The Complete Guide to Foreclosure Investing

The Complete Guide to Foreclosure Investing

Generating a return on your investment from foreclosure investing doesn’t happen overnight.

A successful investor needs to understand the ins and outs of foreclosure including laws and regulations, different stakeholders, and how to make the most of an investment. 

Here, we’re going to dive into the world of Foreclosure investing, covering everything you need to know about:

Let's dive in...

 

foreclosure-basics

Understanding the Basics of Foreclosure

What is Foreclosure?

Foreclosure is the process of a lender repossessing a home or property when the owner fails to make their mortgage payments. Once a home goes into foreclosure, the lender will often try to sell the property.

What causes a foreclosure?

Negative Equity

There is strong evidence to suggest that negative equity, meaning that an owner owes more on their loans than the house is worth, is the leading cause of foreclosure. As lenders rarely loan more on a property than it is worth, this primarily occurs after a significant decline in prices.

Why is having negative equity, also referred to as being underwater, such an important factor? 

Homeowners with equity have options—they can refinance or sell if they run into trouble making their payments. Underwater homeowners lack these options, leaving foreclosure as the only way out unless the lender is willing to take less than they are owed in a short sale, or modify the loan terms.

Typically, the leading cause of price declines is an economic downturn. While this is still the primary issue in certain parts of the country which are losing jobs or entire industries; the housing bubble that occurred from 2000-2007 led to wide-scale price declines, after prices reached unsupportable levels using risky loans. 

These loans put buyers in homes they could not otherwise afford. As these loan offerings were removed from the market, prices were forced to return to levels that buyers could afford using more traditional financing. 

This caused prices to drop by 50% or more in the hardest-hit areas. As prices declined, foreclosures rose.

The Five D's of Foreclosure

Despite the fact that the vast majority of foreclosures are driven by negative equity from price declines, there is a base rate of foreclosure that happens during even the best economic times and housing markets. This base rate can largely be explained by the Five D's of Foreclosure:

Death

The passing of a family member that contributes to mortgage payments can very quickly result in foreclosure.

Divorce

Even in the most amicable of divorces, spousal support and house payments are missed. More common is one former spouse refusing to leave, and the other refusing to pay.

Drugs

Drug use and abuse impairs judgment and can lead to missed payments.

Disease

Catastrophic illness, chronic disease, or lack of health insurance coverage can significantly impact a homeowner's ability to make mortgage payments.

Denial

A home is a person’s castle, their security. Individuals often refuse to acknowledge that their home can actually be taken from them if they fail to meet their financial obligations.

Understanding Subprime

Despite many blaming defaulting subprime loans for the latest downturn, there is little evidence pointing to subprime foreclosures as the primary cause. 

A study done by the Boston Fed looked at various factors, including credit score, income, job loss, and other factors typically blamed for foreclosure; and found that while these factors contributed, foreclosure was unlikely unless there had also been price declines leading to negative equity. 

It makes sense—if a house is worth more than is owed, it can be sold even if the person has bad credit or loses their job.

Now, that's not to say that loose lending standards did not play a role in this crisis. 

They did. 

Together with qualifying pay option ARMs based on the teaser payment, and other exotic and misadvised lending practices, they clearly helped push prices too high, and thus ultimately led to the price declines that are at the root of the foreclosure crisis.

Types of Foreclosure

There are two common types of foreclosure used in the United States: Judicial Foreclosure and Non-Judicial Foreclosure.

Judicial Foreclosure

Judicial foreclosure is allowed in all states and occurs when the lender files a civil lawsuit against the borrower, with the entire process being handled by the court. Judicial foreclosures can be further divided into two types: foreclosure by sale, and strict foreclosure.

Foreclosure by sale requires the home to be auctioned to the highest bidder with the lender placing the first, or opening, bid. These auctions are commonly referred to as sheriff sales.

In a strict foreclosure, the court sets a date by which the owner must pay the mortgage, and if the owner fails to pay, the court awards ownership of the home to the lender with no auction taking place.

The judicial foreclosure process begins when the lender files their lawsuit, at which time they also file a lis pendens (aka notice of pendency of action) on the property.

The lis pendens is a document recorded with the County Recorder’s office, to let potential buyers, lenders, and others know of the pending foreclosure lawsuit. 

A second notice, the Notice of Foreclosure Sale (NFS), is typically filed once the court has set the auction time and bid amount.

Non-judicial Foreclosure

The non-judicial foreclosure process allows a lender to advertise and sell the property at a public auction, without court involvement, by following a process specified by the state. 

As the process is laid out in state laws, or statutes, the non-judicial foreclosure process is sometimes also referred to as Statutory Foreclosure.

A key requirement for non-judicial foreclosure is that the borrower agreed to the process when they took the loan. 

To accomplish this, a power of sale clause is added to the mortgage, or deed of trust, which gives a third-party trustee the right to sell the property in the event the borrower does not make their payments. Given this clause, non-judicial foreclosures are sometimes referred to as foreclosure by power of sale.

In most non-judicial foreclosure states, the foreclosure process is started when the lender files a Notice of Default (NOD) with the County Recorder’s office, putting the homeowner and anyone else who is interested on notice that the loan may be foreclosed on. 

A second notice, the Notice of Trustee Sale (NOTS) is typically filed 30 to 120 days later, depending on the state; and sets the auction date and time. In some states, only the Notice of Trustee Sale is recorded, and the names of the notices sometimes vary as well.

Important Notes about the Foreclosure Processes

There are two important things to keep in mind about both foreclosure processes:

  1. Foreclosures happen to loans, not properties. As such, it is quite possible to have more than one active foreclosure on a single property at the same time.

