You may have heard that foreclosure investment is a great way to make money on real estate. It is possible to secure a property at 30%-60% below its actual value, and with foreclosures, you are dealing with owners who are letting go of the property because they can no longer afford to pay the mortgage, not necessarily because there is a problem with the home.
Many real estate investors regard foreclosures as an effective way of creating large returns through buying run down property, fixing it up and reselling it. However, buying foreclosures is not always as quick and easy as many people think. Investing successfully in foreclosures requires knowing what the regulations and laws governing foreclosures are in your area and doing due diligence to ensure the investment will yield a substantial return.
How Foreclosures Work
When a homeowner is no longer able to pay his or her mortgage, notices are sent out with warnings to pay back the money that is owed. After a period of months or even a year, action may be taken by the bank or the lender to foreclose on the home, along with notices of default. Unlike the owner, the lender is not trying to retrieve an amount that is as close to the actual value of the home as possible.
The lender’s main goal is to have the money that was lent to owner returned at interest. Therefore, the lender is not trying to get back as much as the owner is, and can sell the home, theoretically, for the amount of the outstanding loan rather than the full value. This is one reason why foreclosures can represent significant savings over other types of property.
Judicial vs. Non-Judicial Foreclosures
When you are looking for a foreclosure investment, it is important to know what kind of foreclosure you are dealing with. Two main types of foreclosures are:
As the terms suggest, judicial foreclosures take place with the participation of a court and non-judicial foreclosures are not regulated by the courts and are often pursued by private lenders. With a judicial foreclosure, the owner files a document known as a Lis Pedens which begins foreclosure proceedings. There is usually a certain length of time between the filing of the Lis Pedens and the actual foreclosure auction. This period of time is known as the pre-foreclosure phase. Once a Lis Pedens is filed, the owner can either try to come up with the money or sell the distressed property to avoid bankruptcy.
A non-judicial foreclosure occurs when the lender can foreclose on the property because the owner has signed a Power of Sale clause when taking the mortgage. Non-judicial foreclosures are more common than judicial foreclosures and the process is usually faster. Real estate investors usually prefer to work with non-judicial foreclosures to avoid the delay time, although they may be able to make a deal with the owner who has a pre-foreclosure after filing a Lis Pedens. In such a situation, the homeowner is usually desperate to sell the property to avoid bankruptcy.
The Pre-Foreclosure Phase
You can find some good deals by purchasing homes in the pre-foreclosure phase. One effective foreclosure investment strategy is to negotiate with the owner who is trying to unload the property to avoid the foreclosure auction and to pay off their debts. Although owners are also trying to get approved for loans to avoid losing the property, in many cases, because of their dire financial situation, they are unlikely to be approved. For obvious reasons, these owners will do almost anything to avoid foreclosures that will destroy their credit records, so you may be able to make a lucrative deal on a quality property with an owner. Another advantage is that, unlike an auction, you can thoroughly inspect the property before buying and do not have to pay for it in cash.
The Foreclosure Auction
Real estate investors can find properties at deep discounts by going to foreclosure sales and auctions. At this phase, the lender is simply trying to recoup the money it lent to the owner, and you may find discounts of 60%. There are some disadvantages, however, to using auctions for foreclosure investments. You have to buy the property as it is, and may not get a chance to give it a thorough examination for problems. In addition, you will have to come up with the money right away, and won’t have time to apply for bank loan. However, for real estate investors who have plenty of cash and work well with contractors, foreclosure auctions can be a bargain basement for quality properties.
The story is not over, however, even if there has been a foreclosure auction. After the auction, the owner is given a redemption period during which he or she can buy back the property if they are able to come up with the money. If you purchased a property at a foreclosure auction, you will still need to pay the mortgage and property taxes during the redemption period. For foreclosure investment, a shorter redemption phase is desirable, but in some areas, this period can last up to a year. Find out what the redemption period is for the area where you are investing.
How to Find Foreclosure Investments
There are a number of ways to find foreclosure properties for investment:
Real estate websites
Real estate agents
Multiple Listing Service
Bank REO Departments
You can find properties listed for foreclosure investments on regular websites such as Zillow and Trulia. In addition, local agents also have listings of foreclosure properties. The Multiple Listing Service or MLS is a fantastic resource for foreclosure investment. These lists are accessed by real estate agents, but you can find resources online to gain access to this information. When banks take over properties that have defaults on mortgages, these properties are known as REO or Real Estate Owned. Although the banks turn over the information on these properties to MLS, you can try to get a list of REOs from banks before they have made the listings. Other foreclosure properties not listed on the MLS can be found at the HUD Store.
There are a number of advantages and caveats associated with foreclosure investments. For one thing, it may be reassuring to know the real reason the owner is selling—that he or she can’t pay the mortgage—rather than trying to figure out what is wrong with the property or neighborhood. In many cases, foreclosures are high quality and are the result of an owner purchasing above his or her means a property they can’t afford. However, you may get stuck with a house with problems, especially if you purchase it at an auction where inspection isn’t so simple. Also, indebted owners may not have been able to afford to fix up their home in a long time, so have the number of a good contractor and be prepared.