What do you look for when you’re buying a foreclosure property?
To help you answer that question, we put together a Foreclosure 101 overview, which explains the foreclosure process, its laws, the terminology used and the opportunities foreclosures present to homebuyers and investors who are looking to buy a foreclosure property .
What is Foreclosure?
A foreclosure is a legal procedure that a lender initiates to reclaim ownership and possession of a property after a borrower fails to repay the loan in accordance with contractual terms. Each state in the United States has its own legal procedures for taking foreclosure action.
Mortgages and Deeds of Trust
The foreclosure process — from its initiation to its completion — is determined by whether the instrument that created the borrower’s obligation to repay the loan was a mortgage or a deed of trust. Mortgages and deeds of trust are the legal instruments that create a lien against the borrower’s property. Nationwide, the states are about equally divided in their use of mortgages and deeds of trust, and a few state even use both. While both deeds and mortgages serve the same purpose, the major difference is found in the length of time it takes a lender to foreclose on a delinquent loan — approximately 12-18 months for a mortgage foreclosure compared to 4-5 months for a trust deed foreclosure. Lenders prefer trust deeds because there is no lengthy court action to reclaim their right to sell the property when the loan is in default.
Judicial vs. Non-Judicial Foreclosure
Essentially, there are two types of foreclosure procedures; judicial foreclosure and non-judicial foreclosure. In California, for example, non-judicial foreclosures are more common than judicial foreclosures (lawsuits in court). A non-judicial foreclosure begins with the recording of a “Notice of Default” and ends with a “Trustee’s Sale,” where a third party, known as the trustee, sells the property at a public auction to the highest bidder. The Trustee’s Sale is held like a public auction. The property goes to the highest bidder. If no one bids at the public auction, the property reverts to the foreclosing beneficiary (lender). Foreclosed properties are referred to as REOs (Real Estate Owned by the lender that foreclosed).
In judicial foreclosure states like Florida, borrowers sign two separate instruments: the note (or bond), which is evidence of the borrower’s promise to pay the debt; and the mortgage, which is the legal instrument that creates the lien on the property as security for the debt. If the borrower cannot pay the mortgage, the lender hires an attorney, who begins legal action to protect the lender’s interest. The attorney files several documents: a summons directing the borrower (defendant) to appear in court, a complaint describing the lenders (plaintiffs) allegations of entitlement to relief and the relief sought, and a lis pendens, the legal document that gives notice to the world that there is a legal action pending on the property. Lis pendens is a Latin word meaning “lawsuit pending.” The documents are filed with the clerk of the court in the county where the property is located.
If the borrower fails to respond to the notices within the statutory time limit, the attorney submits a report to the court requesting that the court appoint a referee. The referee reviews the facts and circumstances in the foreclosure action and renders a report to the court. Then a judge issues a Judgment of Foreclosure and Sale in favor of the foreclosing lender. The judicial auction is advertised and the property is sold at the auction to the highest bidder.
Essentially, there are three opportunities for buying foreclosure properties: 1) the pre-foreclosure stage; 2) at the public auction; and bank-owned, or real estate owned (REO). The first step is to determine which stage of foreclosure process you are interested in and figuring out strategies to successfully purchase in that stage. Each of the three ing opportunities has advantages and disadvantage. Here’s a brief overview of the three stages:
1) Pre-Foreclosure (NOD, LIS):
Buying a property in pre-foreclosure involves approaching the borrower/owner and offering to buy the property outright. The borrower/owner can walk away with something to show for any equity in the property and avoid a bad mark on his or her credit history. The buyer has time to research the title and condition of the property and can realize discounts of 20-40 percent below market value. More about pre-foreclosures
2) Auction (NTS, NFS):
If the loan is not reinstated by the end of the pre-foreclosure period, potential buyers can bid on the property at a public auction. Buyers often are required to pay in cash at the auction and may not have much time to research the title and condition of the property beforehand; however, a public auction often offers some of the best bargains and avoids the unpredictability of dealing directly with the borrower/owner. More about Foreclosure auctions
3) Bank-owned (REO):
If the lender takes ownership of the property, either through an agreement with the owner during pre-foreclosure or at the public auction, the lender will usually want to re-sell the property to recover the unpaid loan amount. The lender will then typically clear the title and perform needed maintenance and repair; however, the potential bargain for these REO homes is typically less than a pre-foreclosure or auction property. Bank foreclosures can become government foreclosures if the loan is backed by a government agency such as the Department of Housing and Urban Development (HUD) or the Department of Veterans Affairs (VA). In that case the government agency would be responsible for selling the property.
