The investment dilemma as to 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 accounting for dead grass, unpaid utility notices, and default notices. They investigate “For Sale” signs with the additional clauses “Bank Property” 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 is 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 prescribed loan payments to the bank, the borrower is considered to be in default on the loan. If delinquent payments are not made up in a timely manner, the lender is allowed to foreclose on the property to take title to the home as security for the unpaid debt. It is important for domestic investors 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 the title as collateral for the loan.
Mortgage statements use a two-part security system in which a mortgagor (or borrower) provides a promissory note to a mortgagee (or lender), along with a voluntary lien called a mortgage that serves as security for the borrower’s promise of make the loan payments described in the promissory note. Since title to the property resides with the borrower when the mortgage is created, foreclosures on mortgage statements 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 repay the original loan amount and regain title to the property. As a result, buyers in foreclosure sales in mortgage estates should be aware that they often will not be able to obtain clear title to foreclosed homes, as the previous owner will likely have an opportunity to pay off the original promissory note and claim the property.
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. Additionally, lenders are often able to provide buyers of foreclosed property with clean title since there is no right of redemption for borrowers. The deed of trust process involves a settlor (or borrower) granting a promissory note to the beneficiary (or lender), and the settlor also granting title via deed of trust to a trustee (neutral third party) as security for the promissory note . The important difference here is that the title to the property is held by the trustee and not by the borrower. The trustee is typically a neutral third party appointed by the lender to hold the deed of trust for the life of the loan with the power to more easily administer a foreclosure sale in the event of a default by the borrower.
It is clearly important to determine if you are bidding on a property that was subject to a mortgage or a deed of trust in a foreclosure sale. This differentiation can often be confusing, as many real estate professionals and deed of trust estate 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. Deeds of trust statements also refer to foreclosure sales as trustee sales, where the highest bidder purchases the property in an auction setting. However, buying a home from a trustee’s sale can be a risky proposition as the buyer has little to 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’s title, such as tax liens from a previous owner’s unpaid property taxes, so title insurance is often unaffordable for buyers at trustee sales.
REAL ESTATE PROPERTY (REO)
If a home does not sell to a new buyer through the foreclosure process, the lender holding the note will often purchase 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 defaulted note is transferred to the bank, the property is considered the real estate property (REO) of the bank. The bank will then typically hire a REALTOR® to market the property for sale at less than market value, repair any title defects, remove 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 theoretically be a bit higher than buying at a foreclosure sale, buying an REO property is clearly a much less risky proposition. REO sales also provide investors an adequate opportunity to inspect homes before making purchase offers, and buyers can utilize financing when purchasing these bank-owned properties.
Whether you buy foreclosed or REO properties, the various risks and rewards associated with an investment can 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 chagrin of telling horrifying foreclosure stories in real estate investment circles, an ounce of diligent research into a property’s financial history can prevent a pound of investment headache.