Foreclosure is a process that allows a lender to recover the amount owed on a defaulted loan by selling or taking ownership (repossession) of the property securing the loan. The foreclosure process begins when a borrower/owner defaults on loan payments (usually mortgage payments) and the lender files a public default notice, called a Notice of Default or Lis Pendens. The foreclosure process can end one of four ways:
The borrower/owner reinstates the loan by paying off the default amount during a grace period determined by state law. This grace period is also known as pre-foreclosure.
The borrower/owner sells the property to a third party during the pre-foreclosure period. The sale allows the borrower/owner to pay off the loan and avoid having a foreclosure on his or her credit history.
A third party buys the property at a public auction at the end of the pre-foreclosure period.
The lender takes ownership of the property, usually with the intent to re-sell it on the open market. The lender can take ownership either through an agreement with the borrower/owner during pre-foreclosure or by buying back the property at the public auction. These properties are also known as bank-owned or REO properties (Real Estate Owned by the lender).
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 the 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.
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.
Bank-Owned or 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 re-sell the property to recover the unpaid loan amount. The lender will typically clear the title and perform needed maintenance and repair; however, the discount for these REO homes is typically less than a pre-foreclosure or auction property discount. 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.
Develop a system to keep track of properties that interest you. A good tracking system is important as most foreclosure buyers pursue many properties, sometimes over a period of several months.
After you find a property online, it's a good idea to drive by the property to get a better idea of the property's condition and the type of neighborhood. Some buyers and investors who have driven by the property have found notices posted there that provide more information about the bank who now owns the property. You'll also see if the property is listed with a real estate agent.
When you find a property that interests you, perform some preliminary research to make sure the property represents a good bargain opportunity. Your research should not take more than one or two days because you do not want to delay too long before contacting the foreclosing bank. The key pieces of information you need to gather are the estimated market value of the property and the bank's break-even amount.
The bank's break-even amount includes the unpaid balance of the loan, any fees and costs incurred during the foreclosure process and any other liens the bank had to pay off to take ownership of the property. The unpaid loan balance plus any foreclosure fees and costs are included in the opening bid.
You or your real estate agent should initiate contact with the bank to express your interest in the property. Before you expend the time and effort to contact the bank, make sure you're fully prepared to buy.
At this stage of foreclosure it's more likely the property will be listed for sale on the Multiple Listing Service (MLS), so make sure you or your agent checks the MLS. If the property is listed for sale, you can contact the listing agent directly. Keep in mind that the potential bargain often diminishes if a listing agent is involved.
If the property is not listed with a real estate agent, you'll need to take some pro-active steps to contact the foreclosing bank directly. The bank's main focus is not selling property, which means you may need to do some digging to find the department or person at the bank who manages repossessed property.
When you call the foreclosing bank, you should ask for the REO (Real Estate Owned) department, bank-owned homes department or asset management department. Be patient and persistent at this point because it may take some time to get through to this department.
If you have trouble contacting the bank by phone, another option is to overnight or fax a letter to the bank stating your interest in the property. Some buyers and investors include a check made out to a local escrow company to get the bank's attention. This check is usually a small percentage of the total purchase price and should be refunded if no transaction takes place, but it shows you're a serious buyer.
Once you make contact with the bank's asset manager or REO officer, you should arrange to walk through the property (with your agent if applicable) to make sure it fits your criteria as a buyer. If both you and the bank agree to proceed, you should start negotiating the terms of the purchase agreement. A real estate agent can be a valuable resource during the negotiating process.
If state law allows a redemption period for the owner after the bank takes ownership of the property, you may have to wait until the end of the redemption period - several weeks or several months, depending on the state. During the redemption period the owner can regain ownership of the property by paying the total amount owed to the bank plus any applicable foreclosure expenses.
The bank's primary goal is to at least break even on all the costs that it has sunk into the property. That includes the unpaid balance of the loan, the expenses associated with the foreclosure proceedings, other liens and repairs to the property. Your goal as a buyer is to purchase the property below market value, minus any estimated repair costs. This is often possible if you contact the bank quickly and are a prepared buyer ready to make a purchase.
In the recent real estate market, buying directly from the bank has not been as profitable as buying during pre-foreclosure or at the public auction. That's not to say there aren't good deals available. And many buyers and investors prefer to buy directly from the bank because it's typically a more predictable process than buying during pre-foreclosure or at a public auction.
You'll probably get a better bargain if you're willing to buy the property "as is," meaning you're willing to buy the property in need of repairs disclosed by the seller. Of course you'll still want to figure estimated repair costs into your final purchase offer.
Banks may be more willing to sell at a below-market price if they have a glut of foreclosures, which are non-performing assets from their perspective. If you're an investor or buyer looking for more properties to purchase, you should let the asset manager or REO officer know to contact you in the future if the bank needs to quickly unload foreclosure properties.
Once you've arrived at an agreement with the foreclosing bank, you can put the agreement in writing. You should have a local real estate agent or real estate attorney help if you're not familiar with how to draw up a purchase agreement.