More about HUD foreclosures and VA foreclosures
When it comes to buying a home from a financially-distressed homeowner, many people conjure up the image of vultures swooping in on their helpless prey. And, sadly, there are more than a few unscrupulous opportunists looking to take advantage of homeowners who find themselves in foreclosure. In these situations, the homeowner often loses everything, while the homebuyer reaps a windfall.
But thanks to services like RealtyTrac, there’s an opportunity for a much more positive transaction — one in which everyone wins.
Buying a pre-foreclosure property from a homeowner in default can be a very attractive option because it has the potential to create a win-win scenario for everyone involved. In an ideal transaction, the seller is able to get out from under a defaulted mortgage without destroying his or her credit rating, the lender is saved the time and expense of foreclosing on the property, and the buyer gets a below-market price on a home.
A property enters pre-foreclosure when the lender files a default notice against the owner. You can find default notices at the local recorder’s office or through online services like RealtyTrac, which maintains the nation’s largest database of pre-foreclosure properties — updated daily.
Pre-foreclosure properties can often be purchased for prices well below market value because the owner is very motivated to sell and has a limited timeframe in which to sell. When a property is in the pre-foreclosure period, the owner still has an opportunity to pay off what is owed or to sell the property, thereby stopping the foreclosures process. If the owner doesn’t stop the foreclosure process, the property will be sold at public auction.
The sensitivity associated with these sales is important to note when making offers on properties in pre-foreclosure. More so than with any other real estate sale, it’s important to present an offer that benefits all parties. Read on to find out how you can create positive outcomes all around and still score yourself a deal.
Before you attempt to contact the owner directly, call the lender’s trustee to confirm whether the property is still destined for a foreclosure sale. The trustee will have the most current information on the property, including whether the owner has sold or reinstated the loan on the property. However, any specific questions about the property must be addressed to the owner directly.
Contacting owners in default can be uncomfortable, since they may feel a bit vulnerable, like the vultures are hovering. They are probably being contacted by a host of people including credit repair services, bill collectors and creditors.
So as not to overwhelm the homeowner, it’s best to make your initial contact via the mail and explain your intentions as a private buyer who is interested in the property. Failing that, you can attempt to make contact via phone or in person. Keep in mind, however, that these more direct interactions may not be the most pleasant because you’re confronting a person with the prospect of losing his or her home.
Regardless of the mode of contact, always be respectful of owners, especially if their wishes are to not be disturbed. If this is the case, it may be an indication to wait until the property goes up for sale via public auction or to look into other pre-foreclosure purchase opportunities in the area.
Time your offer and price it accordingly
Timing your offer can be tricky. Since the pre-foreclosure period can last several months, you need to be patient when attempting to contact an owner in default. Conversely, last-minute transactions can require quick action, since there is pressure on the owner to complete a sale before the property goes to auction. It’s best to make contact as early in the process as possible and continue to do so regularly in order to gauge interest as the clock continues to tick. Make sure you stay on the seller’s radar throughout the process. Chances are that an offer that wasn’t of interest early in the process may sound quite attractive when the seller is facing an imminent foreclosure auction.
Before pricing an offer on any property, it’s wise to obtain up-to-date information on ownership of the property and the loan amount, as well as any outstanding debt or lien information. You should also assess the condition of the property by enlisting the services of a professional property inspector. Don’t rely on your own knowledge and inspection; only a professional can fully assess the condition of a home and identify repairs that will be needed. Once you purchase a property, you assume responsibility for any additional repairs that weren’t discovered before the sale, so the cost of hiring an inspector is worth every penny.
Offers on pre-foreclosures often resemble those for any other real estate purchase, stating that the offer is contingent upon a title search and full inspection of the property. Educate yourself on how much is owed on the property and investigate what its market value is by looking at comparable sales in the area. You can estimate the gross equity in the property by subtracting the amount in default (which is publicly available and listed on RealtyTrac) and the outstanding loan balance from the approximate market value. As long as there is some calculated equity, purchasing the property can provide you with a profit of some amount. Of course, how much profit you earn will depend on your ability to negotiate your price with the home owner.