    More importantly, buying a foreclosure at a state-mandated auction doesn’t necessarily mean that you have purchased the property free and clear of other liens.

    For example, the buyer of a foreclosure is almost always responsible for any past due property taxes. 
  2. Foreclosure laws vary a great deal by State and are subject to change. One should never assume that anything they learn about the foreclosure laws of one state will apply to another.

The Three Stages of Foreclosure

There are three distinct stages in the foreclosure process in relation to acquiring property.

Opportunity Traditional Financing Subject-to-Financing Title Insurance Inspections Eviction Required Overall Risk
Preforeclosure Yes Yes Yes Yes No Low
Auction No No No No Maybe High
Bank Owned  Yes No Yes Yes No Very Low
  • Preforeclosure

Properties are considered to be in preforeclosure from the filing of the initial Notice of Default until the property is sold at auction. 

During this period investors can purchase the home directly from the owner, Realtors can list the home, and Lenders can help them refinance. 

Note that prior to the filing of the Notice of Default the home is considered to be “Delinquent” rather than in preforeclosure, despite that period of time also being before the foreclosure sale.

  • Auction

Auction properties have had a Notice of Trustee Sale filed setting an auction date, and have not yet been sold or canceled. 

Investors can purchase the home at auction; and Realtors® and Lenders can monitor their client’s properties, to ensure their listing and loan activities are completed before the auction

Tips for Auction Investing 

It is critical that you never provide legal, tax, or other advice that you are not qualified to offer. An auction investor, however seasoned, is still a client and you should refrain from making any statement you are not qualified to make.

Partner with an attorney, CPA, or other professional that can offer tax and legal advice to your client. This includes shorts sale sellers and auction investors. A partnership with an attorney or CPA could also provide reciprocal referrals.

  • Bank owned

Banks are taking back thousands of homes through the foreclosure process every month. These homes will be listed for sale, or occasionally sold in bulk. These properties are often not fixed up after foreclosure, and therefore can represent a bargain for investors willing to buy diamonds in the rough.

There are also situations when banks need to dump properties to raise cash to meet reserve requirements. Further, banks often use non-local real estate agents that might not realize the value of the property and misprice it. For these reasons and more, REO properties provide significant opportunities for savvy investors.

Find foreclosure investment opportunities using public records with your free trial of PropertyRadar!

foreclosures-buying-and-selling

Big Picture: Things to Consider When Foreclosure Investing

#1: Consider the Foreclosure Laws You Need to Know 

Foreclosure laws vary by state but are often patterned after each other. Realtors, investors, and professionals involved in the foreclosure process should take time to familiarize themselves with the laws that govern foreclosure transactions in their state.

In addition to the core judicial and non-judicial foreclosure codes, a handful of additional laws have been routinely put in place to protect consumers, homeowners, and those in financial distress, from falling victim to those who might take advantage of their misfortune by offering them unrealistic solutions to their financial problems. 

These laws include equity purchase laws, foreclosure consultant laws, and rent skimming laws.

Equity Purchaser Laws

Equity purchaser laws are designed to protect homeowners from equity predators. These laws regulate the sale of homes before the foreclosure auction and typically impose the use of specific contract language, cancellation periods, and impose penalties for making false or misleading statements to entice someone to sell their home.

Foreclosure Consultant Laws

Designed to protect homeowners from Save My Home scams, these laws regulate the sale of services to homeowners in foreclosure.

Services offered by specialists in "getting people out of foreclosure," may include offering to help stop the foreclosure, modify the loan in foreclosure, or collect funds after the foreclosure. 

Typical laws impose cancellation periods, prohibit excess fees, and place restrictions on requiring payment in advance for services performed.

Rent Skimming

During foreclosure, it is not unusual for homes to be left vacant. Rent skimming laws make it unlawful to rent a property you do not own. 

A common scam is to find a vacant home in foreclosure, advertise it for rent, collect the first and last month’s rent, and then abscond with the money, leaving the renter to find out later they are in the home illegally. 

Prior owners who continue to collect rent payments from tenants after their property has foreclosed, are also rent skimming.

#2: Consider the 6 Ways Foreclosures Can Be Stopped

Homeowners who have failed, for one reason or another, to maintain the payment obligations of their loans, and are found to default on their loans, have a number of alternatives to foreclosure, including: 

Bringing the Loan Current

The best possible resolution for homeowners in default is to reinstate the loan by bringing payments current and paying all past-due amounts.

Selling the Property

A traditional sale of the property, in which the asking price covers the costs of the entire loan in default, would stop the foreclosure and eliminate the obligation of the homeowner to make monthly payments, by providing payment in the full amount of the loan. 

Another option, should a conventional sale fail, is a short sale; this is the sale of the house, under agreed-upon terms with all lien holders, to sell the property and settle the debts for less than the amount owed. Short sales can be difficult for properties with significant negative equity.

Refinancing the Property

Refinancing a property with more reasonable monthly payments and interest rates could potentially permit the homeowner to remain in the home, by paying off the current default obligation with the newly refinanced obligation.

Working with the Lenders

  • Loan modification: Modifies the terms of the original loan to enable the homeowner to stay in the home. May adjust the interest rate, principal balance, length of the loan, or other terms.
  • Forbearance: An agreement not to collect past due amounts for some period of time. Can be useful when the borrower fell behind due to temporary illness, or job loss, and can afford payments going forward, but can not afford to repay the past due amounts.
  • Repayment Plan: Similar to a forbearance, except the past due amounts are repaid in small amounts over a period of time, rather than being delayed to a future date.
  • Deed-in-lieu: Sometimes referred to as jingle mail (the sound of keys being mailed back to the lender), a deed-in-lieu is a method of simply handing ownership of the property back to the lender. Many lenders will not accept this deed, as they will then have to pay to remove other liens on the property; whereas those liens may be wiped out if they choose to foreclose.

