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HOW FORECLOSURES WORK LOAN DEFAULTS AND LEGAL RECOURSE FOR LENDERS When someone is no longer able to pay their house
payment, they are considered to have defaulted on the loan. The lender has an equitable interest in the property
created by a legal document called a mortgage or trust deed and note. The
owners previously signed these papers so the lender would loan them the money
needed at closing. In the case of a default, the mortgage or deed
instruments give the lender the legal right to effectively foreclose on
the property and demand that the owners pay the note in full. If the owners are
unable to do this, they forfeit the collateral, which is the real estate
itself. Foreclosure is the process through which the courts
and state law allow the real estate lenders to take control of and sell the
debtors’ (“owners”) real property in order to pay the debt. Property in foreclosure is said to be in distress. Distressed property goes through several stages of
foreclosure. The first stage is known as “pre-foreclosure.” Once the lending institution has begun the process of
reclaiming the property, it enters what is called “foreclosure.” When the property is auctioned to pay the debt, this
begins another phase called “post-foreclosure.” You can buy the property at any phase of the
foreclosure process —
In each case, different strategies determine what
constitutes a “good deal” for you. Why do people allow themselves to go
into foreclosure? On the surface, it may be difficult to conceive of a
person letting a house go and thereby losing any chance of getting a new
mortgage loan for years. Still, this scenario takes place every day. People
slip into foreclosure — sometimes passively, sometimes angrily, sometimes
apathetically — but almost always in spite of everything they can do to avoid
it. The following are several circumstances that
frequently lead to foreclosure of a property: Divorce This is likely the most common cause. Two people are
often angry with each other, and uncooperative over their mutually shared
assets and liabilities. Often neither is willing to bend, so both end up being
financially destroyed. When a couple becomes antagonistic toward each other,
nothing productive transpires, including the making of the house payment.
Frequently the spouse who stays in the house cannot afford to make the payment
alone; as time passes, the house goes into foreclosure. Unemployment Layoffs, firings, downsizings, plant closings. Often,
the higher the income and lifestyle, the more financially difficult this can
become. Losing a job can lead one down the slippery slope to foreclosure. Medical problems and
failing health Encountering sudden medical difficulties, such as
accidents or terminal conditions such as cancer or Alzheimer’s disease can lead
to default on the note. Balloon payments on loans These are loans that come due after a certain date,
perhaps after five or ten years. At the time the loan was taken out, the rate
and terms seemed an eternity away. The arrival of a balloon due date can be the
darkest day in one’s life. When combined with any of the other circumstances, a
balloon due date is a major trigger for foreclosure. Death When the primary income producer suddenly passes
away, the family’s finances can vanish quickly. This is not as common as some
of the other reasons, but it is a foreclosure cause that you will frequently
encounter. We have little control over
the circumstances of life. We can, however, anticipate and plan, knowing we are
not immune from misfortune. Even the
scriptures say, “The rain falls on the just and the unjust.” At the very best, the financial future for each of us
is uncertain. The question is, will we individually take the
investing steps necessary to prepare our own finances when bad times come? By simply studying this section, you are miles ahead
of the curve. You are obviously aware enough and motivated enough to take positive proactive steps to
better secure your financial future. Unfortunately, in the past many people who found
themselves in foreclosure chose not to prepare for when times were kinder and
gentler. As a result, they were not able
to weather the storms of misfortune. Storms are often greater than all the
preparation we can imagine. As we have discussed, people in foreclosure are not
bad people. They are simply folks who have been hit with bad times. In biblical times, all debt was forgiven every seven
years. In medieval days, the manner of resolving debt became much more harsh.
