How does the foreclosure process work? When a person buys a house, they normally have a small down payment and obtain a loan from a bank or mortgage broker for the balance of the purchase price. This loan is secured by the property in the form of a mortgage or deed of trust. If the lender does not receive their payments, they may file foreclosure to recover their debt.
The foreclosure process allows the lender to foreclose on any liens or encumbrances in order to take the property and become the legal owner of record. This allows the lender to resell the property and recover the original loan amount, plus expenses associated with the foreclosure. The foreclosure process can be lengthy depending on the state, but up until the public auction, the homeowner owns the property and has several options available to avoid it.
It's important to realize when talking about pre-foreclosures, we are talking about acquiring the property any time before the public auction sale. The sooner you contact a homeowner in pre-foreclosure, the more time you have to structure a deal and purchase the property yourself.
A common misconception is that people buying homes in foreclosure are taking advantage of another person's misfortune. This is simply not true. The lender made a loan in good faith and the borrower agreed to repay the loan. If the borrower does not make the required payments, they have broken the agreement and the lender must protect their financial interests. They may foreclose on the property as agreed to by all parties when the loan was originally made. Any time there is a foreclosure, the borrower has broken the terms of the agreement, and your intervention solves a problem the homeowner created.
When facing foreclosure, many homeowners bury their heads in the sand, hoping it will just go away. No action by the owner ensures losing the house in foreclosure, a severely damaged credit profile, and a loss of all equity in the home. When dealing with an owner in pre-foreclosure it is important to explain the benefits to them of avoiding foreclosure:
1. Protecting their credit profile. A person in foreclosure is often overwhelmed with battling life-changing events and has multiple financial challenges. By working with an investor, it may be possible to stop the foreclosure and start rebuilding their credit profile or prevent their credit profile from getting worse. In today's credit-conscious society, a damaged credit rating negatively affects everything from buying a car to getting property insurance.
2. Protecting their equity. When a home is foreclosed, all of the equity is lost. That includes any down payments and other money contributed to principal. By working with an investor, it may be possible to recover some of the equity and prevent the foreclosure.
3. Rebuilding their life. The pressure and strain of a foreclosure affects all areas of a person's life. Under such pressure people often become depressed, are unkind to loved ones, or make poor personal and business decisions. Stopping the foreclosure allows a person to remove an albatross from their neck and start getting their life back on track.
For the real estate investor there are many ways to financially profit. It can also be a great feeling to help people move on with their lives. If not for investors, lenders would foreclose on most properties and the homeowners would lose all equity and have a foreclosure on their records.
Investors provide the vital role of helping homeowners salvage some equity, can often help the homeowner's credit, and help people start rebuilding their lives. Unfortunately, many homeowners will not see or understand the vital role investors have, but it is not uncommon to receive thank-you letters after stopping foreclosures.
In order for an investor to be involved, there must be a profit, or there is no reason to be involved in the first place. When working with sellers, we let them know up front we expect to make a profit, and for us to make a profit we need to be able to stop the foreclosure. There is no charge for our services and the only way we make a profit is if we can stop the foreclosure. By being direct, the seller understands our incentive and motivation and this helps establish trust and rapport. When dealing with pre-foreclosures there are 3 main ways to profit:
1. Purchase the property from seller at a discount. Many times, a seller is willing to sell the property well below market value because they recognize it is better to cut their losses and move on instead of hanging on and going down with the ship. If the seller has enough equity, we can structure a purchase so they receive cash at closing, the balance of their equity in payments, or a balloon payment due at a later date.
This can be a good option for sellers with enough equity. Unfortunately, in today's society the majority of sellers owe close to the value of the property and when an investor takes into account acquisition costs, sales costs, holding costs, and repairs there is not enough equity in the property for an investor to make a profit.
2. Take over the loan and make up back payments. When a seller is in foreclosure it is possible to buy the house from the seller, take over the loan, and make up the back payments. The advantages for the seller are that the foreclosure is stopped and the property is sold to an investor who will make the payments. A drawback for the seller is that the loan remains in their name until paid off by the investor or a third party at a later date.
The process of buying a home and taking over a loan in another person's name is commonly referred to as buying a property "subject to." In such a transaction, the title of the property transfers to the new owner, but the loan remains in the seller's name. Lending institutions frown on buying properties "subject to" and include a due-on-sale clause stating the lender can call the loan due upon a transfer of title. In practice, lenders rarely enforce a due-on-sale clause and are more interested in receiving timely payments then enforcing the loan-due clause.
Selling "subject to" is not without risks to the seller since the loan remains in their name and if payments are not made, their credit can be affected at a later date.
The benefits for the investor are that they can acquire a property with little money out-of-pocket, no loan costs or appraisal fees, and their credit is not affected or put at risk by the loan they are taking "subject to." This is a powerful investing strategy unknown to most investors. It is one that should be used by ethical individuals. Like many powerful tools, it has the ability to be used for good or bad. When purchasing "subject to" properties there are documents that must be signed for the protection and understanding of all involved.
