Real Estate Foreclosure
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A practice very much related to the surplus business is the field of real estate foreclosure investing — the buying and selling of foreclosure or pre-foreclosure properties. It is quite common to find those running successful surplus businesses to be dabbling in real estate foreclosure investing. And, as a way to diversify your income streams if you’re currently, or thinking about becoming, involved in making money in the surplus business game, you’d be well advised to investigate the possible opportunities which present themselves in the area of foreclosure investing.
How does the process of foreclosure investing work?
To begin with, when someone obtains a mortgage for the purpose of purchasing a home or other property, a bank will provide to that person a loan for the amount of the house or property. This loan is secured by the bank, in almost all cases, by the very property which is to be mortgaged. Therefore, when someone obtains a mortgage from a bank in order to purchase a new house, the buyer, in practical terms, enters into two agreements with the lending bank. The first of these is the actual mortgage agreement itself. The second is a security agreement. This security agreement specifies that, if the buyer should have the misfortune of defaulting on their mortgage payments, the issuer of the mortgage may then foreclose on property being mortgaged in order to recoup the outstanding debt owing to the lender.
In the event that a homeowner, still owing on a mortgage, does come to find themselves in the unfortunate situation of being unable to continue their mortgage payments, and they allow the debt to go unpaid, the issuer will, at some point, file a legal notice known as a Notice of Default, or sometimes what’s known as a ‘Lis Pendens‘ (Latin for ‘suit pending’). Depending in which state the foreclosure is occurring, the lender will file at least one of these two documents. These legal documents, once filed, allow the public to know that an action of foreclosure on the property has commenced.
Foreclosure Investing Explained – Pre-Forclosure
Prior to the property entering into full foreclosure, there is a period of time which exists, after the Notice of Default, or Lis Pendens has been officially filed, but before the actual foreclosure auction takes place, which is known as the pre-foreclosure phase of the foreclosure process. During this pre-foreclosure period, interested members of the general public receive their first opportunity to attempt the acquirement of such properties. This is done by contacting the property owner directly — the current holder of the mortgage in default — with an offer to buy the property from them and take it out of foreclosure.
Such an offer can be attractive for both the party making the offer, and the current owner of the property. If the house goes to full foreclosure while in their possession, the current owner loses it completely. They walk away with nothing and must simply absorb the entire loss of the money they’ve already paid into the equity of the property. The bank seizes the property, sells it, and retains all proceeds in order to recoup their investment. For this reason, knowing that they are currently on track to lose their property entirely with pretty much nothing to show for it, an owner, at this stage, will be primed to give serious consideration to an offer which may well be below the market-value of the property in question, or even below the amount of equity they currently have in the property.
The owner of a home currently in the pre-foreclosure stage, very often, may be highly anxious to sell the house at a significantly undervalued cost. In doing so, they may avoid losing their property entirely, and actually gain walking away from the mess they’ve found themselves in with at least some amount of money from the deal. They can avoid having their credit rating destroyed by holding a property that goes to full foreclosure. And, if their property does end up going to full foreclosure while in their possession, and the mortgage lender, upon selling the foreclosed property, is unable to fetch a price that fully covers their losses, the mortgage lender then has the ability to bring a civil action against the borrower in order to gain judgment for the difference. All of this can be avoided by the unfortunate home owner by unloading the property while it’s still in the pre-foreclosure phase. And so, of course, there exists, at this point in the process, a strong incentive to sell off the property.
Full Foreclosure — The Foreclosure Auction
In the event, for whatever reason, the current owner does not sell off the property prior to the date of full foreclosure and the occurrence of the foreclosure auction, or if default hasn’t been cured via some other means, then the foreclosure sale will go forward and a trustee will attempt to sell the property at auction to the highest bidder. The trustee will attempt to garner a final price at auction which recovers any outstanding balance on the mortgage owing, plus any related expenses associated with the process.
Just before the auction for the property takes place, in most cases, the lender will pay-off any secondary debts or liens which may be owing on the property. This might include things like outstanding property taxes, or other related taxes. The reason for doing this is so the property can be sold off at auction with a clear title — otherwise, the new owner obtaining the property at auction would also be taking upon themselves the responsibility for those outstanding debts. The lender, very often, at this time, will submit what’s known as a ‘credit bid‘. This bid is the amount still owing on the mortgage, along with any related expenses the lender may have incurred. This can sort of be seen as a bid the bank enters, in which they will purchase their own property being sold — as in, any bid lower than this amount would make the sale pointless and undesirable for them, so they themselves will bid this amount in order to keep the property. In reality it acts as an opening bid. So, the bidding process does not start at $1.00, or some such other low, arbitrary figure, but instead it begins at this ‘credit bid‘ amount.
In some legal jurisdictions, previous owners enjoy what’s known as a ‘right of redemption.’ This affords the previous owner of the property a set time limit, the length of which varies from area to area, in which they may redeem the property if they are able to come up with the money that the property was sold for. Although this very rarely occurs, one should be aware of the possibility and investigate what the specific law is regarding a right of redemption in the area in which you may be interested in bidding on a foreclosed property. If you do end up placing a winning bid on a foreclosed property, it could be that the previous owner may show up within 30, 90 days, 6 months, or what have you (again, depending on the laws of the area) after the date you acquired the property with the amount of cash that you paid for the property. In such a case, you would be legally required to hand the property back to the original owner in exchange for being reimbursed your purchasing price.
Along with the original owners right of redemption — which may, or may not, be in effect in the area in which you’re bidding on a property — the IRS also enjoys the ability to be able to redeem the real estate if there are back taxes still owing on the property. This too, however, is quite rare, as in most cases the lender, for the purpose of fetching a higher price and attracting more bidders, will have cleared such outstanding debts before putting the property up for auction. Properties wherein a buyer, once acquiring the property, will take upon themselves a claim against them by the tax man tend to scare people away. Because of this, it’s quite rare that such properties are put up for auction with such debts still attached to the property. But, in rare cases it can, and does happen. So, one should be aware of this, do their due diligence in attempting to discover the exact nature and financial standing of the property on which they’re bidding, and factor such things into their bidding decisions.
FORECLOSURE INVESTING EXPLAINED — REO Properties
The final phase which may, or may not, take place in the foreclosure process is what’s known as the ‘REO’ stage. REO is an initialism which stands for ‘Real Estate Owned‘. When a property which has entered into foreclosure and has been put up for auction fails to attract a high enough price to cover the lenders losses on the property, the mortgage lender will take control of the property. If the lender happens to be an institutional lender, the property in question will become an REO property.
The REO property is basically just a real estate property that is owned, held and is being managed by a bank. Lending institutions, however, are usually quite eager to liquidate these properties as quickly as they possibly can. Banks are in the business of lending money, they’re not in the business of managing and holding real estate, and doing so is seen as an unprofitable distraction. The money that is tied up in the value of the property which itself is, basically, just sitting there, is money they could be using to loan out at interest. So, banks holding REO properties are usually quite motivated to move the properties swiftly. For this reason, a solid investment deal also presents itself to interested property buyers at this final stage of property foreclosure.
To search through a comprehensive listing by area of properties currently either in the pre-foreclosure, or full foreclosure stage and scheduled come up for auction, visit this online resource, and, once there, click on the ‘foreclosure’ tab located near the top-right of the screen.
(Title photo credit: Jeff Turner)