgage payment, the bank can foreclose on the real estate you are buying
and that you put up as a security.
If, Heaven Forbid, one does end up in serious
default with mortgage payments, the bank will prepare, send, file, and record a
document known either as Notice of Default or a Lis Pendens, the latter meaning
literally that a lawsuit is pending. These documents simply let the outside
world know that a foreclosure action has begun.
The two documents for the most part mean the same
thing, except that a Lis Pendens is utilized in states when there are judicial
foreclosures – that is, where the court is involved in the foreclosure process –
and a Notice of Default is utilized in states with non-judicial foreclosures –
where court is not involved, and where instead once certain requirements are
met, the lender can conduct the foreclosure on its own. (Some states -- commonly
known as hybrid states -- also have a mix of a judicial and a non-judicial
foreclosure processes.)
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Pre-Foreclosure Stage: The First Buying
Opportunity
The period from the time of the Notice of Default
or Lis Pendens, to the actual foreclosures sale is the first stage of
foreclosure, and the first opportunity for the general public to buy up
potential real estate bargains. Here, one can approach the owner of the property
and offer the buy the house before it gets sold at the foreclosure auction.
Buyers can actually get a great bargain here by offering the homeowner l ess than
the equity the homeowner has in the house. This way, the homeowner can avoid
losing the house completely, and can even walk away with a little cash in his or
her pocket. This is a very lucrative stage to buy. Your bargaining leverage at
this point is tremendous because:
- if the homeowner lets the home go to
foreclosure, he/she will lose it completely,
- the homeowner’s credit will be ruined; and
- if the subsequent foreclosure auction does not
fetch enough of a price, the lending bank can go after the homeowner for a
deficiently judgment
You, on the other hand, can walk away with a
great bargain.
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Foreclosure Auction Stage: Second Buying
Opportunity
If the owner is unable to sell the property
before the auction takes place or if the default is not otherwise cured before
the scheduled foreclosure sale, the house will go to sale and the referee or
trustee (in many cases,
 the county Sheriff) will sell it to the highest bidder
to attempt to cover the outstanding mortgage balance plus expenses. This
represents the second stage of the foreclosures process, and yet another
opportunity to buy up a bargain property.
Once the date of the auction is at hand, the
trustee will auction the house off to the highest bidder. At this time, most
banks and other lenders will pay off any outstanding debts such as property
taxes or amounts owed to the IRS so to be able to to sell the foreclosure real
estate with a clear title. You should also know that most often, the bank will
submit a credit bid, which is simply the outstanding loan amount (along with any
other out-of pocket costs), and so the bidding will not begin from zero.
That having been said, buying property at a
foreclosure auction is an experience unlike any other in purchasing real estate.
Although it can be a risky venture, it can often also very lucrative.
Consequently, while you should try to participate in a foreclosure auctions,
first-time and inexperienced investors should tread very carefully. In contrast
to an ordinary real estate sale, most times a potential buyer will not even be
allowed to inspect or survey the property prior to the auction. Partially as a
result of that, and owing partially to the fact that one will have to come up with
the entire purchase price in cash over a short period of time, a purchaser at a
foreclosure auction would likely have to find nontraditional financing and then
later refinance to a more traditional mortgage.
Although very rare, buying real estate at a
foreclosure auction comes with at least the theoretical possibility that the
former owner will exercise his/her right of redemption by coming up with the
cash to buy the house back within a certain allocated period of time after the
foreclosure sale. (Although many jurisdictions do not have right of redemption
provisions.) Another warning is that IRS also has several months to redeem the
property if back taxes are owed. But this rarely happens, and if back taxes are
indeed owned, and the bank has not taken care of this prior to auction, you can
always calculate it and figure it into your bidding price. The bottom line is
that is you should be aware of the aforementioned pitfalls, but these same
characteristics of a foreclosure auction that make it an inconvenient and
somewhat burdensome process are what keep many reserved or timid bidders away,
and therefore allow you to bid on the property with less competition.
If you decide to attend this type of auction
you're probably curious as to where they're held. Foreclosure auctions are
typically held at the property's local courthouse or at the property itself
(although this is rare.) If you’ve never been to an auction, when a property
goes up for foreclosure auction, the competition can initially seem even be
intimidating. Don't let this discourage you because purchasing real estate this
way is ultimately be very lucrative, and that’s why investors and others do it.
If you're interested in attending a foreclosure auction you should consider the
following:
- Investigate the condition of the foreclosed
property and along with that make sure you research any existing debts such as liens, unpaid taxes and
previous construction debts that were not taken care of by the bank.
- Scope out any possible land use issues such as
zoning problems or toxic waste.
- Find out ahead of time the auction rules and
make sure you have a good handle on how the auction process works.
- One way to do this is to sit in (without
bidding) on some foreclosure auctions ahead of time.
- Do all the calculations, decide, taking all
potential costs into consideration, what your
maximum offer will be in advance, and make sure not to go above it under any
circumstances.
- Arrange for any financing you may need ahead
of time with short-term lenders (sometimes known as hard-money lenders) with a
view towards flipping or refinancing later.
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REO -- the Last Stage of Foreclosure: Third
Buying Opportunity
When a property does not fetch a high enough of a
price at a foreclosure auction – and there are various reasons for this – the
bank or lender will take the property back, and if they are an institutional
lender, the property will become known as an REO (Real Estate Owned) property.
These lenders aren’t usually too interested in
keeping the REO for very long, since banks are not in the business of managing
real estate, and are therefore anxious to liquidate these properties as quickly
as possible. This presents yet another opportunity to, once again, get a
potential bargain on real estate.
Investors who consider purchasing an REO usually
have two distinct advantages that they would not have had they instead been
dealing with a property at a foreclosure auction. First, the benefit of an buying in
the REO stage is that you are able to inquire and ultimately buy the property at
your convenience with no auction deadline to work with because these properties
are listed with real estate brokers and, for the most part, sold just like any
other property. The other big advantage of investing in an REO is that you have
the option of inspecting the property thoroughly before you actually close the
deal, which, as mentioned above, is an option you do not ordinarily have in a
foreclosure auction. You have the liberty to walk through the property and make
all sorts of inspections without annoying the seller – in this case, the bank
since it will help them get rid of the property. To be sure, the bank stands to
gain from a quick sale because by liquefying their real estate holdings banks
can reinvest that money back into the bank's main business of lending. Further banks will
typically want a quick sale so as not to prolong real estate management expenses
longer than necessary. The traditional nature of the selling process in a REO
combined with the bank’s sense of immediacy makes the REO stage be a great one
for beginners to take a successful plunge into the real estate investment
business.
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