These unfortunate people would have lost their house and been thrown in
debtors’ prison or sold into indentured servitude until their debts were paid. Foreclosure, in our day, is once again a helpful
process. It closes the door on a person’s debt. This relief allows them to
eventually reestablish themselves and start a new life with more financial
security. It is important to remember
that you did not create the problems a homeowner may be experiencing. Instead,
you are offering a possible solution. Your solution may be their only viable
way out. FINDING FORECLOSURES IS EASIER THAN EVER BEFORE There are many foreclosure-finding resources available today that were not available even a few years ago. Ask your advisor or mentor which ones they prefer to keep abreast of as properties move through the foreclosure process. ____________________________________________________________________________________Pre-Foreclosure Investors ... At www.REISkills.com
we assist REIs find and negotiate with Pre-Foreclosure Home Owners. Not long ago, finding pre-foreclosures was
largely a game of luck. If you knew a
foreclosure attorney, they might have had advance knowledge of properties about
to be foreclosed on. Foreclosure auctions gave public notice in the local
paper, and getting through the bank managers in the post-foreclosure stage was
iffy, at best. Many have made a fortune by becoming friends with an
attorney who specialized in foreclosing on properties. Knowing the attorney who represented the
banks and lending institutions made this client rich. On more than one occasion, he was the only bidder at
the foreclosure auction. Today, a number of services offer print and online
tracking of foreclosed properties through every phase, in every state, so you can easily find these
exceptionally good deals. There is still research to be done on the individual
properties, but finding foreclosures has never been easier. Many public records
showing liens and judgments on foreclosed property are now available online. Just as in other areas of real estate investing, (a) finding the properties, and (b) making suitable
offers are the keys to your success in the foreclosure business. Is it worth including foreclosure properties in your
business? Certainly . . . IF you remember this: Your objective as an investor in foreclosure properties is to generate
a twenty to fifty percent return on your investment. As an investor, these properties take more research,
time, effort, and a willingness to get an understanding of the foreclosure
marketplace. There are
simple formulas to use in estimating values, repairs, and specific techniques
you will use to negotiate discounted payoffs of other debts that may be
attached to the property. BUYING STRATEGIES: PRE-FORECLOSURE Pre-foreclosure is the period when the owners still
have the right to sell their property. The owners know they have a problem
because they are in default on their note. They have been notified by their
lending institution that their property is about to be foreclosed on, so it is
no secret, except perhaps to their family, co-workers, and friends. Depending on the emotional state of these people,
they may be open to structuring a winning deal that will salvage a portion of
their credit. They may be behind several payments (in addition to late fees),
and at this point they get little or nothing from their lender. Obviously, if they have not been able make partial
payments, they are likely not able to pay a lump sum of several payments. This first phase of property foreclosure deals with
people. The public makes a catastrophic mistake by thinking that real estate is
only about buildings and land. This notion couldn’t be farther from the truth. It
concerns itself with people — the person or family presently owning the
property. These people are in serious trouble, and so this period is a time
when they are desperately seeking solutions to their problems. People may experience financial hardship through
death, excessive debt, sickness, job loss, job transfer, or divorce. Something unexpected hits them squarely between the
eyes, and they stagger, dazed and unable to cope. This state is something like a scene from the movie, The
Matrix. In this movie, a bullet is fired out of a gun. The
bullet flies in slow motion across the screen. The scene is very compelling and
is visually impressive. It is while the financial bullet has been fired, or
while a person is falling behind on their payments, that pre-foreclosure takes
place. Unfortunately, our society teaches us to prepare for
gainful employment. We then go to school, or become trained, and are taught to
be productive in a given profession. We are also often taught to work for
someone else, rather than to work for ourselves. This mentality is frequently
fatal. Regardless of what hits us, when we then lose our
job, we are ill prepared to continue making mortgage payments. We get behind
and begin to experience a financial stranglehold. This condition throws us into
a fiscal and emotional tailspin, and we plummet into financial and emotional
darkness. We are often still occupying our home, but every day we are unable to
make our mortgage payment, we become more vulnerable to losing our position
with the property. Because of this financial paralysis, we become more
desperate. It is essential to understand that the foreclosure
process varies from state to state. There are judicial states and non-judicial
states. There are mortgage states and trust deed states. The When initially purchasing a home or land, a loan is
secured. The person or entity making the purchase becomes the mortgagor. The
person or entity loaning the money is called the mortgagee. The loan on the property becomes a promise to repay
as evidenced by a promissory note obligating the mortgagor to pay the amount of
the loan. The legal instrument giving substance to this note is
the mortgage or trust deed attaching the loan to a piece of real estate. If the
owner’s (or mortgagor’s) promise to repay the loan goes into default — and if
the owner is unable to cure the note within a specified time period — they
will lose the property. The bullet will hit, and the person’s legal entitlement
to the property will cease. If the property is occupied, the person or family
occupying it will be evicted. During a property’s pre-foreclosure, as a potential
buyer, you can actually visit with the owner and walk through the property with
them. You are dealing with the owner/seller directly.
