Many people believe that to profit from foreclosures, you buy a property at a foreclosure auction for pennies on the dollar-then quickly resell that property for large and easy windfall gains. In fact, buying foreclosures at auction represents just one type of foreclosure possibility. And that approach generates risks and uncertain profits. Consequently, most investors usually buy before or after a foreclosure auction-not during.
The Foreclosure Process
Typically, borrowers default because they have failed to make their scheduled mortgage payments. But defaults also occur when owners fail to pay their property taxes, fail to pay some related obligation (homeowners' association fees, a superior mortgage claim, special assessments), transfer a mortgaged property without lender approval, or undertake renovations, remodeling, or demolition that diminish the value of the property.
Lender Tries to Resolve Problem
In contrast to the late 1980s and early 1990s, most lenders today give borrowers generous opportunity to reinstate or even refinance their mortgage defaults. That's why even though the current number of mortgages in foreclosure has reached high levels; the number of properties actually sold at foreclosure auctions remains low. With more loan workouts, fewer properties go to a foreclosure sale-especially as compared to the huge numbers of 10 to 15 years ago. Nevertheless, mortgage lenders (or guarantors) will get the keys to several hundred thousand properties this year. And the number of borrowers who have fallen behind in their payments (and thus are in need of a workout) now exceeds 1.0 million. Given these huge numbers, serious investors can still ferret out foreclosure bargains.
Filing Legal Notice
When a lender finally gives up on a pre-foreclosure workout, its lawyers file either a legal "notice of default" or a "lawsuit to foreclose" (depending on the state). This legal filing and its subsequent posting of notice on the Internet or in newspapers formally announce to (1) the property owners, (2) any other parties who may have legal claims against the owners or their property, and (3) the public in general that legal action is moving forward to force a sale of the property.
At least one month passes between the date of legal filing and the foreclosure sale. More typically, this waiting period ranges between 60 and 180 days. If the property owners file a legal defense to the lender's foreclosure action (e.g., lender violated due process, fraud, consumer rights, truth in lending), the foreclosure sale date may be delayed until after full-blown litigation and trial. Those kinds of legal battles can drag on for a year, two years, or even longer.
Also, to delay a foreclosure sale for at least a month or two, property owners may file for bankruptcy. Any bankruptcy filing by the property owners immediately and automatically stays a foreclosure action. To proceed further in its efforts to force a sale, the lender must petition the bankruptcy court. Only after the court grants permission will the foreclosure process start running again. (In fact, in some situations, a bankruptcy court can even annul a foreclosure sale that has already occurred.)
The Foreclosure Sale
Eventually, when defaulting property owners run out of legal defenses or delaying tactics, the foreclosure sale date arrives. At this point, the property is auctioned to the highest cash bidder. On occasion, the winning bid is submitted by a real estate investor (foreclosure specialist), speculator, or even a homebuyer. More likely, though, the lender who has forced the foreclosure sale bids, say, one dollar more than the amount of its unpaid claims (mortgage balance, late fees, accrued interest, attorney fees, foreclosure costs) and walks away with a sheriff's deed to the property. From then on until the lender (or its realty agent) sells the property, that property remains on the lender's books as an REO.
The most important thing to know concerning foreclosure should be written in capital letters: LENDERS DO NOT WANT TO OWN FORECLOSED REAL ESTATE. For a lender (or institutions such as the Federal Housing Administration [FHA], Department of Veterans Affairs [VA], Fannie Mae, Freddie Mac), holding onto an REO that has been acquired through foreclosure rarely seems like a good idea. No matter how much potential the property offers, owners of REOs want to sell quickly. For you, their desire to sell quickly may mean their loss and your gain.
Nevertheless, do not let the foreclosure gurus mislead you. Lenders do not sell foreclosures for pennies on the dollar. Especially in strong real estate markets, lenders try to negotiate tough.
When dealing in foreclosures, you can try three different approaches.
1. Negotiate with the distressed property owners and, if necessary, the foreclosing lender (i.e., to obtain a short sale or refinance).
2. Bid at the foreclosure auction.
3. Buy an REO from the lender or the "insuring" agency (FHA, VA, Fannie Mae, Freddie Mac) that owns the property. (This topic is covered in Section 7.)