An Introduction To Foreclosures
Are you looking for money-making real estate deals? If so, the word foreclosure probably makes you think of opportunity.
What Are Foreclosure Homes?
Foreclosure homes can have many different meanings, all of which can be great opportunities for real estate investors. Foreclosure investing is something most successful real estate investors consider, but how they locate foreclosed properties and how they take advantage of the opportunity can be vastly different. To start, you can break down the foreclosure process into three stages.
This stage starts when a homeowner misses a handful of mortgage payments, and the lender notifies them that they need to pay or they could lose their home. This initial notice is public record and gives the world notice of the lender’s intent to repossess the property. Governments make this information public to help lenders get their money back, but also it notifies other creditors of the risk of them losing their collateral. Unless the homeowner makes arrangements with the lender, the pre-foreclosure process ends when the home is auctioned off to the public. The auction either generates the money to pay the lender, or the lender ends up with the property.
To some real estate investors, pre-foreclosure is the best time to buy foreclosure homes because they believe you will have opportunities for the steepest discounts. In this stage, you, as a real estate investor, will buy the house directly from the homeowner. Since they still own the property, you would negotiate a deal directly with them that works for both of you. Often these houses are not listed on the MLS, so there will be much less competition. If the home is not listed for sale, finding them can be difficult. You would need to figure out how to open a dialog with the homeowner to have a chance at buying the home before the auction. Finding such opportunities is typically done via marketing, whether through a mailing campaign to homeowners in foreclosure, signs, direct phone calls, or even knocking on their door.
As mentioned, the sale is when the Trustee, courthouse, or Sheriff, sells the home to the highest bidder at a live auction.
Each county across the country will have different guidelines. Some will require deposits the day you win your bid with the balance due at some set time. Others will require all the cash to buy the property on the day of the auction. Some even want the money deposited with them the day before the auction, and you will be refunded any unused funds. Since each county is radically different, it is essential to understand the process and risks before you bid on a property.
These auctions typically happen once a week, and it is very common for properties to show up on the list to auction off and then get pushed to a different auction date. Investors that buy at the foreclosure auction, also known as public auctions, typically follow property status through the entire process. A property might hit their radar a month before the auction, and they will track it through the auction.
Some investors prefer this way of foreclosure investing because they immediately know if they got the deal or not. There is no negotiation back and forth with agents or sellers. There is also nothing required as far as marketing for sellers, so there is a much smaller time commitment required.
Post foreclosure or REO
After the auction, aside from a redemption, the house will go to the highest bidder or the lender. A “redemption” is when another lender or the owner pays the foreclosing lender what is owed. In that case, they would get the property.
The lender’s initial bid can be anything up to the full amount of what is owed on the loan. A bid in the total amount owed is known as a “full debt bid.” If there are other bidders, the lender will get their bid amount in cash. If there are no other bidders, which is quite common, the lender gets the house.
If the lender ends up owning the house, they put it in their real estate-owned (REO) department. From here, anything can happen. Some lenders will clean it up and list it on the market with a Realtor, some call their clients to see if someone will buy it as is, and some might even donate it. What is most common these days is for the lender to clean it up and list it. These are known as REOs and can be found on the MLS with any local real estate agent’s help. If the foreclosing lender had a Federal Housing Administration (FHA) insured loan, the property would likely end up as a HUD home. HUD homes are government-owned homes and are treated a little differently than other foreclosures but are still foreclosures after the auction.
Some investors prefer buying foreclosures at this stage because it is much safer than buying at the auction and less work than finding deals before the auction. The problem with this stage is it is incredibly competitive. Once on the MLS, everyone has access to it, and the great deals get snatched up in record time. Because it is more competitive at this stage, investors buying here typically pay a little more than they might before or at the auction.
Why Does A Foreclosure Happen?
The sad truth is that sometimes people have their houses taken from them. That is what this process is. If the lender uses a home as collateral for a loan, it has the right to protect its loan with the house. Lenders protect themselves by forcing the sale. If the owner does not do this personally, the lender can ask the government to do it for them. If the sale does not produce enough to pay back the loan, the lender will get the house. In some cases, the lender can end up with the house and still have a balance on the loan, which is known as a deficiency. With a deficiency, the owner will still owe that money.
Some real estate investors search for deficiency bids; this is when the lender bids less than it is owed and could indicate the lender wanting more bidders. There could be equity in a home that can be scooped up by savvy real estate investors in such cases.
How Do Foreclosures Work?
Even though the foreclosure burden falls on the counties, it is the state that dictates the foreclosure laws. Each state can be a little different. Real estate investors are encouraged to dig into the foreclosure laws in their state.
In general, there are two processes depending on the state. The difference depends on what document is used to secure the property as collateral for the loan. In states that allow a deed of trust, most lenders would use that. If a deed of trust is used, the lender will avoid a court process and foreclose by advertisement. This process requires that the lender gives notice to both the homeowner and the world by publishing the notice in a public place, such as a newspaper. After the notice runs for a specific period, the trustee in that county is directed to auction the home. Again, each state is different, but this is typically a smooth and quick process for the lender.
In states that don’t allow deeds of trust, the lender will use a mortgage. In mortgage states, the lender would need to foreclosure judicially. As such, the lender would need to go to court and convince the court that they have not been paid and have the right to force an auction. Assuming that they can do that, which is typically not an issue, the court will issue a judgment. The lender can then use that judgment to force an auction carried out by the court or a sheriff. Because the court is involved, the timeline can vary and typically takes much longer. In some states like New York, it is common for the foreclosure process to take a year or more.
