Before examining the foreclosure profit opportunities and discussing the pros and cons of each one, it is important to understand the basics of the foreclosure legal process. The exact procedure varies in each state.
To illustrate, Texas has the most unusual procedure I’ve seen. Texans hold all their foreclosure sales on the same Tuesday each month (rather than spreading the sales throughout the month, enabling bidders to buy at many auctions rather than just one auction each month). Theoretically, a Texas foreclosure can occur as fast as 21 days if the legal notice timing is just right. But the reality is Texas foreclosures usually take longer than 21 days.
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In most states, the legal foreclosure process from start to finish takes four to six months. But before the legal foreclosure procedure begins, the borrower has usually been in default on the mortgage for one to six months, often even longer for FHA and VA mortgages. In addition, some states have a “redemption period” up to 12 months after a foreclosure sale during which the defaulting borrower can occupy the property and buy it back from the successful high bidder or foreclosing lender.
If the IRS has a recorded federal income tax lien against the defaulting borrower in the county where the property is located before the foreclosure sale, the IRS has an automatic 120-day redemption period after the foreclosure auction. Please bear this in mind if you are the successful high bidder at a foreclosure sale where the IRS has recorded a lien – don’t make any fix-up improvements until after 120 days following the foreclosure sale because the IRS won’t reimburse you for any unnecessary costs if they decide to redeem.
1 – THE NOTICE OF DEFAULT OR JUDICIAL FORECLOSURE LAWSUIT. The first step in the mortgage foreclosure process is the official filing by the lender in the county or city deed or court records of either (a) a Notice of Default (if a deed of trust was recorded by the lender as the security for the property loan), or (b) a judicial foreclosure lawsuit with a “lis pendens” recorded against the property title to give notice of the court action (if the security was a recorded mortgage not containing a power of sale – some mortgages contain a power of sale and can be foreclosed non-judicially as easily as deeds of trust).
Home loan lenders prefer deeds of trust because the non-judicial foreclosure trustee’s sale procedure is much faster and doesn’t involve court delays. The biggest advantage of a trustee’s sale is there is usually no redemption period after a non-judicial foreclosure sale (except the IRS 120-day redemption period if a tax lien was recorded).
2 – THE REINSTATEMENT OR PRE-FORECLOSURE PERIOD. Until the property is foreclosed either at a non-judicial private trustee’s auction sale, or at a judicial auction sale conducted by a judge, referee, sheriff or marshal, the missing loan payments, plus attorneys fees and other foreclosure expenses, can be paid to the lender and the loan is reinstated as if nothing ever happened.
Of course, the borrower’s default is usually reported to the credit bureaus, thus ruining the borrower’s credit. But after loan reinstatement, the borrower still owns their property because no foreclosure sale occurred.
This time in the foreclosure process is sometimes called the “pre-foreclosure period.” However, that name is misleading because the property is actually in the foreclosure process.
During this “buyer opportunity period,” the defaulting borrower has four choices: (a) cure the default, such as by borrowing the needed money on a second (or third, or fourth) loan secured by the property, (b) refinance with another lender (amazingly, it is possible to refinance even when a current loan is in default!), (c) sell the property to pay off the defaulted loan(s) and walk away with cash from the property equity (equity is the difference between the market value and the total debt secured by the property), or (d) do nothing and lose the property at the foreclosure auction.
3 – THE FORECLOSURE AUCTION SALE. After the reinstatement or pre-foreclosure period ends, if the defaulting borrower hasn’t reinstated the defaulted loan, refinanced, or sold the property to pay off the loan, then the lender takes the property to the actual foreclosure auction sale.
There is an advertising period before the sale during which state law requires the lender to publish legal notices in a local “official newspaper.” In some counties and cities, there is more than one official newspaper that is designated to carry these legal notices so you might need to read several papers to see every foreclosure sale notice.
The sale will be either (a) a court-supervised judicial sale or (b) a non-judicial sale, often called a “trustee’s sale.” Procedures for these sales vary widely so ask lots of questions to learn the foreclosure sale details used in your community. It is best to attend several of these sales before you go to one where you intend to bid.
The foreclosing lender usually opens the bidding with a “credit bid” for the amount of the defaulted mortgage or deed of trust, plus any costs such as for the attorney or trustee fees, newspaper publication costs, and other foreclosure expenses. Sometimes, if the property is not worth the amount owed to the lender (perhaps because it was poorly maintained or the local real estate market has declined), the lender’s opening credit bid will be less than the actual total amount owed to the lender.
EXAMPLE: As a foreclosing second mortgage lender, I’ve submitted a lender’s credit bid for less than I was owed when I didn’t (a) want to receive the property title and (b) expect the bidding to go as high as the amount I was owed. Also, by advertising the bidding will start below the amount owed to the foreclosing lender, more prospective bidders will show up. Although I didn’t receive the full amount owed to me at that foreclosure sale, I was very happy because I (a) didn’t have to deal with the property (which had been trashed by the defaulting borrowers) and (b) could deduct my capital loss on my income tax returns to offset capital gains. Of course, if the property offered a substantial profit opportunity, as a foreclosing lender I would have entered a full credit bid for the total amount owed to me.
A major advantage of being the successful high bidder at the foreclosure auction sale is any “junior liens” are wiped out. To illustrate, suppose a house has a $100,000 first mortgage (or deed of trust) and a $25,000 second mortgage (or deed of trust). If the foreclosure sale is conducted by the first mortgage lender, when the property is either (a) sold to the highest bidder, or (b) the property goes to the foreclosing lender because no bidders showed up at the auction, that $25,000 second mortgage (and any other junior liens, such as a third mortgage, judgment lien, etc.) will be wiped out.
For this reason, it is sometimes best not to buy before the foreclosure auction during the reinstatement period from the defaulting owner if the total loans and liens secured by the property are too high in relation to its market value. However, unpaid property taxes are NEVER wiped out because they always have #1 priority!
But a major disadvantage of buying at the foreclosure auction sale is 100 percent cash is usually required (however, bringing cashier’s checks payable to yourself is much safer – if you are the highest bidder you can then endorse them to the proper party). In some states, the high bidder need only pay 10 percent of his high bid and then produce the 90 percent cash remainder either the same day or within a specified time period.
For this high cash requirement reason, if the amount of the mortgage being foreclosed is large, such as $400,000, there are often either (a) no bidders at the auction (the lender then receives the property title), or (b) bidders represent groups of investors who pool their money to bid as an investment group.
4 – BUY AFTER THE FORECLOSURE AUCTION SALE EITHER FROM THE FORECLOSING LENDER (WHO TOOK TITLE IF THERE WERE NO BIDDERS), OR FROM THE HIGH BIDDER WHO MIGHT WANT A QUICK PROFITABLE “FLIP” SALE. This is my personal favorite time in the foreclosure process to profit (although I have acquired foreclosure properties during all of the foreclosure opportunities, depending on the circumstances).
The reasons I especially like this time for buying after the foreclosure auction are (a) the emotion is out of the situation and it is a pure business transaction, (b) any junior liens have been wiped out by the foreclosure sale, (c) my purchase offer can be made subject to the buyer’s inspection approval of the property, and (c) whether I buy from the foreclosing lender (it’s called REO property – real estate owned in the lender’s portfolio) or from the successful high bidder who wants a quick resale profit, easy financing is usually (but not always) one of the buyer benefits.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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