As a rule of thumb, you should present an offer that is below total market value of the property but above the total amount of outstanding loans, liens and necessary repair costs. This enables you to purchase the property at a substantial savings, while keeping the owner, lender and any other parties satisfied.
In negotiations, be sensitive but hold your ground
Negotiations between the buyer and seller of a pre-foreclosure can be difficult, especially since the seller would typically prefer not to sell the property in the first place. Remember that you are, in essence, doing both the lender and the owner a favor by purchasing the property early in the foreclosure process, saving the lender money and time, and potentially even allowing the owner to make a profit if you pay more than they owe.
Avoid mentioning the foreclosure situation in any written communication to the owner that might be seen by others, but once you meet with the owner in person, it is completely appropriate for you to express an understanding of the situation and indicate your willingness to help stop the foreclosure process and alleviate some financial concerns. Most importantly, treat the owner with the respect and dignity they deserve.
That said, it’s just as important to stand firm on what you plan to spend, especially if you want a sale price below market value. After all, saving money is the main reason people entertain the idea of a pre-foreclosure purchase in the first place! In this market, it’s imperative to be patient and understanding of the circumstances, but ultimately diligent about getting what you really want. You may have to work a bit to motivate the homeowner to make a sale, but a bit of extra effort is completely worthwhile if it wins you the property at a savings to you.
Following these suggestions should help you identify opportunities to make the pre-foreclosure process work for you as a buyer. For more information about pre-foreclosure and foreclosure or to locate properties for sale, check out resources available online at www.realtytrac.com.
Buying at the Public Foreclosure Auction
In the fast-paced foreclosures market, many sales are made at public auctions. While attending auctions can be a great way to purchase a property well below its market value, the process moves rapidly and can sometimes seem like a dizzying blur to the prospective buyer.
These events are often frequented by more seasoned buyers and investors who understand the ins and outs of the process, so you need to be prepared if you plan to attend an auction. That means understanding the auction process before you arrive, including how to make a bid and actually pay for the property if you bid successfully.
Real estate investment trainer and author T.J. Marrs says he rarely frequents auctions and prefers to buy during the pre-foreclosure period whenever possible, simply because of the growing number of bidders driving up the prices at auctions. However, he advises those who do plan to buy at auctions to “get to know the property by either personal inspection, professional inspection or by getting as much background information on the property as possible.”
Those who heed that advice and take time to understand the foreclosure auction process have a better chance of achieving a successful outcome.
First things first: Know when and where, make time to prepare
While the details concerning public auctions differ from state to state, and whether the sale is judicial or non-judicial, usually foreclosure properties are auctioned off at the site of the property or at the courthouse in the county where the property is located. The date of a scheduled auction is typically posted at the courthouse, at the actual property and in a local newspaper.
Thanks to online data services like RealtyTrac, buyers and investors can use the Internet to locate auction property nationwide. RealtyTrac maintains a daily updated list of sale notices nationwide along with property research tools, giving buyers the information they need to prepare for an auction. Buyers can find the street address, which gives them a chance to view the property (at least from the outside), evaluate the neighborhood to determine what the property is worth, and plan a reasonable amount they would be willing to bid for the property at the upcoming auction.
Most likely, you’ll be bidding on a property without really knowing its condition on the inside, so it’s important to do any research you can in advance in order to minimize the risk of over-bidding and increase your return on investment. It’s also a good idea to research the title on the house and to find out what you’re actually bidding on at the auction, such as whether it’s the first mortgage or second mortgage. This information is crucial to bidders because it affects whether liens will remain on the property or dissolve as a result of the foreclosure auction.
“You have to know the property inside and out and know the party that is auctioning the property is, in fact, in the first lien position,” advises Marrs, noting that if you buy from a party that is in a secondary lien position, you could be responsible to pay for the first lien in addition to the auction price.
Game Day: What to do
The morning of the auction, it’s a good idea to contact the lender’s representative to confirm whether the auction is still taking place as scheduled, since lenders sometimes change the date of the auction at the last minute.
This is also a good time to verify the opening bid for the property, so you’ll know what to expect and be better prepared to plan your bidding strategy.
The rules (and art) of bidding
The lender typically sets the opening bid by calculating the full amount owed on the loan. This includes the principal, interest, any late charges, penalties, and foreclosure fees (as allowed by state law). At the auction, proceedings are opened when the lender or official running the auction announces the sale and the opening bid amount, with bidders free to call out bid prices until a high bid is reached.
