In layman’s terms foreclosure is when a borrower fails to make payments on his or her house and the bank takes action to protect their loan. How does foreclosure happen?

When someone buys a home they generally finance the purchase. In other words, they borrow money.

There are two parties involved in this transaction. There is a lender, also called the mortgagee and there is a borrower, also called the mortgagor. The lender loans the borrower money to purchase their home and, in turn, the borrower gives the lender a promissory note to repay the borrowed sum of money.

Now, the next step is the lender has to protect their loan amount, so they use the house as collateral.

The mortgage becomes what is called a lien on the property. That house can’t be sold with clear title until that lien is paid off. The promissory note is a promise that the borrower will pay the lender back in a timely fashion and as stipulated in the note.

Note: Some states use what are called Trust Deeds as opposed to a mortgage. This newsletter is focusing on properties with a mortgage as the lien.

When a borrower does not adhere to the terms of the agreement, meaning they don’t make their payments, the lender starts the foreclosure process in order to recoup their money. Typically, a borrower must be 90 days behind in order for the lender to the start the foreclosure process.

This means the borrower has not made payments in approximately three months. The borrower is said to be in arrears at this point. They owe the lender the 3 months of payments plus interest. The lender, under the terms of the original agreement, has the right to call the balance of the loan due immediately.

This starts the foreclosure process. If the borrower does not pay the lender the money, the house will go to public auction and will be sold to the highest bidder.

Foreclosures can be categorized in three parts:
1. Preforeclosure
2. Public Auction or Sheriff’s Auction
3. REO’s also known as bank owned property

Preforeclosure

What is preforeclosure? Preforeclosure is the time period from which the bank gives notice of default, once the homeowner is approximately 90 days late in payments, to the time the house sells at auction. Preforeclosure is also the most crucial time in the foreclosure process. It is during this period that you as an investor stand to make the largest profits and can literally make thousands of dollars in months, weeks, days, or even hours!

The key to preforeclosure houses is equity. Simply put, equity is the difference between what a house will sell for (fair market value) and what is owed on the house. The whole concept to making money with preforeclosures is to buy a house for less than fair market valuing, thus immediately creating equity for yourself.

Here is an example of how this can work. Let’s say someone owns a house with a fair market value of $200,000. Now let’s assume that this homeowner has lived in the house for several years. If you consider that the property has most likely increased in value over time, while at the same time the homeowner has been paying down the mortgage on a monthly basis, it is fair to assume they owe less than $200,000 on the property.

For this example let’s assume that the homeowner owes $160,000. This means there is $40,000 in equity in the house. As an investor, you would want to buy the house for $160,000 or slightly higher. If you can do this, you have a shot at making $40,000.

I know what you are thinking. Why would they sell the house for $40,000 under the market value? Right? Here is one reason why. If they sell the house to you, you can promise them a quick closing, thus stopping the foreclosure (losing the house at auction).
This will prevent a foreclosure from going on the homeowner’s credit record. A foreclosure can stay on someone’s credit for seven to ten years making it next to impossible to get another mortgage in the future. This is just one of many reasons.

So let’s say they sell the house to you for $160,000. You can turn around and put the house back on the market for the $200,000 that it is worth. Once the home sells, you could put a whopping $40,000 in your pocket. Sounds pretty nice, huh? The best thing is there are ways to make similar deals with little or no money! An that is an example of how you can make money with preforeclosure houses.

In order to buy preforeclosure houses you first need preforeclosure leads. This is how you are going to get your leads. You are going to implement a powerful direct marketing campaign soliciting those who are in preforeclosure. How do you learn where to start looking?

One of the most valuable sources for preforeclosure leads is mortgage brokers. Almost everyone knows a mortgage broker. Maybe your brother is a mortgage broker. Maybe a good friend is a mortgage broker.

If you don’t know anyone in the mortgage business, network a little bit. I am confident you will be introduced to someone in the mortgage field that can help you.

If not, that is OK too! You will just have to do a little more legwork. Go through the yellow pages and look for mortgage companies. Start calling around and introducing yourself. See if you can talk to the manager. If not ask to speak to a loan officer.

Ask them if they have someone in particular that handles foreclosure financing. They may or may not. Often times in mortgage companies, they will receive large volumes of calls from distressed homeowners.

These are homeowners who are trying everything to stop foreclosure. Most of the time, it is too late for the mortgage company to help the homeowner because their credit is already shot. At this point the mortgage company may refer them to what is sometimes call a hard money lender. A hard money lender is a lender that specializes in high risk loans. Often times, they are private investors.

This is where you come in. These leads are invaluable. They are homeowners that are exhausting their last options to save their home. What you do is have the mortgage company start to refer these deals to you. If you can get the names and phone numbers of these homeowners, you can contact them directly. More importantly, you can contact them when they are open to listening and expecting your call. If the mortgage representative that can’t help them gives a high recommendation of you to the homeowner, they will be excited to hear from you.

Public Auction or Sheriff’s Auction

Public Auctions or Sheriff’s Auctions are not for the novice real estate investor. Generally they are the most risky time to purchase foreclosed property. This is not to say that they can’t be an overwhelming profit center. There is no doubt that auctions can yield major returns.

What happens at an auction is generally very similar in all states. Some states will auction the property in a courtroom and others will literally auction the property on the courthouse steps.

At an auction there will typically be a referee who handles the bidding. Most likely there will be a representative from the bank that is foreclosing, and there will be some investors present, and others just interested in what is happening.

The bidding at an auction will start at whatever is owed to the bank, plus legal fees. Like preforeclosures, auctions are a good time to buy property at below market value. Buying below market value will give you equity. I have seen properties sell for half price at auctions!

You can find great deals at auctions, but there are also many pitfalls, particularly for novice investors. One major obstacle with auctions is you generally need to pay cash, on the spot, for the property. This alone eliminates 95% of people from buying at auction.

Another drawback to auctions is that the homeowner is given a redemption period. Typically, the redemption period is six to twelve months. From the time the house sells at auction, the homeowner has the right to buy it back for what it sold for plus interest. This means you could buy a house at auction and might have to sell it back to the original owner during the redemption period. Additionally, if the homeowner does not move out at the end of the redemption period, it becomes your responsibility to remove the tenant through the eviction process.

Public auctions are very easy to find. Just call your local county assessor’s office and ask whom you need to speak to regarding sheriff’s auctions.

What are REO’s? REO is an acronym for Real Estate Owned. REO is used to describe houses that the bank has taken back through foreclosure. In the last newsletter I discussed sheriff’s auctions. Well what happens if a house does not sell at the sheriff’s auction? The answer is it goes back to the bank.

The house becomes part of the bank’s REO portfolio and the bank must market and sell the house in order to recoup the money from their defaulted loan.

There are many ways to find REO houses. One of the easiest ways to find REO’s is to subscribe to an Internet service that lists REO property in your area.

The nice thing about REO’s is the bank wants to sell them as quickly as possible. You have to understand that banks are not in the business of owning and managing houses. They are in the business of loaning money. REO properties are a financial burden to banks. All of the upkeep is their responsibility. REO properties can cost banks thousands and thousands of dollars a month, therefore they are motivated to sell them.

Often time’s banks will offer very favorable financing for REO properties. In fact, favorable finance terms may be more common than reduced prices. An example would be the interest rate. A bank may offer a reduced interest rate to help sell an REO house.