Though you cannot give them what they may consider market value for similarly
situated houses in their area, you may be able to pay off their loan balance. Depending on their equity, you may be able to pay
them enough money to move, or to make a security deposit on an apartment. One very wealthy client of mine uses this approach
exclusively. He never goes to an auction. Instead, he visits and writes form
letters to people in default. He has a very charming personality and genuine
interest in saving his clients’ reputation from an auction. He is truly
perceived as a problem-solver for his people. Talk about win/win. This approach
has made The Real Estate Investor independently wealthy. Another of my associates lived in In fact, he often found himself counseling them,
giving them hope for the future. In his mind, this wealth-producing business
was all about helping people. If you are interested in researching properties in
the “preforeclosure” condition, go to your county courthouse and ask to examine
what is called the Mortgagee Index. This index will show when the mortgage was
recorded. By computing the time lapsed from that date to the present (which may
be a few months, or many years), you will be able to determine the approximate
amount of equity in the property. Equity, of course, is the difference between
the value of the property and any mortgage(s) on the property. Rather than
mortgages, some states have recorded trust deeds. The sellers have nothing to lose. To the contrary, they have everything to gain. When a property goes into foreclosure, it will
generally be auctioned for the loan balance plus legal and other fees. Chances are,
the owners will get nothing from the process. Because they are likely to get
little or nothing if they choose to wait it out, you are not taking advantage
of them by stepping in. In fact, you are probably giving them their last best
hope at saving their credit and getting a small amount of much-needed cash from
their equity. BUYING STRATEGIES: FORECLOSURES Once the foreclosure process begins, the lender turns
the property over to an agent or a trustee — often an attorney — who in turn
attempts to sell the property for enough to pay the loan balance and added
costs. Usually this takes place at an auction or trustee sale. Generally when a property is in foreclosure, an
auction or trustee sale is held where investors are able to bid on the
property. The first bidder will typically be the lender, who will bid the
outstanding amount of the loan. This bid may also include legal expenses in
processing the foreclosure. If you are interested in purchasing a property that
is in foreclosure, the first consideration should be to the person or family
losing the property. This might include a phone call to them in an effort to help
them through their difficulty. After introducing yourself, you may wish to walk
them through the legal steps to foreclosure. Or, you may provide information on
housing alternatives for them. Working with people in this condition, without
competing with other realtors and potential buyers, makes this investment
strategy very appealing. It is also very rewarding as you are able to assist
them in their time of dire need. Once the foreclosure process has begun, legal and
other fees are normally added to the owner’s increasing debt. While the owner
could still sell the property at this point, several factors combine to make
this outcome less and less likely: ✓ The combination of loan balance, legal fees, and
late fees may be too great for a new buyer to make the purchase ✓ As time passes, there is less time for a new buyer
to get qualified on a loan (before the foreclosure process moves to the auction
stage) ✓ Through misplaced resentment, anger, or despair the
owners have allowed the property to slip into disrepair (or worse, purposely
damaged it), making it less desirable ✓ The owners may have simply emotionally “dug in their
heels,” and are now resistant to doing anything, and may be
automatically fighting anyone from outside their castle who suggests
alternatives. LOCATING HOMES IN FORECLOSURE When a person is unable to make their mortgage
payments, the matter is turned over to legal counsel by the mortgage holder. When this happens, a liz pendens is filed
against the property. This a Latin phrase that means “lien pending.” It is a