At your first auction, knowing what not to do is almost as important as knowing what to do. The day of the auction, it’s important to feel confident in your ability to bid, so that you won’t be distracted by comments or “advice” given by other bidders. Remember, everyone attending the auction is likely there to bid against you, so it goes without saying that you’ll be hard-pressed to find a mentor to guide you through the process and look out for your best interest.
“Since you’re paying cash and there are a lot of unknowns, certainly you should keep your maximum bid in a safe range, like 60 to 70 percent of market value,” suggests Marrs, adding that one might be willing to go higher than 60 to 70 percent in more competitive markets.
Handing over the money
Once congratulations are bestowed on the highest bidder, it’s quickly time to pay up. The majority of auctions require the successful bidder to pay for the property in full, in cash and on the spot. So it’s important to have your finances in order well before the date of the sale and come to the auction with cash or certified funds such as a cashier’s check, money order or a bank certified check made payable in the buyer’s name.
In some cases, the successful bidder is given 24 hours or even up to 30 days to pay the full amount cash. Check state foreclosure laws to determine the auction payment options for each state.
A few things you should know before moving in your furniture
Once you’ve placed the high bid and paid in full, the property is yours for good, right?
Like anything else, there’s a bit of fine print to be aware of when buying at a foreclosure auction. In some states, the original owner of the foreclosed property has what’s called a right of redemption. For a set amount of time (often up to 12 months), the original owner has the right to pay the full amount owed for the property, plus any applicable fees and interest, and buy it back it, barring any additional foreclosure activity. It’s a good idea to check the foreclosure laws in your state to understand what right of redemption exists. Though these procedures are rarely taken advantage of, it’s important to know what they are.
Foreclosure auctions certainly present great opportunities to grab bargain deals in the real estate market. But they’re not for the faint of heart, nor the unprepared. Still, doing your research on the property for sale and on how the process works can demystify things, allowing you participate with confidence.
Good luck and happy bidding!
Buying Bank-Owned Real Estate
As housing costs continue to slide, more and more people are looking into the option of buying bank-owned foreclosure properties. Some opt to look for properties in the early stages of default; others frequent auctions or sheriff’s sales. But if you don’t have the nerve to approach homeowners in default or the cash in hand to bid at foreclosure auctions, buying a bank-owned property may be the best way for you to tap the hidden market of foreclosure real estate.
Bank-owned properties are known as REOs, or Real Estate Owned (owned by the bank or lender). These properties have gone all the way through the foreclosure process and become the property of the lender. Once a property becomes an REO, the lender clears the title of any liens, evicts occupants if needed, typically does a limited amount of repair and clean-up work to the property, and prepares documents for the issuance of a title insurance policy for the buyer.
REO properties tend to be slightly less risky investments than properties purchased at an auction. In addition to the work done by lenders as noted above, potential buyers of REO properties are entitled to having a professional appraisal or inspection completed on a property they are interested in before making any sale final. They will also generally have the opportunity to tour the property personally and assess the neighborhood. None of these safeguards are available to someone buying a property at an auction. These benefits, along with the possibility of reaping a potential bargain, make REOs an attractive alternative for investors.
Homebuyers can often save money by purchasing an REO. Many banks want to get REO properties off their books and will price properties to move. This means REO sales tend to move rather quickly, so anyone interested in purchasing an REO property needs to be ready and able to make a quick decision.
But make no mistake! This doesn’t mean every bank is willing to dump REO real estate at pennies on the dollar. In recent years, some lenders have been willing to hold properties a little longer than usual, in order to benefit from steadily-increasing real estate prices. While finding a middle ground that works for both the bank and the buyer can be tricky, the following tips should help investors and buyers negotiate great deals on REOs.
Find REO Properties as Early as You Can
One of the often-overlooked strategies for purchasing an REO property is to make an offer on it before the lender has listed it for sale. Doing this ensures the bank of a short sales cycle and saves them the expense of listing and marketing a property. There are several ways of finding these REO properties early in the process — such as tracking properties scheduled for auction, closely watching the classified ads in the local newspapers and visiting the county recorder’s office. Online services such as RealtyTrac, which hosts the nation’s most comprehensive database of pre-foreclosure and REO properties and sends daily e-mail notifications when new properties arrive, make the process much easier.
Know who to contact – bank or agent.
