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27 Jul 2008
“We want to buy a nice 3 bedroom, 2 bath home in a good area, and we heard we can get a really good deal right now buying a foreclosure. Can you help us find one?” I get this question a lot lately.
As a Realtor who was a real estate lawyer for 20 years and did many foreclosures and short sales, let’s clear the smoke and get to the truth about buying foreclosures. There is far too much nonsense being published about buying foreclosures, mostly by get-rich-quick artists and seminar leaders who have found a niche to make a lot of money fairly easy. There’s a lot of hype, and there are also a lot of foreclosures in some parts of the country, especially California, Nevada, Arizona, and Florida. So what is the truth? Can you buy a great foreclosure home in Sequim or Port Angeles, or anywhere for that matter? If you are an investor, can you make tons of money buying foreclosures. Let’s shine a light in the dark corners of the foreclosure world, expose the lies, and reveal the truth.
When we speak of a foreclosure, we are referring to a note and need of trust which is in default. The note is the evidence of the debt, and the deed of trust secures that debt against the real estate. When we speak of a forfeiture, we are referring to a real estate contract, also known as a land contract. The land contract is a single document which evidences the debt and represents the security instrument (like the deed of trust). The foreclosure process [view my 31 point checklist to foreclose] and the forfeiture process [view my 24 point checklist for a contract forfeiture] are two entirely different processes. Here we will address the foreclosure of a deed of trust, although most people blur the two together. Almost all secured instruments against real estate today in Washington are deeds of trust, but there are still many land contracts on the books.
The process to foreclose a property is a statutory process in Washington [RCW 61.24]. This process is called a non-judicial foreclosure. In this process no deficiency judgment is permitted, meaning the bank can sell the property but cannot come after you for any loss the bank suffers. The bank could foreclose as a mortgage, in which case they could come after you for a deficiency, but they never use this process, unless you are a multi-millionaire investor, and you have not used effective asset protection strategies to shield yourself. (Do you get the feeling that this business is not for the novice?)
Banks don’t start a foreclosure until the third month in default. The minimum time period from the first default payment to the Trustee’s Sale is 190 days, and from the commencement of the foreclosure (the third month) to the Trustee’s Sale will take about five months, if everything goes smoothly. This means that from the first late payment to the sale will typically be 8 to 9 months, or longer because the banks’ legal departments often don’t get everything done exactly according to the ideal calendar dates.
A defaulting homeowner can reinstate the note and make the foreclosure go away if they pay all past due payments, accrued interest, and the banks costs and fees associated with the foreclosure. Those figures are spelled out in the Notice of Foreclosure. [View a copy of a Notice of Foreclosure.] The homeowner has until 11 days prior to the Trustee’s Sale date to reinstate. Then it goes to sale.
At the Trustee’s Sale, which must occur on the properly scheduled Friday morning at 10:00 a.m. at the county courthouse, the Trustee reads a script to sell the property, and anyone who wants to bid must bid the minimum amount, which is the balance owed to the bank plus all the costs and fees. All subordinate security interests and liens are wiped off the record on this real estate. Of course, a subordinate lien holder could bid to protect his interest. They rarely do. Anyone who bids must have a cashier’s check. If no one bids the minimum amount owed to the bank, the Trustee bids that amount for the bank, and the show is over.
After title is placed in the bank’s name by the recording of a Trustee’s Deed, the property will sold. Banks are not equipped to hold the real estate and manage it until it is sold, so there are hundreds of companies around the country that handle that task for the banks. Those companies will list the property with a Realtor, and the property will be listed and eventually sold. When the property is owned by the bank, it is called an REO, which stands for “real estate owned.”
A short sale occurs when someone makes an offer on an REO, and the offer is less than the current balance owed on the original loan. It takes experience to know how to put together a proposal to convince a bank to accept a short sale. This is not for the uninitiated either. It is a very complex package that requires a lot of data and justification for the price. It is like a “comp” only ten times more involved. Inexperienced Realtors often dive into this process only to find out after a couple of months that they are way over their heads, and the deal is dead. A Realtor could get lucky and get a short sale through, but they may still not know how to present the next one properly. [Read about the Short Sale Process.]
How hard is it to find a good foreclosure deal? Extremely hard, and here is why. First, there are potentially 100’s of properties that are in pre-foreclosure or in foreclosure with a Trustee Sales date looming. Clearly before you can even consider making an offer, you have to investigate all of these properties to narrow it down to the one or two that may work for you. If you spent 40 hours a week full time, you might have enough time to do this, assuming you have the knowledge and skills, and the databases and resources to collect accurate information.
Assuming you could narrow down the potential good deals, you then have to either cut a deal with the current owner, or purchase the property at the Trustee’s Sale. Either way, you do have some serious competition with several millionaires looking at the same parcel. They have the time and money. Do you?
There are many traps for the unwary here, and I only mention one. Years ago a young man came into my office and told me he just bought a foreclosure at the courthouse for $50,000. It took him years to save that money. The bad news was that he bought a second, which means he still owed the entire first mortgage. He thought he was buying the property free and clear for $50,000. Instead he spent $50,000 and still owed more on the first mortgage than the current fair market value of the property. What a hard lesson he learned. A little knowledge is definitely dangerous.
Elsewhere I’ve written, “Buying a foreclosure will be one of three experiences: 1.) a dead end after months of frustration, 2.) a fast way to lose money because of major mistakes in the process, or 3.) a great way to pick up a lot of equity immediately at closing because your purchase price is below the true current fair market value of the home.”
We just waived a flashlight quickly around the foreclosure landscape. There is much more that could be written about the process and the traps for the unwary.
Can money be made buying foreclosures? Absolutely, but it is not a game for the inexperienced. It is one of the most advanced areas of investing in real estate, full of complexities and traps, and potential profits. Those who sell their foreclosure packages and seminars preach their prosperity doctrines, and insist that anyone can do this and get rich. They are wrong. Not anyone can do it, or perhaps I should say, “not anyone will do it.” In fact, like all real estate investing, only 2% of the population of eager investors will ever successfully invest in real estate. Ouch! That’s reality.
When the real estate market goes down, and this foreclosure market will definitely be recorded in history as a down market, CASH IS KING. Those who have access to the cash and who connect with knowledge and experience, will do well . . . so long as they are patient and wise.
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