Unless you plan to stick to foreclosure investing only after the auction, it is imperative to know the timeline and the rules around the auction and redemption rights in the state and county you are buying in.
Is It A Good Idea To Buy A Foreclosed Home?
There are several pros and cons with foreclosure investing, and it depends on what stage of foreclosure you are investing in.
The Pros And Cons Of Buying A Foreclosure
Here are some of the pros and cons of buying a foreclosure (depending on the stage of the foreclosure you are buying in).
Pros: Many investors will tell you that you will find the best deals at this stage. That is because you can negotiate directly with the homeowner and could potentially have very little competition. Negotiating directly with the owner also allows you to get creative if needed. For example, if the homeowner has equity, they may be willing to carry a loan for you to help you get the deal financed. Foreclosure pressure creates tremendous motivation and a definitive deadline, resulting in a little more negotiation strength. You will also find that these properties tend to be in better condition because the owner is often living there.
Cons: If the property is on the MLS, it will be just as competitive as a post-foreclosure home. The only real downside to this stage compared to the other stages is they can be harder to find. Often, the homeowner is not listing their home with an agent, so you need to track them down and make contact with them. You can do this through marketing via mailers or signs, or you can get the foreclosure lists and make direct contact with the owner. Pre-foreclosure investing is very much a business that takes time and money to operate.
Pros: Investors that buy at the auctions love the fact that there is no negotiation. They bid on a property they want, and if they win the bid, they typically end up with the property. Foreclosures are extremely transparent, so it is easy to see what is available and what the starting bid is, making it easy for investors to focus on specific properties and save time.
Cons: This can be very risky. The auctions do not tell you if the foreclosing lender is a senior loan or a junior. If you end up bidding on a junior foreclosure, you would still need to pay any senior lenders their entire amount owed before you would own the property. I have seen investors make this mistake and lose their entire investment.
You also cannot inspect the property before you bid. Of course, I have heard of creative ways investors have been able to inspect a home, but most of the time, those strategies are not legal. You probably should not go into a house owned by someone else without permission. Another disadvantage is it is common for sale dates to get postponed. If you were tracking a property set to go to auction this week, you might check the morning of and find that it has been moved to later in the month. Such a delay is probably not that big of a deal, but it is common and could end up wasting your time.
Finally, the biggest downside to foreclosure sale investing is that you need the cash. Lenders will not lend on auctions because it is difficult to get title insurance, and it is hard to get diligence for a lender done so fast. Not to mention that a lender would do a lot of work in diligence for a property you may or may not buy. Most foreclosure sale investors I know either use lines of credit or use cash, and once they own the house, use hard money to free up their cash for construction or to bid on another home.
Pros: This biggest pro for REO investing is it is the easiest to do. They are straightforward to find on websites such as Fannie Mae, Freddie Mac, or HUD. They are also almost all listed on the MLS.
Cons: Because they are so easy to find, they are incredibly competitive. Competition drives up the price, so you will likely pay more for a deal in this stage than you would in the other two.
Other Factors To Consider
Foreclosure investing can be confusing due to the different stages and the pros and cons of each since each state has its laws, and each property and deal can come with its own challenges. Here are a few other items to consider before investing in foreclosures.
- Redemption Period – A foreclosure redemption is when a junior lender or the owner pays off the foreclosing lender in full after the sale. When this occurs, the redeeming party will get the house, unless, of course, they too get redeemed. The law provides certain rights depending on your lien position and if you are the owner. For example, in Colorado, the owner does not have any redemption rights at all. Once the auction occurs, the owner has lost their home, making it popular for investors to invest at the auction. In Minnesota, the owner has up to six months after the auction to redeem. Because of this redemption period in Minnesota, most real estate investors choose not to invest at the auction. They do not want to tie up cash in a deal that may get redeemed. For this reason, you will see more investors approach homeowners and try to buy their redemption rights than bid at auctions.
- Presence of Squatters – Sometimes, squatters will occupy vacant homes for shelter. It is crazy, but occasionally they really believe it is theirs and will not move out. Squatters create a problem as you will need to go through an eviction process to remove them. It can also be a little dangerous if you do not expect them there when you enter the property.
- Lack of Maintenance Records – Unless you are buying pre-foreclosure, the chances of getting any records or documents relating to the property are small. There have been occasions when I have purchased properties and later found out there were open permits. Open permits are something I have learned to check for. When buying foreclosures, I would expect not to receive any records.
How To Buy A Foreclosed Home
Buying a foreclosure will vary depending on the stage in the process you are buying in.
- Pre-foreclosure: In this stage, you will be buying directly from the owner. It may be that you found the foreclosure with the help of a Realtor, in which case he or she will help you. Or it could be you working directly with the owner. In that case, you might want to hire an attorney or Realtor to help you with the first few, but then you will be able to contract on these on your own. Of course, you will still want to use a title company or attorney to close the transaction to ensure that you are getting what you are expecting.
- Foreclosure sale: As mentioned, this will vary greatly depending on both the state and the county you invest in. I would call or review the county website for specific guidelines for bidding at the foreclosure auction. You will most likely need cash to participate.
- Post-foreclosure/REO – This is almost always going to be done with the help of a Realtor. In fact, some banks and the government will require that someone represents you. Find these deals on the MLS and have the professional help you need to get them closed.
Investing in Foreclosures
If you hear the word foreclosure and think “opportunity,” you are on your way to your next great real estate deal. Foreclosures are an excellent way to pick up bargain real estate deals, but it is such a broad topic. First, decide which stage you want to focus on and then start to build your team. Realtors and lenders are crucial to making this business work. As a hard money lender, we are real estate financing experts and would love to help you navigate this tricky but rewarding strategy.