A Straightforward Tutorial on Foreclosures, Pre-Foreclosures and REOs
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. Thus, 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.)
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 to buy the house before it gets sold at the foreclosure auction. Buyers can actually get a great bargain here by offering the homeowner less 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. See Foreclosures
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 foreclosure 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 be very lucrative. Consequently, while you should try to participate in 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 the 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 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 intimidating. Don't let this discourage you because purchasing real estate this way is ultimately 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. See Foreclosures
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 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 a great one for beginners to take a successful plunge into the real estate investment business. See Foreclosures