Suing the Lender

While it is often a good idea to have an attorney review loan documents for problems and to help negotiate better loan modification terms; lawsuits are expensive and likely beyond the reach of most homeowners, unless working together in a class-action suit.

Declaring Bankruptcy

Bankruptcy really only delays foreclosure. While Congress is considering allowing judges to modify loan terms, they currently can’t.

As such, if the owner fundamentally can't afford to make payments, the judge will likely have to grant the lender a motion allowing them to continue the foreclosure. This option should therefore be used carefully, as it impacts your credit for 10 years, versus 7 years for a foreclosure alone.

Now that we’ve taken a look at some of the things you need to know about foreclosures and the way they can be stopped, let’s dive into The Complete Guide to Foreclosure Investing.

foreclosure-investing-right

The Complete Guide to Foreclosure Investing

There are many ways to buy foreclosures: from the no cash, no credit methods taught on late-night TV, to billion-dollar bulk purchases. 

There are significant discounts available on foreclosures, but buying a foreclosure is not a get-rich-quick proposition. For those willing to work, and in some cases, take some risk, foreclosures represent a unique opportunity for acquiring real estate at discount prices.

Step #1: Qualify Foreclosed Opportunities

When you’ve decided you want to pursue a Foreclosure Investment strategy, it’s time to determine which opportunities are right for you and, eventually, find properties that match your criteria. 

Let’s take a look at what you need to do to successfully qualify foreclosure opportunities.  

Determine Opportunity Types That Are Right For You

There are several opportunity types foreclosure investors will target as part of the investment strategy, including: 

Preforeclosure

 A notice of default has been filed. PropertyRadar provides a projected sale date that is the approximate date the property could go to auction based on regulatory requirements. The actual date is not set until the default period expires and the Notice of Trustee Sale is recorded. 

PropertyRadar shows all preforeclosures as active for 120 days by default. If the Notice of Trustee Sale has not been recorded within 120 days, then the foreclosure record is moved to historical records and can be accessed by checking the box “Include historical records.” 

A Notice of Default does NOT have an expiration date and can sit dormant for years until the Notice of Trustee Sale is filed. 

Auction

A notice of trustee sale has been filed. The sale date is the scheduled auction date. The published bid that appears on this notice is the amount owed on the foreclosing loan at the time the notice was prepared, including principle, past-due interest, and foreclosure fees. 

A sale date can be continuously postponed for up to one year before a new notice must be posted, published, and recorded. 

Bank Owned

The foreclosing lender gets to make the first bid which is called the opening bid, or drop bid. This bid amount can be substantially lower than the published bid or it can be higher if the lender chooses to add the additional interest and fees that have accrued since the Notice of Trustee Sale was prepared. 

If no bidders placed a bid above the opening bid at the auction, the lender now owns the property. The sale date is the date the sale took place. The estimated value (AVM) and winning bid give an indication of the level of discount lenders are making. 

Sold to Third

A third party, such as an investor, bought the property at auction. An investor can bid as little as a penny over the bank's highest bid. The sale date is the date the sale took place. The estimated value (AVM) and winning bid give an indication of the margins investors stand to make. 

For preforeclosure and auction properties, it’s important to understand the outstanding loans against the property, such as what the current owner paid for the property, the lenders that originally made the loans, as well as any other liens against the property or the homeowner. 

It is also important to know whether or not they were purchasing money loans. There can be legal and tax consequences that are specific to their current situation that must be addressed for a homeowner to make the best decision for their situation.

A little research gives you enough information to know how much time is left before a property is lost to foreclosure, whether pursuing the listing is a good use of time, or if you need to contact the seller’s agent (if the property is scheduled for auction) to verify that they have a plan to delay the sale long enough for you to close escrow.

Step #2: Find Foreclosure Opportunities

Once you’ve qualified which opportunity types make sense, it’s time to move onto finding a foreclosed property. Let’s take look at some of the ways you can do this.

Utilize Foreclosure Comps

A Foreclosure Comp is a list of foreclosure properties comparable to a subject property, similar to MLS-based Comparable Market Analysis (CMA), typically showing comparable properties in terms of location, beds, baths, and other features. However, these properties are not typically listed in the MLS. Instead, the information comes from public records.

Foreclosure Comps offer a glimpse of properties in foreclosure as well as properties recently taken back by the bank at auction. The foreclosure comp report allows agents and their clients to see the discount that banks are taking in a particular area. An advanced glimpse of a market helps agents price aggressively, secure the best deals for buyers and sellers, and get bank offers approved.

Foreclosure comps can give you a clear picture of potential REO listings for the next 6 to 9 months and will help you get listings priced to sell, buyers off the fence, and your bank offers approved. Remove the fear, uncertainty, and doubt of home buying by incorporating Foreclosure Comps into your opportunities analysis.

Track Foreclosure Status

Foreclosures are broken down into stages similar to the Active, Pending, and Sold statuses in an MLS Comparable. The three stages are:

Status Description
Bank Owned Likely to show up as REO listings in the next 2 to 4 months, these properties provide the best pricing information as banks typically set an auction opening bid at or near what they see as the wholesale value of the property. 
Auction These properties are actively scheduled for foreclosure sale with a considerable percentage likely to show up as REO listings in a 3 to 6 month timeframe.
Preforeclosure While a little less certain at this stage, a percentage of these properties will end up as bank owned properties (REO) in the 5 to 9 month timeframe.