3. Discount the loan(s) from the lenders. Commonly referred to as a "short sale," this is nothing more than negotiating with the lenders to accept an amount less than they are currently owed. Why would lenders discount their loans? There are a couple of reasons:
a) Lenders do not want to own properties. If a borrower does not pay the loan, a lender's recourse is to foreclose on the property. If the property is not bought at public auction, the lender becomes the new owner of the property. Lenders are in the business of loaning money, not owning homes. When a loan is not being paid, it is considered a non-performing asset and affects their lending ratios. Also, as owner of the property, the bank becomes responsible for property taxes, insurance, association fees, Realtor commissions, and closing costs. Things they do not want to deal with managing.
b) "Cash now" is better than "cash later." Many times a bank would prefer the certainty of accepting a discount instead of unknown holding costs, liability, and unknown sales price at a future date. The bank understands that a discounted offer today could actually net them more than a higher potential future offer when considering the closing costs, Realtor fees, and lost opportunities of lending money based on their ratios.
Whether buying a property "subject to" or attempting a short sale, you want to complete many of the same documents. Since short sales can be a lot of work before we begin, we hold title to the property "subject to" before negotiating with the lender. Experience has taught us the painful lesson of working months on a project and having everything worked out with the lenders, only to have a previously cooperative seller change their mind and refuse to complete the transaction. Trust our experience on this.
The following documents are necessary:
* Standard Purchase and Sales Agreement & Escrow Instructions:
This document details the terms of the sale.
* Authorization to Release Information:
This document allows us to contact the bank, discuss the property and the loan, and work out payment/payoff arrangements.
* Letter of Agreement and Addendum:
This document clarifies that we will do our best to stop the foreclosure, but cannot and do not make any guarantees. We will not make promises we are unable keep.
* Warranty Deed to Trustee:
This document conveys ownership of the property. Must be signed before a notary.
* Agreement and Declaration of Trust:
This document creates the land trust. A land trust is nothing more than an entity we use to title the property and keep our name off public records.
* Notification Letter That Trustee is Making Payments:
This letter is used when taking property "subject to" and notifies the lender that payments will be coming from a trustee.
* Escrow Letter:
This letter instructs the lender to apply to funds in any escrow account to the loan balance when the loan is paid in full. There is no guarantee the lender will comply with the instructions and they may send the escrow proceeds to the original borrower.
* Special Power of Attorney:
Applies only to the property and is used to handle any situations that may arise. Must be signed before a notary.
* Residential Real Estate Disclosure:
Discloses any defects in the property and prevents parties from saying, "I did not know about that defect." Complies with state law.
* Hardship Letter:
When dealing with foreclosures, the lender normally requires a letter from the borrower explaining their hardship and why they are unable to make the payments.
* Financial Statement:
Before discounting a loan and taking a known loss, the lenders will want to review the original borrower's financial statement and make sure the borrower does not have the ability to repay the debt now or in the foreseeable future. When preparing a short sale, lenders require a short sale package before they will consider accepting a discount. We recommend you provide the following documents:
* Cover Letter: A letter requesting a short sale and why the lender should consider your offer.
* Authorization to Release Information
* Standard Real Estate Purchase and Sale Agreement
* Hardship Letter from Borrower
* Financial Statement From Borrower
* Proposed Closing Statement (HUD1): All lenders want to see a HUD1 so they know their bottom line and to ensure the seller is not receiving any compensation.
* Opinion of Value: We recommend you provide the lowest comparable sales in the area.
* Estimate of Repairs: Most properties need repairs, and if you expect the lender to discount, you need to detail the necessary repairs.
* Notice of Trustee's Sale: The actual foreclosure notice should be included. This subtly lets the lender know you understand the foreclosure process.
* Color Photos: Supply the lender with photos of all problems on the property. This helps the lender justify accepting a lower price for the property. Short sales provide a great opportunity for creating equity and can be done without risking your cash and without using your credit. By negotiating discounts with the lender, you can create a situation where the property can be purchased well below market value. Then other investors will purchase this opportunity from you and close the transaction with cash! Everyone wins: the seller has the foreclosure stopped and may receive some of their equity, the lender receives a negotiated amount of cash at closing, the investor that purchases the property is able to buy at a below-market price, and you receive a well-deserved profit for your negotiating skills and ability to put the transaction together. And of course, you can always buy the property yourself.
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Gerald Romine is a nationally recognized real estate expert that has been featured across North America sharing the stage with political leaders, film stars, and business leaders.Since 1989, Gerald has been involved with real estate as a real estate agent, broker, rehabber, investor, and builder and has been involved with everything from houses to apartments. For more information about Gerald's products or services visit http://www.geraldromine.com.
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