cloud on the property title. A date of sale will be determined at the county
courthouse, and on that date the property will be sold to the highest bidder. From that date, the family has three or four weeks in
which to vacate the premises. They are literally forced to leave, and if they
do not voluntarily surrender the property, a sheriff may be forced to evict
them, change the locks on the house, and restrain them from entering. The information on properties in foreclosure is found
in the courthouse of the county where the property is located. While some county computer facilities are
sophisticated, many are not. In addition, many employees working in the real
estate foreclosure division are not trained to be helpful in providing
foreclosure information. Therefore, a potential buyer of foreclosed properties
must be assertive. When looking for a property in foreclosure to
consider purchasing, my rule of thumb is to consider only those properties with
a mortgage (or trust deed) that is at least five years old. Assuming a normal rate of inflation, this means that
I will be examining properties with built-up equity. It almost goes without
saying that equity plus motivation equals huge profits. If you are motivated, and if you take the time to
examine elements of properties in foreclosure, you have the potential of making
considerable profits. RIGHT OF REDEMPTION If a mortgagor or owner of a property loses their
home, there are eight states that allow them to redeem their ownership in the
home. Yes, even if the property has been lost in
foreclosure and sold in a bank sale, the owner can reclaim the property by
making up the amount of deficiency on the loan. If you are living in a politically liberal state, you
are likely in one of the eight states providing this “right of redemption.” If so, and if you are interested in purchasing a
property in foreclosure, you can request that the person in default waive his
right to redeem the mortgage on the property. This can be done in a short
letter that states: “I hereby waive my right of redemption on said (give
address and legal description) property.”
Although a notarized signature is not necessarily
required, I would strongly advise you to have the mortgagor’s signature
notarized with two witnesses. By taking these safety measures, you add an extra
amount of legitimacy to the document. AUCTION SALES When attending an auction, or sale of property in
foreclosure, you must have already lined up the cash needed to purchase the
property. At the time of the auction — and if you win the bid
by offering the highest purchase price on the given property — you must
generally pay five to ten percent of the purchase price to the trustee holding
the auction. In most states, the entire amount of the bid must be presented to
the trustee in certified funds within twenty-four to forty-eight hours of the
auction. Most investors purchasing properties at auctions have
a line of credit established at their bank, and they are able to provide
certified funds within the allotted time period. When attending an auction, you may be the only person
attending, or there may be other interested parties making bids along with
yours. If you have never been to an auction, I would highly
recommend that you first attend one, without participating. Get a feel for the process and for expectations of
when you do successfully bid on a property. For instance, if you bid
prematurely, and are not able to have the entire cash purchase price by 4:00
p.m. that afternoon, or whenever the time deadline is, you are in serious
trouble. You will not only forfeit the money you have given as
a deposit on the property, but you will likely be banished from ever
participating in a subsequent auction. This is not an area for novices or for
those who are ill prepared to act responsibly. As a word of caution, detach your emotions from the
property you are bidding on. Many times I have attended auctions where bidders
become emotional and even irrational. Some properties sell for more than their
appraised value, simply because of the emotion-packed competitive spirit of the
occasion. These events are highly energized, and can be
exhilarating to attend — but you must remain detached enough to make sound
financial decisions surrounding your own bid. Therefore, prior to attending the
auction, determine a ceiling price you are willing to pay for a given property.