Track Foreclosure Amounts

The status of the property indicates which bid type to look check out. The estimated and published bid amounts pertain to the loan in foreclosure and what is owed. The winning bid shows what was actually paid. None of these numbers reflects the possible list price of the property in a traditional sale.

Status Amount Description
Bank Owned Winning Bid This is the amount the lender was willing to take to unload the property quickly
Auction Opening Bid The actual beginning bid the bank will make at the auction. This value can be discounted off the published bid and is sometimes available a few days before the sale. Other times, nobody hears the opening bid until the property comes up in a list at the courthouse steps. There can be several entities responsible for determining the opening bid, such as a servicing lender, investing lender, government reinsurer, or mortgage insurer. It is impossible to tell before it is announced which properties will have a discounted opening bid.
Auction Published Bid The estimated total debt on date of the foreclosure auction. It includes the principle, past due interest and foreclosure fees and may be discounted in the opening bid at the sale.
Preforeclosure Estimated Bid The loan amount plus default amount. This amount is likely to change when the Published Bid is released in the Notice of Trustee Sale, and may be discounted at the actual sale.

Evaluate Foreclosure Comps

Get sellers priced to sell. Want to move a listing quickly? See what banks are accepting discounts on properties at auction. Generate reports on competing properties not yet listed but could significantly impact price.

Coupled with comparables from pending, listed, and sold properties from an MLS, foreclosure comps provide the necessary insight into a market so your listings are priced appropriately.

Foreclosure Comps are powerful and easy to develop, following these few simple guidelines and steps.

Search

Search broadly. Using the PropertyRadar radius or map search functions, generate a range of potential comparables. Conduct your initial search with a limited number of criteria. It’s better to have too many properties to select from than too few.

Select

Narrow your list of properties by selecting criteria that meet your specific property requirements. You’ve narrowed the search area, now refine the search by beds and baths, square footage, estimated values, and other features.

Print

Print your selected properties, with maps, showing areas and values to:

  • Convince uncertain buyers
  • Determine the best place to buy
  • Negotiate the best price
  • Convince lenders  to accept an offer

The foreclosure process starts with notice being filed at the County Recorder's office, and you can typically browse these recorded documents at the county for free. 

Attend Auctions

Auction investing is considerably more risky than other potential investment opportunities. But, with greater risk comes greater reward. 

With a defined strategy, the right focus, an accounting of the inherent risk and a qualified and thoroughly researched list of auction properties, there is much to be gained from these investment opportunities.

Unlike preforeclosure investing, an auction investor isn’t concerned with subordinate liens because they are wiped out at the auction. 

Typically (but not always, so be careful) the foreclosure is on the first mortgage, so all that may be left to deal with are outstanding property taxes, or perhaps an IRS lien. Another advantage of auction investing is that because of the cash requirements, the pool of competition is much smaller. 

In fact, if you attend a few auctions, you’ll start to recognize the faces of the serious investors. And they’ll notice you, too.

Auction investing poses greater risk because of the collapsed timeframe for research and the lack of access to the property. This means no professional property inspection to uncover fundamental problems and no professional title research to reveal title issues. 

And the winning bidder may have eviction issues to deal with before they can take possession of the property.

Consider Listing and Closing Short Sales

You can be a hero – and it pays! Short sales are the right thing for homeowners in distress.

According to current FNMA/FHLMC guidelines, a party with a short sale on their credit report may qualify for an insured home loan after two years as compared to the FNMA/FHLMC guidelines for a party with a foreclosure on their credit report. They may qualify for an insured home loan after five years.

In addition, a successfully negotiated short sale resolves the problem for the homeowner by potentially eliminating deficiency judgments or recourse issues from junior liens hanging over their heads.

Don’t Forget to Perform BPOs

Foreclosure comps can give you the necessary insight to provide a qualified BPO. A BPO is a broker’s price opinion on a specific property. Asset managers may not accept foreclosure comps for BPOs, but with an increasing percentage of foreclosed properties, or properties soon to be in foreclosure, knowledge of what is on the horizon is indispensable.

The ability to complete a quality BPO is essential to getting an REO account. An agent report card can suffer for not providing good quality BPOs and supporting the value they submit. This is an essential skill for an REO agent.

There are BPO courses and certification programs through REOMAC and 5Star. You can also find other BPO courses and lists of companies online where you can register to become a BPO agent.

Keep in mind that lenders typically have two lists:

  1. Agents that get BPO assignments
  2. Agents that get REO listings as a result of their BPO business

The goal is to be placed on the REO list.

Look into REO properties

Like all other clients, getting bank clients is a matter of relationship building. Many REO Brokers get their start and introductions to banks by doing BPOs (broker price opinions) or working with smaller local banks and lenders where it is possible to meet management in person. Getting REO listings is about building expertise and providing value to asset managers as a professional who can list, manage and sell these non-performing assets.

Often new agents break into REOs via BPOs while established agents miss out. How does this happen? A new agent sees a class that allows them to make a little money while learning to do valuations while they build their business and they jump on the opportunity. Established agents see this as a waste of their time, doing all that work for a hundred dollars or so.

But as a result of doing BPOs, the new agents built relationships with banks and when REO business increased, they had built the network to get the listings. Even now there are people who pay their monthly bills just by doing BPOs, but few agents enjoy the process.

Marketing to Owners in Preforeclosure

Email 

Start with email to introduce yourself, your company, or your service over email. Remember to keep it 

short and sweet - nobody will read a novel!

