Large fictitious overhead green freeway sign saying "Foreclosure Next Exit"
 Foreclosures-
  • When to buy
  • Pitfalls to avoid

What is a foreclosure?

Foreclosure is the process by which the lender on a property gets rid of (forecloses) the borrower/owner's interest in the property. There are different rules that apply depending on the state where the property is located.  There are also different rules depending on the type of lien created by the documents at the time the borrowing takes place.  Whether it is a mortgage, a note and deed of trust or a land sale contract, a way is always provided for the lender to "get rid of" a borrower who doesn't make the agreed-upon payments.

 When can you "buy" a foreclosure?

When someone asks to buy a foreclosure, they are usually looking for a bargain due to the sellers financial problems.  There are several times during the foreclosure process when a buyer might be able to purchase the property- 

1. before it becomes a foreclosure

2. after a foreclosure notice has been filed

3. at the Trustee's sale on the courthouse steps

4. from the lender who has 'bought back'' the property (at the Trustee's sale)

First, before it becomes a foreclosure.  You might be able to purchase a listed or non-listed property when the borrower/seller is behind in payments, but the lender has not yet issued a notice of intent to foreclose.  This notice is not usually issued until the borrower is at least 90 days late in repayment. During this time, the borrower might be able to work out a new repayment program with the lender if she is proactive about contacting them.

Lenders occasionally (if they think it is warranted) will reduce the interest rate or allow the borrower to try to "catch up" the payments over a period of time.  With the current credit market bail out, the government is encouraging lenders to make modifications in the loan, where possible, if it looks as if the borrower's situation will improve.  This is especially true if the lender feels they are doing everything they can to hold onto the house.

Unfortunately, during this early period of late payments many borrowers are in denial and “hide” from their lender, not responding to letters or phone calls.  They may actually resist putting their home on the market to get it sold before the foreclosure date arrives. The seller is not likely to sell unless he is getting enough money to pay off the costs of sale and the loan balance and fees (which can include late payment and other fees paid to the lender, unpaid property taxes, etc.).

Homoe with a 'Home for Sale' sign with a 'Foreclosure' sign rider above it.
    Second, after a foreclosure notice has been filed.  You might look to buy
    during that time after the notice of foreclosure or trustee's sale has been
    issued to the borrower/seller, but prior to the actual foreclosure sale. 

    Unfortunately, during this stage the payoff to the seller’s lender can go up
    dramatically. This is due to additional missed mortgage payments plus legal expenses beginning to accrue on the lender’s end of things. This makes many sellers hold out for more money than is realistic. Also, sellers don’t have time to wait around for your house to sell- so offers contingent on your finding a buyer for your house are seldom acceptable. So the home often ends up going to ‘stage three,’ the actual foreclosure sale.

NOTE: In a market where values are declining significantly, it’s not uncommon for the total loan payoff to exceed the value of the home. The silver lining in that cloud is the mechanism called the “short sale.” In a short sale, the lender allows the property to be sold for less than is owed on it. The borrower/seller is not allowed to receive any proceeds from the sale. Since, in a down market, short sales can occur even when borrowers are current on their mortgage payments.  

A drawing of a home with a For Sale sign behind it and an auctioneer's gaven in front of it.
    Third, at the Trustee's sale on the courthouse steps. You may wish to buy at
    the foreclosure auction. While good deals can be available, there are are also
    some big drawbacks-

 
        • You must be prepared to pay immediately. You can't finance the purchase of a house at a foreclosure auction.  You must attend the auction with cashiers checks in the amount of your starting bid plus several more checks in $5000 or $10,000 increments so that you will be able to pay the full price on the spot if the bidding goes higher than expected.
         
      • You must keep your head.  You're competing against professionals and semi-pros: the lenders who put up the mortgages and those who buy these properties for a living, While most of these people are hard-working and ethical, there are "sharks" and "barracudas" as well. Sometimes they try to keep down competition by deliberately bidding up properties they aren't really interested in. They’re hoping you'll pay too much for the house, lose money on reselling it and be discouraged from bidding at future sales.

  • There may be 'hidden' liens that you cannot discover through a normal title search.  An example is a federal tax lien that has been assessed but not yet filed as a lien on the property. There may also be liens by contractors who provided materials and labor to work on the property and who haven't been paid.  The unfiled tax liens simply will not show up in the public records you are using to research your proposed purchase. And the contractors' lien may not show up until closing.  When you go to close your sale you will have to pay off such tax lien and 'mechanics' liens in order to complete your purchase.
    Different states have different rules regarding when and how contractors must file their liens against a property. So do your homework and bid accordingly.
  • There may be hidden property defects.  The opportunity for inspection of the property is limited, so you may discover serious undisclosed physical problems with the property after you close your purchase.

    These can include broken and missing fixtures; renovations started but never completed by the former owner; deferred maintenance or even stealing and vandalism by the dispossessed homeowner.
For Sale sign with a 'bank owned' rider sign above it.    Fourth and finally, you can buy a REO (real estate owned) or a REPO
    (bank repossession).
 
They are really just different names for the same
    thing.  After a bank or mortgage company gets the property back at the
    auction (probably because no one else bid on it), they will put it back up for
    sale.

    From your viewpoint as a buyer, these purchases have definite advantages.  First, the bank does not have the level of emotional attachment to the property as the dispossessed homeowner did. This makes them more likely to look at reasonable offers.  Second, the time needed by the bank to respond to your offer is usually no more than a couple of days.

But again, there are downsides.  Lenders won't accept your offer on a REO property if you still have a house to sell and if you aren't already preapproved (sometimes by their own home mortgage department).  Also, often they may not agree to pay your buyers closing costs as a motivated homeowner might.

In addition, there are frequently multiple offers. When that happens, the lender usually sends back an addendum to each buyer requesting their "best and final" offer.  This can result in your starting bid being below market value but your ultimate bid being higher than market value (especially if you get really attached to the property during the negotiating process).

SUMMARY

Despite the many books written and seminars taught on becoming rich overnight, buying and selling of foreclosed properties is a business and not without some very real risks. If you’re buying in order to ‘flip’ the house quickly after some cosmetic upgrades, be very cautious. Do your homework. The sizable profit you are hoping for may never appear.

On the other hand, if you’re buying a home to live in for the next few years, you may have the advantage of time correcting overpaying for the property due to overbidding and the costs of correcting hidden defects and paying off hidden liens.



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