The investment dilemma of the best method of acquiring foreclosed properties at deeply discounted prices inevitably arises at the same stage of the real estate cycle every ten to twenty years. After housing booms and home prices corrected back to affordable levels, real estate investors were suddenly inundated with an almost overwhelming supply of potential homes to choose from. These prospective buyers scan city blocks for evidence of distressed properties that may lead to an investment opportunity by noting dead grass, unpaid utility notices, and default notices. They investigate “For Sale” signs with the additional clauses “Bank Owned” or “Foreclosure.” Tech-savvy bargain hunters browse online websites to identify delinquent properties. These opportunists also compare notes with each other at various social functions, water coolers, chat rooms, and anywhere else real estate is discussed. Here they can learn that to get the most lucrative price, it’s best for investors to buy the property outright at a foreclosure sale on the courthouse steps. Regardless of the preferred method of locating distressed properties, a thorough understanding of the different foreclosure processes is imperative to developing and implementing a successful investment strategy.
If a homeowner fails to make the prescribed loan payments to the bank, the borrower is considered to have defaulted on the loan. If late payments are not remedied in a timely manner, the lender is allowed to foreclose on the property to acquire title to the home as collateral for the unpaid debt. For domestic investors it is important to understand that lending practices and foreclosure procedures vary from state to state. For example, some states consider themselves “mortgage” states, while other states prefer the “deed of trust” method of lending and holding title as collateral for the loan.
MORTGAGES
Mortgage states use a two-part collateral system in which a mortgagee (or borrower) provides a promissory note to a mortgagee (or lender), along with a voluntary lien called a mortgage that serves as collateral for the borrower’s promise of security. make the loan payments described in the promissory note. Since title to the property resides with the borrower when the mortgage is created, foreclosures in foreclosure states can be relatively lengthy and expensive for banks. In addition, mortgages also provide borrowers with redemption rights that allow borrowers a specified period of time after foreclosure and final sale to a third party to pay off the original loan amount and regain title to the property. As a result, buyers in foreclosure sales in foreclosure states should be aware that they often will not be able to obtain clear title to foreclosed homes, as the previous owner will likely have the opportunity to pay the original note and claim the property.
DEEDS OF TRUST
A minority of states including California favor the three-part deed of trust system due to the relative cost effectiveness and convenience provided to lenders in the foreclosure process. In addition, lenders are often able to provide buyers of repossessed assets with a clear title since there is no right of redemption for borrowers. The deed of trust process involves a settlor (or borrower) giving a promissory note to the beneficiary (or lender), and the settlor also gives title through a deed of trust to a trustee (neutral third party) as collateral for the promissory note. . The important difference here is that the title to the property is in the hands of the trustee and not the borrower. The trustee is usually a neutral third party appointed by the lender to hold the deed of trust for the term of the loan with the power to more easily administer a foreclosure sale in the event of default by the borrower.
It is clearly important to determine whether you are bidding on property that was subject to a mortgage or deed of trust at a foreclosure sale. This differentiation can often be confusing, as many real estate professionals and deed of trust experts often casually refer to home loans as mortgages. Many lenders in these states refer to themselves as mortgage brokers or mortgage companies when they actually originate notes secured by deeds of trust. Trust deed statements also refer to foreclosure sales as trustee sales, where the property is purchased by the highest bidder in an auction setting. However, buying a home at a trustee’s sale can be a risky proposition as the buyer has little or no opportunity to inspect the home prior to purchase. In addition, the buyer must pay for everything in cash, as financing is not normally allowed on trustee sales. There is also no guarantee that the property is not currently occupied by tenants or a previous owner. Finally, buyers in a trustee sale are not protected against clouds in the property title, such as tax liens from a previous owner’s unpaid property taxes, so title insurance is often unaffordable for buyers in trustee sales.
REAL ESTATE PROPERTY (REO)
If a home doesn’t sell to a new buyer through the foreclosure process, the lender holding the note will often acquire the property and try to sell it on the open market to a new buyer. Once the title to the home that once served as collateral for the unpaid note is transferred to the bank, the property is considered real estate (REO) of the bank. The bank will then typically hire a REALTOR® to list the property for sale at less than market value, repair any defects in the title, remove any tenants or squatters occupying the property, and often hire to contractors to repair any major physical defects that exist on the property. the property. Although the typical price paid for an REO property may in theory be slightly higher than buying at a foreclosure sale, buying an REO property is clearly a much less risky proposition. REO sales also give investors a convenient opportunity to inspect homes before making purchase offers, and buyers can use financing when acquiring these bank-owned properties.
Whether you’re buying REO or foreclosed properties, the various risks and rewards associated with an investment may depend not only on the features of the home itself, but also on the type of security the home provided to the previous owner’s lender. To avoid the disgust of telling foreclosure horror stories in real estate investment circles, an ounce of diligent research into a property’s financial history can save a pound of investment headaches.