Calling/Texting 

Once you’ve contacted local owners in preforeclosure, following up with calls and texts is a great way to build rapport with anyone who’s opted into receiving phone communication. Make sure to reflect the messaging from your emails for consistency.

Direct Mail

Direct mail is any form of a physical piece of marketing or promotional material sent through the mail. For example, you can connect with leads with postcards, letters, brochures, etc.

Door Knocking 

You can approach the property, talk to owners and neighbors, and learn more about the property and the property owners.

Online Ads

Search and Social Media ads are a great way to spread awareness. A huge benefit is the ability to control how much or how little you spend per day.

When creating social media online ads, strive for shorter word counts, catchy titles, and appealing video or photo imagery. Think about what you can say and show that will encourage your audience to click, call, and take action towards your business services.

By using foreclosure comps, foreclosure statuses, and attending auctions, you’re almost sure to find a foreclosure investment opportunity meeting your criteria. 

Now, it’s time to move on to purchase your investment property.

Step #3: Purchase A Foreclosed Property

This step is the most involved, so we’re going to step-by-step into all of the different things that go into buying a foreclosed property.

This section may be the longest, but it’s arguably the most important! Nailing these steps will ensure you’re setting yourself up for long-term success with every investment you make.

Let’s dive in…

Check the Property Title

When you go to a trustee sale, you will hear terms like “no warranties or guarantees,” “subject to existing liens and encumbrances” and “address purported to be.” There isn’t even a guarantee that the address is correct, because the sale is based on the legal description, not the street address.

If you place the winning bid, you take possession of the property with no guarantee of the condition, the title history, or the presence of senior liens against the property.

The title is the auction investor’s iceberg. It is the biggest source of potential problems, either because of irregularities or mistakes in history or because of a lack of understanding of the subtleties of title research. 

Title insurance is typically the safeguard for these issues, but it is not available for properties going to foreclosure auction. You can go a long way toward minimizing the greatest risk factor in auction investing by learning to do your own title research.

When you buy a property at a trustee sale, you are really buying a loan position based on the deed of trust held by the trustee that initiated the foreclosure process. This sounds complicated, but it’s actually fairly simple.

Lenders don’t foreclose on a property, they foreclose on a loan. The property is involved because of a mortgage. Some people use the word mortgage as a synonym for a loan, but a mortgage is actually a legal instrument whereby the borrower (mortgagor) offers real property as security against a loan provided by a lender (the mortgagee).

A loan of this type is referred to as a mortgage loan, a term that is often shortened to the word mortgage. It is important to keep the two ideas distinct because it is the mortgage the borrower offered to the lender that involves the property in the process of foreclosure. 

It places a lien, a legal claim, on the property specified in the mortgage. There can be more than one lien against a property.

The lender requires the borrower to convey a deed of trust to a trustee, a disinterested third party who holds the title to the property, until either:

  1. The borrower pays the loan, at which time the title returns to the borrower
  2. The borrower defaults on the loan, at which time the lender instructs the trustee to initiate foreclosure proceedings. 

This process starts with the notice of default, followed by a notice of trustee sale, and culminates in a trustee sale, the auction where investors gather.

Senior liens

Keep in mind that a winning bid at a trustee sale means you own the property subject to the existing senior liens. Property taxes are always senior to any other liens, including mortgage loans. This is known as a super-senior position.

Besides taxes, there may be other government liens, such as abatements or uncollected fees. 

In California, the Government Code section 38773.5 gives a city the authority to pass an ordinance that allows the cost to abate a nuisance to be applied as a special assessment against the property on the tax bill, thus arguably giving it senior status.

But that should only apply if there is a local municipal code providing for the special assessment and if the assessment was actually levied against the property. In addition to government liens, the first loan on a property, usually a purchase money loan or a refinance, is the senior loan.

Junior liens 

Any secondary loans or home-equity line of credit (HELOC) loans are subordinate to the first loan. If the foreclosing trustee represents the senior loan, all subordinate loans are wiped out. But, if the foreclosing trustee represents a junior loan, the buyer is responsible for the first loan.

You can get an idea of the title history through several methods:

  • Preliminary title report. A title company can provide a preliminary title report that indicates who currently holds the title and documents exceptions, such as easements, liens and encumbrances. This is not the same as title insurance and does not provide any guarantee.
  • Property profile. A Realtor or a title company can provide a property profile, which includes public record information about the property, its features, open loans and sales comps. However, it may be incomplete and like a preliminary title report, comes with no guarantee.
  • Abstractors. An abstract of title is a condensed history of the title. It includes the original grant and all subsequent conveyances and encumbrances affecting the property with a certification by the abstractor that the history is complete and accurate. Like the other documents, an abstract does not provide a guarantee.
  • Real estate professionals. Some real estate agents provide this kind of service. You could become one of them, but until then, you could use an agent to do the research.

How to check the title yourself

You can do your own research by making use of various sources, including property profiles available from a service provider, and records from the county tax assessor and the county recorder.

Foreclosure information sources

In the event that there are loans that appear to have been refinanced, especially those that appear earlier in the title chain than the loan under foreclosure, it’s important that you verify that the earlier loans were actually reconveyed and are no longer outstanding against the property. 

In addition to assuring prior loans were reconveyed, it’s also important to do a name search of the owners of the property to make sure there are no IRS liens, mechanics liens, or other loans, liens, and encumbrances that the buyer may be responsible for after a trustee sale.

County recorder

Legal documents are recorded in the county where the property resides. Access to the grantor/grantee index, which records the document number, recording date, and names of the parties, is free. In some cases, the index is online and you can do a basic search, typically by name, document number, and document type. The actual documents, which contain more information, are available for a small fee and are sometimes available for purchase online as well.

