03/27/07: Buying Foreclosure Property is Risky Business
By Benny L. Kass
Q: We have been reading that a lot of homeowners are in financial trouble, and their homes are going into foreclosure. We would like to buy a home at a foreclosure sale, and need guidance as to how to go about this process.
A. Some people might call you mercenaries, trying to take advantage of other people’s troubles. But the reality of the situation is that in many cases, the real mercenaries were the lenders who made loans to consumers who either could not afford them or did not understand the terms and conditions of the loans, or both.
Buying a home at a foreclosure sale is fraught with risks. You can end up spending a lot of money doing your homework, only to learn that at the last minute the foreclosure sale was cancelled, or that the borrower filed bankruptcy minutes before the sale takes place. And even if the sale proceeds, you may not be the successful bidder. You have to know at the outset that there are a lot of professional buyers who know the players and the process, and they often are the ones to get these properties.
The very first thing you must do is to hire an attorney who is not only knowledgeable about real estate, but who also has experience with foreclosures in the jurisdiction where the property is located. There are different State laws and requirements throughout the United States, so you cannot rely on books and other publications which try to explain the foreclosure process.
Your attorney will explain the procedure to you and will immediately order a title search on the property. Presumably the lender who instituted the foreclosure has also obtained a title search, because lenders are required to provide notice of a foreclosure sale to all persons (or entities) that have an interest in the property.
But generally, that title report will not be shared with you. You want to know everything about the title to the property, including such matters as:
- who owns the property? In whose name is the title?
- how many mortgages exist on the land records?
- are there any lawsuits against the homeowner?
- are there any filed mechanics liens on record?
Why is all this important? Let’s say that the house has a market value of $300,000, and there is a first trust (mortgage) in the amount of $175,000, and a second trust in the amount of $100,000. It is important to know which lender has instituted the foreclosure.
If it was the first trust holder, then by law the second trust will be wiped out. That does not mean that the homeowner will no longer owe money to the second trust holder. If that trust holder wants to pursue the homeowner, it will have to file a suit in court; it cannot foreclose on the property. Keep in mind that when you borrow money to buy or refinance a home, you sign two legal documents: (1) a promissory note, whereby the borrower agrees to pay the lender pursuant to the terms of that document, and (2) a deed of trust (also known as the mortgage) which is the document which allows the lender to foreclose on the property. The deed of trust is recorded among the land records in the jurisdiction where the property is located.
On the other hand, if the second trust holder starts to foreclose, it must formally notify the first trust lender, who then has an opportunity to protect itself. In some cases, that first trust lender can negotiate to buy the second trust – usually at a discount because the second lender is happy to get its money quickly – and then the first trust holder can start its own foreclosure.
This sounds complicated, and it is – especially for novices in real estate.
While your attorney is obtaining a title search, you should make arrangements to inspect the property. Why is the owner letting it go to foreclosure? Is the house in such bad condition that the owner is unable to sell it? Most homeowners do not want their home to be foreclosed upon, because it will significantly impact their credit standing for many years. No lender wants to make a new loan to a borrower who has a foreclosure on his/her credit report.
Accordingly, many homeowners faced with the threat of foreclosure will try to sell the house – even at a discount – rather than have to face foreclosure. You should try to talk with the homeowner, and see if you can negotiate a deal whereby you can buy the house directly and thus everyone will avoid foreclosure.
This means that you will need to know the true value of the property, and will also have to obtain a preliminary loan approval letter from a mortgage lender in advance of any discussions you have with the homeowner. You also need to know the exact amount of money that the lender will require in order to stop the process. Often, this is difficult to obtain, because some lender’s attorneys are reluctant to provide you with the complete payout amount., which includes the outstanding loan balance, late fees, attorneys fees and foreclosure costs.
If you can convince the homeowner to sign a contract to sell you the house, that contract should be contingent on your ability to go to closing before the house is foreclosed upon. You should not give the homeowner any money; your earnest money deposit will be held by your attorney in an escrow account.
You – or your attorney – should immediately contact the lender (or its attorney) to advise them of the sales contract. You should get written confirmation that the foreclosure will be postponed in order to give you time to go to settlement on the property.
It should be noted that once the foreclosure process has begun, you will have very little time in which to do all of your homework. Most legitimate lenders will not ever start to foreclose until they have exhausted negotiations with the homebuyer on options short of foreclosure.
The lender will place a notice of foreclosure in a local newspaper. You and your attorney should read the advertisement very carefully. When and where will the foreclosure take place? Often the process can take less than10-15 minutes, and if you are late, you will lose out.
Are there any conditions or restrictions placed in the ad? Will the successful bidder take subject to any outstanding liens or obligations?
Now, it is foreclosure day. You should go to the auctioneer’s office (in some jurisdictions it takes place on the steps of the local courthouse), and listen carefully to the bidding instructions. Sometimes, new terms and conditions will be presented at the time of the auction, and these terms may not be satisfactory to you.
You are the successful bidder, and have to post with the auctioneer a good faith deposit, which will be forfeited if you do not close promptly – usually within 30 days from the date of the auction sale.
Congratulations are not yet in order. Did you take into consideration that fact that the current owners are still in the property and you will probably have to take them to the appropriate Landlord-tenant court and seek to evict them? This can be an expensive, time-consuming project, which must be accounted for in your planning budget.
Buying property at a foreclosure sale is not for everyone. It can be expensive, time-consuming and disappointing. Always ask yourself this question: if this is such a good deal, why is it only coming my way?