Once you find an REO property you would like to make an offer on, you should contact the bank in possession of the property directly and ask for the department or person who handles REOs. Some banks have REO or “asset management” departments that handle the sales of these properties, making the process much easier for potential buyers anxious to make an offer.
Sometimes you will hear that the sale of the property has been turned over to an agent. If this is the case, the bank should be able to refer you to the person handling the sale. Working with the bank’s agent is, in most cases, a lot like working through any other real estate agent.
Hold that offer! First find out what the property is really worth.
Prior to making an offer on any property, you’ll want to do a bit of research to obtain as much information as possible about the property. It’s wise to obtain information about comparable sales in the area, either through a buyer’s agent or from the agent responsible for selling the property. You can also do this through online services like RealtyTrac, which offers a complete set of property valuation reports on its site.
Inquire whether any inspection reports are available, whether the property is being sold “as is” or if the bank plans to pay for any repairs and how offers should be presented to the bank for consideration. You’ll also want to find out how long it takes for the bank to review and accept an offer. In some cases, offer acceptance is subject to corporate approval within five days — a much slower turnaround time than is expected with traditional real estate transactions.
Lastly, never underestimate the value of a professional inspection. Inspectors are trained to find things you won’t even know to look for, so they are well worth the investment if you are really serious about a property.
Consider the bank’s bottom line
Banks foreclose on property to recover a debt owed them by the property owner. The amount of that debt — plus foreclosure-related expenses — is the bottom line that banks need to recoup when they sell the property to avoid a loss on their books. The more you know about the bank’s bottom line, the more leverage you’ll have in negotiating a great bargain.
The debt amount is included in the public foreclosure documents filed by the bank. You can sift through those documents at the county courthouse or find the same information online with services like RealtyTrac, which maintains a daily updated national database of REO properties.
Make an offer, but be ready to play hard ball
Once you’re ready to make an offer, who you present it to depends on who is handling the sale. If you’re working through the bank’s agent, the transactions will be quite similar to those with any traditional real estate purchase. The only real difference it that you are likely to have a bit more negotiating room, since the property is an REO that the bank is motivated to unload, rather than a property a seller has lots of personal attachment to.
If you are dealing with the bank directly, you need to be prepared for the process to take longer and be a bit more cumbersome than it might be with the help of an agent. This is a strong incentive for you to be as prepared as possible to at least move things along quickly on your end.
“When presenting an offer to purchase an REO, one essentially needs to follow the same procedure a realtor would follow. Of course this is done without the benefit of having the realtor to help you complete the paperwork,” according to real estate investment trainer and author T.J. Marrs. He suggests the following three strategies to improve your chances of success when making direct offers to banks selling REO properties.
Have all your paperwork ready. Use a standard purchase and sale agreement and have your earnest money ready. In fact, Marrs suggests buyers have their earnest money already waiting in escrow, and send a copy of their escrow receipt to the bank along with their offer
Have your loan approval ready and submit it with your offer or have cash in escrow. The more you can prove you are a serious player, the more likely your offer will be taken seriously.
Do not EVER offer the asking price. “You can’t offer too little, but you can always offer too much,” says Marrs. “My rule of thumb is, if they accept your first offer, you offered too much. You can always negotiate a little but you can’t go down in price once the offer is accepted.”
Keep in mind that the bank must attempt to get the highest possible amount for the property and must demonstrate this to its shareholders and auditors. Once you present an offer, don’t be surprised if the bank submits a counteroffer that is much higher than your offer. The amount listed in the bank’s counteroffer is rarely the lowest the bank would consider. This is your cue to counter again.
The key to countering a bank’s offer is the understanding that, while they are certainly motivated to sell, bank representatives are also quite well-versed in managing money. They know precisely how much they can afford to sell the property for, but it’s your job to research what that amount is. The trick is to be patient and chip away at the bank’s price slowly in order to avoid paying over market value.
A bit of advice to remember when engaging in multiple rounds of counteroffers: try your best to separate your actions from your emotions. If you keep a clear head, you might find that the time and frustration spent countering with the bank has paid off, translating into your owning a property for a lot less than you might have paid in a traditional sale.
For Marrs, a successful investment is one that is purchased well below market value. “As an investor, you’ll never survive unless you stick to paying less than market value,” he advises. “When the market calms down, the over-paying speculators will get killed, while the real investors who work hard at buying below market value will win.”