County tax assessor

You also need to determine whether property taxes are current on a property or if back taxes are outstanding. The winning bidder is responsible for the payment of all back taxes.

Types of notices and key documents

Deed of Trust

A deed of trust indicates that the title is not free and clear and that a trustee holds it until such time as the loan is paid off. A deed of trust is a voluntary lien that the owner signed as a condition to get the loan.

Reconveyance deed

When a loan is paid off, a reconveyance deed releases the borrower from the mortgage and clears the way for the title to return to the owner. In the case of a refinance, the original loan would be paid off and reconveyed. A new deed of trust would be recorded for the new loan. 

The lien position is determined by the recording date. First in time is first in line. However, mistakes are sometimes made and the reconveyance is neglected, leaving what was originally a smaller second loan in the first position, the larger refinanced loan now in the second position. 

Lien

A lien indicates a party has a legal claim to sell the property to satisfy a debt. Only a deed of trust and an HOA lien have the power of sale (if granted in the terms of the CC&Rs and bylaws). 

The lien holder can be a homeowner’s association, a contractor, the county tax assessor, the IRS, a family support judgment, or a judgment from a lawsuit. 

These are all involuntary liens attached to the property when recorded and owned by the owner of the real property, which will be you if you buy this property.

Transfer

A transfer confers title from one party to another. It can be noted as a grant deed, deed of trust, trustees deed, gift deed, warranty deed, tax deed, or quitclaim deed. Transfers indicate the chain of title.

Abstract of Judgment (ABJ)

If the title of the property was awarded to a party by a court of law, it is recorded as an ABJ.

Chain of title

When researching the title, you want to determine two things:

  1. All the parties who have a claim (lien) against the property.
  2. The true position of each lien.

The rule of thumb is “First in time, first in line.” However, as always there are exceptions. And those exceptions can signal a stealth deal that gets you in under the radar for a nice profit or a turkey that can put you out of business. 

Understanding title research gives you a competitive advantage by allowing you to identify the good, the bad, and the bragging rights deals.

  • Senior liens. Tax liens are always super senior. They stay at the front of the line regardless of whatever loans may be present. Typically, the first loan after taxes and CC&R (See HOA liens below) is the senior loan, indicated by a deed of trust.
  • Junior liens. Loans that come after the first loan are in a subordinate position. This includes a second mortgage loan or a HELOC. Make sure a HELOC is reconveyed because otherwise the former owner could continue to draw against it but the new owner is responsible.
  • IRS/Tax liens. The IRS has a 120-day right of rescission, meaning that for the four months after the auction the IRS can exercise the right to pay you what you paid for the property and take it to pay off back taxes. 

They haven’t aggressively exercised this right in recent years, but it is prudent to hold off on improvements until the period is past. This has implications for your time-to-revenue and for any financing you may get for the deal. Include this variable in your financial analysis.

  • HOA liens. A homeowner’s association has legally enforceable rules, called covenants, conditions, and restrictions (CC&R). Violation of the rules (including non-payment of HOA dues) can result in a lien being placed against the property. HOA laws vary from state to state.
  • Mechanic’s liens. Relevant to remodeling and code enforcement. A contractor can place a lien against the property for non-payment for work. The date work began establishes priority.

Beware of position

Thorough research pays in profits gained or losses avoided. A missed reconveyance can create a stealth deal for an investor. 

Example:

Past sloppy title work made everyone, lenders and investors included, think a second was really a first. In that situation, because of a mistake, a $150K SBA loan was the senior loan, and $600K of mortgage loans were wiped out at the auction of a property valued at $550K. However, a mistake in the other direction could be disastrous.

An investor could bid on a property thinking the second would be wiped out, only to discover that it was really a first and was now due.

Subordination agreements also affect position. They are common when refinancing a senior loan where junior loans are present. The refinancing lender would agree to give the loan on the condition that the junior lien holders sign a subordination agreement that would place their interest subordinate to the new (refinancing) lender.

Beware of validity. Some people use fraudulent reconveyance to delay foreclosure or as a scam to steal money. If there is a reconveyance in a title history, verify that a title company recorded it. Do the documents look like other reconveyances from the same bank/timeframe? Also, it pays to be aware of stories of fraud in the news.

Example:

In Modesto, CA a loan officer worked with a title officer to run a scam. The lender created new loans, but instead of paying off the old loans, he moved the cash into an offshore account and had the title officer issue fraudulent reconveyances.

The original first and second loans were still outstanding and now the owner had four loans on the property. Because of title policies, the lender was covered. But an investor buying the property at auction would not be.

If something is too good to be true, it could be the sign of a great deal or the worst deal in history. It’s your job to figure out which. Check for fraudulent reconveyances and subordination agreements. 

Determine your offer or bid

One of the most difficult parts of buying real estate, foreclosure or not, is determining what price to pay. 

  1. Be sure to review the entire market, not just what is in the multiple listing service used by Realtors®. Other sources you should consider include foreclosures, new home projects, for sale by owner listings including Craigslist, and even local rental data. 
  2. Know your desired outcome. A person is likely to pay a premium to get exactly the right house if they plan to spend the rest of their life there but may need a certain discount if they plan to flip it for profit, and want a certain return on capital if they plan to use it as a rental. 

Too many buyers focus on a handful of comparable sales and miss the big picture. When determining your bid, know the whole market; and to the extent possible, make sure it makes sense for your goals, no matter where the market heads next.

Make your offer or place your bid

This will vary a lot depending on the stage of foreclosure, and whether or not the property is listed for sale. Be patient, and don’t worry too much about missing a deal. There is a saying among the auction pros: "Sometimes the best one, is the one you didn't buy".