Any purchase agreement should make closing of the deal contingent on a full title search conducted by a title company or attorney. The purchase agreement should also allow for a professional inspection of the property before closing the deal.
An escrow company, who acts as a third party, can manage the transfer of money and property ownership. Assuming that you have your financing secured, this should be a fairly smooth process.
Buying at Auction
Develop a system to keep track of properties that interest you. A good tracking system is important since most successful auction buyers pursue several properties sometimes over a period of several months.
After you find a property online, it's a good idea to drive by the property to get a better idea of the property's condition and the type of neighborhood. For some buyers and investors, driving by the property has also facilitated a casual meeting with the owner (you may be able to still work out a last-minute deal before the auction) or yielded a wealth of unexpected information from a talkative neighbor.
Confirming the auction status, location and bidding procedure
After a property is scheduled for auction, the owner has a chance (typically less than a month) to stop the auction by paying the amount owed to the foreclosing lender. It's also not uncommon for auctions to be postponed without a new date being published. Although cancellations and postponements are announced at the time and location of the originally scheduled auction, you can call the trustee to find out beforehand.
Most auctions are at a public place in the same county where the property is located. In many states, all the auctions in each county are at the same location. The auction location is usually listed online (e.g. RealtyTrac) or you can typically get the location from the trustee or the county clerk. If you call the county clerk, make sure you clarify that you are looking for the location of mortgage foreclosure auctions, not tax foreclosure auctions.
The bidding procedure varies from state to state, so you should become familiar with the procedure in your area before bidding at an auction. In some states, bidders are required to bring the full amount they want to bid in the form of cash or cashier's check to the auction. In other states, bidders are required to bring a certain percentage (10 percent is common) of the bid amount to the auction and pay the remainder of the amount within a certain timeframe. If you get a friendly representative when you call the trustee, you might be able to get information about how the bidding works in your area, but in most cases you'll need to educate yourself. You could also contact a local real estate agent or attorney in your area. Of course, the best education will come from simply observing a local auction.
Researching the potential bargain
You need to find out as much as you can about the estimated market value of the property, how much is owed on the property and if the owner has any other liens against the property. If there are outstanding liens on the property, the winning bidder at the auction may be responsible to satisfy these liens in some cases, so it's important to check for any liens and the priority of the liens before you bid at the auction. A real estate attorney or title company can check for liens, or you can check directly with county records.
The priority of a lien is usually determined by the date it was placed on the property. So a first mortgage will usually have the first priority, and all other liens will be considered junior liens. In most states, the public auction clears out any junior liens, but there are exceptions such as tax liens, which typically will continue to be in effect after the auction.
The opening bid at the auction is based on the total amount owed to the foreclosing lender and may include fees incurred because of the foreclosure proceedings. If no one bids above that amount, the foreclosing lender will take possession of the property. It's important to know this amount so you can determine if the auction represents a potential bargain purchase when the opening bid is compared to the property's market value.
Determining your bid
Based on all the factors used to determine the potential bargain - and your financial capability - you'll need to determine how much you can and should bid at the auction.
Determining your bid amount is more important in states where bidders are required to bring the full amount in cash or cashier's check to the auction. You won't even be qualified to bid if you don't meet that requirement. If you don't have that type of cash lying around, you have a couple options. If you own a home, you might be able to take out a home equity line of credit, which is a cash loan. If you can't secure a cash loan, you may consider buying a pre-foreclosure or bank-owned property, which usually require only a regular mortgage loan secured by the property being purchased.
It's also important to determine the bid amount even in states where you don't need to bring the full amount to the auction. By setting a firm ceiling for your bid, you'll avoid getting caught up in the heady auction atmosphere and overbidding, which can result in little or no bargain for you. Also, if you're not able to pay the remainder of the bid within the time frame stipulated by state law, the deposit you paid at the auction is often nonrefundable.
A reasonable purchase amount at auction is at least 20 percent below full market value, and much better deals are often possible. Other factors to consider are the rate of real estate appreciation in the area and the potential for increasing the property's value by making repairs and improvements.
Bidding at the auction
Call the trustee the day before or the day of the auction to check one last time if the auction has been canceled or postponed. If an auction is postponed, the trustee should provide the new auction date.
Arrive at the auction location early and locate the auctioneer as quickly as possible. Bidding at an auction can be intimidating, especially if you've never done it before. Take as many cues from the other participants as you can, but don't let them dictate how much you bid. You may encounter investors who attend many auctions every month and who don't necessarily appreciate new competition.
If you are the winning bidder, make sure you get the necessary documents from the auctioneer to verify that you are the winning bidder. Clarify with the auctioneer and a real estate attorney what further steps need to be made before you take ownership and possession of the property. In some states, ownership can be transferred immediately or within a few days. In other states, you may need to wait a month or more for the sale to be confirmed by a court. Some states have redemption periods for the owner, in which case the owner can buy the property back from you if they pay the full amount paid at the auction, plus applicable fees. You should avoid spending money on repairs or improvements during the redemption period.
If the trustee does not evict the current owners, you may be responsible to do this. If eviction is necessary, you can contact a local real estate attorney or the county sheriff for the proper procedure