Then, no matter how much pressure there is, walk away
if and when the bidding price exceeds your assessed maximum purchase price. To assist you in keeping track of properties in
foreclosure, as well as future auction dates, etc., there is a computer
software “foreclosure model” to assist you. This model manages your database so
you don’t miss an auction on a given property. This time line also allows you
to help the person whose property is in default. It can assist you in being a
problem solver for this person, as well as a property purchaser and manager for
yourself. Can you still save money at these sales? Absolutely. A working knowledge of property values in
your area is essential, something you will learn firsthand through experience
with your coach or advisor. Properties are almost always sold for less than the
retail market price. In addition, you will not be dealing with potentially
emotional owners. Above all, pay close attention: Trustee Sales of properties
are always sold “as is.” “AS IS” MEANS AS IS! The property is sold just as it exists, with no
quality or condition guarantees provided by the lender or owner. If the owner
has damaged the property, or has allowed several years of disrepair to take
place, or if the building has termites, if the roof leaks, or if the
foundation has cracks, you will buy the property “as is.” If the lender has set up a pre-auction tour of a
certain property, by all means attend it. Take along a home inspector, roofing
or plumbing contractor, or other experts. Their fee(s) will be worth it, I
assure you. You may not have had the opportunity to inspect the property unless
you did so during the preforeclosure stage. This is where your training and knowledge will give
you the edge over investors who often bid “by the seat of their pants.” Preparation, and paying for professional advise, are
often the differences between a poor investment and one that is highly
profitable. ONE CLIENT STRIKES IT RICH Over a six-month period, one of The Real Estate
Investor s hired his unemployed nineteen-year-old nephew to do something both
interesting and rewarding. His nephew attended every courthouse auction in his
city during this time period. Doing so, he discovered two interesting facts: First, an average of only three to five other
potential bidders showed up at each auction. Second, every property sold
between fifteen and forty percent below retail value. The Real Estate Investor ’s nephew purchased fourteen
homes during this six-month period. By the time he had resold these properties,
The Real Estate Investor made over
$850,000 profit on this simple six-month auction-buying experiment. The Real Estate Investor further told me that they reached the point
where they did not even look at some of the properties they purchased. If they could buy a home from ten to thirty percent
below the conservative estimate of value by the county assessor’s office, they
knew they had struck it rich. On one occasion, I asked The Real Estate Investor ,
“Did you lose money on any of your purchases?” He said, “No, our only letdown was making only
$15,000 on one home. The other thirteen purchases were gold mines!” AUCTIONS REQUIRE CASH At a real estate auction, you will need to
pre-qualify in order to participate. You do this by demonstrating that you can
pay cash up to the amount you bid. This is often in the form of a cashiers’
check. At some auctions, you must certify that you will
deliver the funds within twenty-four to forty-eight hours. There are “hard money” lenders in every part of the
country. These are lenders who often require an equity interest in the property
in return for supplying you with immediate cash. They will work with you so you
can bid confidently, knowing you have the cash available. You can also create a consortium of project
investors, where you receive a cut in the deal for your knowledge of the
business, or establish your own stable of hard money investors when you need
cash quickly. Yes, there is a cost to using other people’s money
(or OPM), just as there is a cost to using a bank’s money. Having money on hand to make the deal is more important
than the cost of the money itself. OPM is a powerful tool, especially when you
have a good handle on your costs ahead of time. Your bidding will always reflect your anticipated
expenses, leaving plenty of room for you (and your partners, or lenders) to
profit. Finally, if you do not have enough room in the deal
to“breathe financially” you simply do not buy! Many auctions will allow you to post a deposit of
between $500 and $5,000 at the close of bid. This deposit gives you a certain
number of days to provide a cashiers’ check for the remainder. You will learn
ahead of time what the auction requires. OTHER LIENS ON THE PROPERTY Whenever a lender forecloses on a given property, not
all liens are automatically extingiushed. You could still be liable for all or
part of other liens and other judgments. Go to the county recorder’s office and carefully
research any property you plan to bid on. Be aware of the outstanding encumbrances to a
clear title. You may be able to
negotiate a reduced payoff simply by asking. If the combination of liens and judgments plus the
purchase amount is greater than retail market value, pass up the opportunity to
bid. In fact, Many successful RE Investors will generally
pass on a deal if the combined costs exceed the assessed value of the
property. SO, HOW MUCH DO YOU BID? The rule of thumb at an auction is to bid only enough
to purchase the property, and never more than it is worth (taking into account
outstanding liens and judgments). This formula seems simple enough, and if you are
knowledgeable and alert, the bidding process will not create a problem for you.
Unlike the retail market, most foreclosure buyers are
unemotional about the process or the property. They will often start their bidding at sixty to
seventy percent of the market value, and generally drop out if it exceeds
eighty percent, thereby allowing lessexperienced bidders to buy the property.