Bottom line, is that it better to have no deal, than a bad deal. So, take your time, stick to your numbers, and if a deal is getting too difficult or pricey, just walk away. There will always be another one.

If You’re An Agent

Switching gears for a moment, if you’re a Realtor, there are several ways you can partner with investors during the transaction process.

Investors need an agent

Investors need to sell the properties bought at the auction and usually do so through a Realtor. It’s common practice for the Realtor who has assisted through them through the BPO or otherwise to get the listing. Even investors with a buy and hold strategy need a Realtor to find renters. Either way, the investor needs an agent.

Method 1: Find an investor

Auction investors can generate a steady stream of listings, but first, you need to find the investor who is actively buying foreclosures in your market. You can also go to the courthouse steps and see who’s buying. 

While you’re there, go ahead and introduce yourself, pitch your superior local knowledge and let them know that you are ready, willing, and able to help make them bigger profits.

Method 2: Birddog for investors

If you haven’t yet found your gold goose investor with the endless supply of listings, try sniffing out properties going to auction for a single deal or two that you can refer to an investor. Investors can share with you their good fortune when they capitalize on your lead and will then look to you to bring them more. 

Next thing you know, you could have that pocket investor. Birddog deals with the mindset that it’s your cash and do your homework accordingly.

Method 3: Investors are sellers too

Not only are investors a great potential source for listings, but they’re also sellers too. If you’re a buyer’s agent, investors are a source of fresh inventory and are motivated to close. 

Follow the auction and you will know the day that a property is bought by the investor and can be first to the opportunity with your buyer, before your competition is even aware that it is available.

Method 4: Provide Services to Auction Investors
Investors need BPOs

Most auction investors need accurate BPOs and who better to get them from than you, a Realtor® with local market knowledge? An accurate understanding of a property's retail price is critical to the investor when making the bid-no-bid decision at the auction. 

Too low of a valuation and the investor could pass on a good opportunity. Too high of a valuation and the investor may end up losing money on the flip. The role of an accurate BPO from a Realtor® who knows the local market can be crucial to the investor’s success.

Investors need feet-on-the-ground

A great agent is in the community and can spot auction opportunities. Frequently check properties coming up for auction for condition and occupancy. 

This reconnaissance work will not only be of direct benefit to investors bidding at the auction but will start conversations with homeowners and renters that can lead to other new business opportunities.

Now that we’ve taken a brief look at some ways agents can help, let’s get back to investors…

Make sure it doesn’t sell out from under you

If you make an offer on a property in foreclosure, continue to check as you are in escrow to make sure the property isn’t sold at auction, undermining all your hard work. Don’t assume that because the loss mitigation has negotiated a short sale that anybody has told the loan department because they haven’t. 

Close the deal

Your work is not done when the offer or bid is accepted, it may just be beginning. This is especially true for preforeclosures, and REOs if you need financing—the lending markets have never been crazier. So, stay on top of everything: financing, inspections, escrow & title, and never assume anything will go as planned. 

If you are buying a preforeclosure, pay extra attention to the auction date if scheduled, since many properties are sold at auction despite being just days from closing escrow. If there is a sale date scheduled before your escrow is set to close, be sure you get the bank to agree to postpone the sale in writing.

Step #4 Maximize Return on Your Foreclosed Purchase

Manage the Property

If there is a ticking clock in foreclosure investing, it’s the holding time – the period from purchase to disposition.

Every day spent between those milestones is a day your investment is not delivering a return, yet, and each additional day that doesn’t add value lowers your return on investment.

Consider your holding period in terms of your annualized ROI. If you buy for $90K, put in $10K, and then sell for $110K, you make a 10 percent return on your investment. Do that in 90 days and it’s a 40 percent annualized return. Take 180 days to do the same thing and it’s a 20 percent annualized return.

Some repairs increase the value more than others, but they may also take a lot longer than others. A new kitchen, a new addition, or anything that requires a permit will push out your holding period. 

You may increase your return with that renovation, getting say $115K instead of $110K and pushing your ROI to 15 percent, but because it took you 180 days, your annualized return shrinks to 30 percent instead of 40 percent.

So, when looking at repairs, you want to look at how long they take, not just the cost of the repairs and the increased value.

At the fix stage of a fix-and-flip strategy, it’s about controlling costs and avoiding delays. This is where the team of professionals you’ve assembled can make or break you. A good contractor can put you ahead of the game. A bad one can put you behind the eight-ball.

Estimating property repairs

During the evaluation stage you made estimates as to the cost of repairs After purchase, you’ll get more solid estimates or quotes from licensed contractors.

Establish a reputable pool of contractors

As a foreclosure investor, it’s a good idea to build a team of professionals you can call on during each state in the process. This team would include real estate agents, inspectors, contractors, handymen, cleaning services, and others.

A contractor is in a unique position to affect the profitability of a deal. A good contractor can increase your profit by delivering solid, good-quality installations and repairs at a fair cost. A poor contractor can eat up all of your profit margins and even cause you to lose money on a deal.

Because the contractor is so important in a fix-and-flip strategy, it pays to take the time and effort to identify the good ones and keep them happy. You should focus on contractors that are licensed, insured, experienced, and who provide references. If they use subcontractors, get information about their experience and verify that they are licensed and insured as well.

Multiple estimates

Once you have possession of the property, draw up a list of the repairs to be made, specifying scope of work and schedule, and get three or more bids for each project. Let your contractors know you are putting the job out for competitive bids, which means they are more likely to give you their best prices.

Ask that the bids break out material and labor costs. By establishing a solid group of dependable contractors, managing repairs becomes the business that it is intended to be, rather than the headache it can often be.

Managing Repairs

Getting a contractor to do the work for you is not a set-and-forget activity. Schedule and costs are both greatly influenced by the amount of attention you pay to the project.

Timelines and payment schedules

The timeline for the repairs to be completed should be explicit and the contractor who wins the bid should understand the time-critical nature of the project. While contractors may have their own preferences for payment, it’s best to establish payment based on progress, not based on the calendar.

Incentives and penalties for contractors

One way to encourage timeliness is to write the contract to include a bonus for early completion and penalties for being late. The penalty can be based on the daily lost income (for a rental property) or the daily cost of a mortgage, whether you have one or not (for a property to be flipped).

Controlling costs

Select durable materials of an appropriate quality for their purpose. Lower quality materials might cost less initially but will require replacement or repair much sooner. Exotic floorings, countertops and wall coverings may appeal to you, but potential buyers may have different tastes.

Keep costs in check by taking a moderate route on repairs. Stay sensible and keep fixtures, colors and materials common and easy to obtain and repair. The new homeowner can always install exotic fixtures to their taste later.

Material selection depends on the outcome

Your decisions about materials and appliances are influenced by whether you’re renting versus selling. When preparing a rental, the emphasis is on durability and ease of maintenance. If you’re selling the property, you may want to get a nicer grade carpet, custom paint colors, upgraded appliances, and lighting fixtures.

Availability of materials

Time to revenue depends on minimizing downtime. Get to know the builder supplier in your area, whether local or chain, and what they stock. Learn their return and builder/contractor bulk discount policies.

Waiting to improve

There are some situations where haste is either inadvisable or impossible.

Legal Actions

It’s best to wait for the trustee’s deed to be recorded before investing in the property beyond replacing the locks, in the case that the trustee or lender decides to rescind the sale, or if a lis pendens is filed against the property. 

Rights of Redemption (IRS)

The IRS has the option of exercising a right of redemption on a lien against a property for up to 120 days after the sale by matching the highest bid and taking possession of the property. Any repairs you have made have just become a gift to the taxpayers.

Estimating return – key fixes

Focus on repairs and upgrades that will make a property more attractive and desirable. Renters who want to live in a home are more likely to care for the property than renters who are just settling for the cheapest option.

When selling the property, focus on key fixes, updating aspects of the home that will improve the livability and functionality of the home.

One rule of thumb is to work with the bumps that you have. Additions are not cost-effective. Renovations trump rebuilding in most cases.

Maximize curb appeal by repainting the front door. If the lawn is anemic, go the extra mile and roll in sod, drop in a tree, and spread a few yards of bark where it will do the most good.

You can standardize your colors and materials for renovations to establish a brand. By taking advantage of the economies of scale you can establish a signature in your area. 

Example:

One investor who follows this tactic has agents calling to ask if he has anything available in a specific area where their clients are looking. If he doesn’t, it tells him where to invest next, as there are buyers for that area.

Bathrooms

A little renovation goes a long way in a bathroom. It doesn’t cost much to clean the walls, scrub an old shower door, install a pedestal sink in a small space replace the faucets, light fixtures, towel hangers, toilet seat, and shower curtain, or to caulk and clean the grout.

But those simple changes can completely transform a bathroom and dramatically increase the perceived quality of the house.

Kitchens

You don’t have to replace appliances to improve the kitchen, although there are times when you should. Surveys show that new appliances bring high returns. Like the bathroom, some simple repairs and renovations can add significant value. 

Refinish the cabinets and drawers. Upgrade the knobs and handles. Replace the sink and faucet. For a little more, you can polish a granite or marble countertop with scratches or replace a laminate counter.

Flooring

Replace worn or damaged flooring with quality ceramic tile, laminates, or stain-resistant, low-pile carpets. Exotic floorings may appeal to you, but potential buyers may have different tastes.

Paint and walls

A quality paint job can make a room pop. You don’t save anything by getting budget paint and then having the extra expense and time of doing multiple coats. Pick a pleasant but neutral color scheme that will allow buyers or renters to visualize their furniture in the space.

Siding and Windows

Installing siding can be less costly and more durable than painting. Quality windows can increase curb appeal and increase energy efficiency, but for the typical house, it takes 10 to 20 years to make back the cost of the windows in energy savings, and upgrading windows has a lower ROI than other renovations, such as bathroom and kitchen upgrades.

Foreclosure investing isn’t easy, but when you do your homework and use the right tools, it can be well worth the time, money, and risk.

Recap

Foreclosure investing isn’t easy.

However, when you do your homework and use the right tools, it can be well worth the time, money, and risk.

Foreclosure investments often bring positive outcomes to all parties involved. If you're an investor, you're can find properties with substantial upside and return. If you're the homeowner, the transaction can help alleviate the financial burden of owning a foreclosed home.

As an investor, start out by determining your investment strategy and identifying the types of foreclosure opportunities you're going to pursue.

Once you've nailed that down, leverage public records data, comparables tools, attending auctions, and evaluating bank-owned listings to find your next foreclosure investment.

Then, ensure you've done your diligence by checking the title and other key notice documents so you know exactly the financial circumstances surrounding the property.

When you've closed the deal, quickly move onto to determining how to maximize your investment. Whether that's immediately renting out or undertaking renovations, time is money and your return lowers every day your property isn't generating income for you. 

Over time, as you start to establish a playbook for foreclosure investing, you'll become more and more comfortable with your system and it all won't seem like such a monumental undertaking! 

Now, go out there and find your next investment. 

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