This is just
business. They have their parameters and they stick to them. As a professional
investor, so should you. BUYING STRATEGIES: POST-FORECLOSURES If, at a given auction, a specific property does not
sell, the mortgage company who placed the minimum bid wins back the property by
default. The question posed is: “What happens to the property now?” In this instance, the property enters a category
called real estate owned properties, or REOs. Banks sometimes call these
properties non-performing assets, but from a technical perspective they are
different. When a bank takes back the ownership of a property, this property
does not automatically become an asset of that bank. It is a liability they
must dispose of. Federal laws mandate that the property be immediately
liquidated or sold. Since this property is called a non-performing asset,
rather than a bank liability, it must be sold as soon as possible. When banks
are not able to liquidate their repossessed properties, the federal government
can liquidate the assets for the bank. The government did this in the 1980s,
when they formed what was called the resolution trust company, or RTC. Many lending establishments, particularly savings and
loan institutions, were forced out of business at that time. When considering a bank REO, we immediately know that
this property must sell quickly. Banks usually sell these properties through
realtors. These realtors become agents for the seller, which is
now the bank. The realtor becomes a fiduciary, or a legally
responsible agent of the bank. The reason this is pertinent at this point of
the foreclosure process is that, when speaking with a realtor who is agent for
the bank, you are giving the realtor information that can and should be given to
the bank. This may mean the amount you are willing to pay for the property, the
terms and conditions, etc. When considering how much to pay the bank for a REO,
consider what repairs the property will require in order to prepare it for
resale. Consider the exterior, including the roof and
landscaping, as well as the interior, especially the paint, carpets, and tile.
Make sure you do not pay too much, just to own a specific property. Although banks do not want to deal directly with
potential buyers of their REOs, you can request an REO list. Sometimes, the management information systems, or MIS
department, will have these lists. People in this department manage databases,
including the REO database, and they will provide it to you upon request. In speaking about REO’s, and the opportunities
available in this area, my associate James Smith says: “I live in a home in “Some people say, ‘But, I want to build my dream home.’ My reply is, ‘Why build your dream home when you can
purchase someone else’s?’ Luxury homes cost from $150 to $300 per square foot
to be built and require a tremendous amount of energy and commitment. Many
wealthy people experience financial setbacks and allow their homes to go into
foreclosure. This is often the perfect way for someone to purchase their dream
home, or even a dream home to re-sell on the market.” It is essential to remember that banks and lenders
are in the money business. They are not generally in the real estate
landlording business. They are burdened with a property they do not want, and
they are definitely motivated to sell it. Above all, this motivation includes
getting back as much of their money as possible. By learning the motivations of the banks, and more
specifically the REO officer at the bank, you will find that there is less
competition for these deals than almost any other area of the business. Another successful investor uses this REO strategy
almost exclusively. His solid, cordial relationships with his bank’s REO
department has greatly enhanced his millionaire status. REMEMBER: IF IT WERE ALL EASY, EVERYONE WOULD DO IT. Foreclosure purchases are not in the mainstream of
property acquisitions. On a general basis, you will not find them listed in the
real estate section of your paper. When you do find them, it will usually be in
the “Notices” section in the local financial newspaper, or in a specific online
service featuring these distressed properties. Like any legal processes, foreclosures can be a
complex area for an untrained investor. Rather than seek competent training on
the subject, many investors simply avoid them because of fear. If it were a simple process, everyone would be buying
them. Because of this, often only a handful of investors show up at these
incredible sales. Your preparation and training will allow you to make
a significant profit when the opportunity to acquire these distressed
properties comes along. When it does, consult closely with your advisor so that
you can readily take advantage of the best investment opportunities in your
area. Remember, “good luck” is where preparedness and
opportunity meet. From my personal experience, few real estate
investment opportunities provide greater quick returns than purchasing a
property in legal foreclosure. Whether the intent is a short-term turn-around,
a fixer-upper to rent, or a long-term property to occupy, this investment
vehicle is remarkably lucrative. IN CONCLUSION The three phases of foreclosure are pre-foreclosure,
auction or foreclosure, and post-foreclosure. Each of these phases maintain a
unique position in your portfolio. One of the exciting aspects of this type of real
estate investing is that it provides an entry level. There have always been
foreclosures, and there always will be foreclosures. There will always be
lower-end economy houses to purchase, as well as upper-end luxury houses. When people experience financial difficulties, a
wise, principle-based investor can provide timely assistance. Because most
people who are in financial difficulties are emotionally and financially
drained, they are often unable to think rationally to solve their problem. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
