Pre Foreclosures - the First Stage of Foreclosures
In this chapter we will review pre foreclosures, which represent the first stage in the foreclosure process. In this phase, the homeowner has missed at least one payment and is now considered delinquent on the loan. A pre-foreclosure can also be referred to as a Notice of Default or Lis Pendens, which is a formal warning sent to the borrower on a loan regarding the delinquent payment(s). A Notice of Default or Lis Pendens are essentially the same thing but just signify whether the loan is secured through a mortgage or deed of trust. Once the trustee files a Notice of Default it immediately becomes public record.
Understanding Distressed Homeowners: To effectively help a homeowner in distress, it is important that you understand the psychology of the owner. In most cases, the owner is dealing with a negative event in his life that has caused him to fall behind in his mortgage payments. Often times it can be the result of divorce, illness, job loss or other monetary obligations that have grown unmanageable. Making matters worse, owners often fall into denial or procrastination, which undoubtedly makes the situation worse. Only once you understand the problem the homeowner is facing can you effectively help. Remember , you may very well be the last alternative for a homeowner who is facing inevitable foreclosure.
Preventing further credit damage: While it is unlikely that a distressed homeowner has great credit, adding foreclosure to their credit history will have long-term consequences. Specifically, it will make buying another home or establishing other types of credit very challenging for a long period of time.
Saving some equity: If you are able to pay the owner some amount above their mortgage balance, it may well be more than they would receive through a trustee sale or real estate auction. The reason being that the owners' equity is often times completely offset by the expenses and fees incurred leading up to the auction.
Deficiency Judgment: If the proceeds from the foreclosure sale are not enough to pay off the lender, then the borrower is liable for any deficiency. Depending on the particular state laws, a deficiency judgment that is not resolved can result in the previous homeowner experiencing garnished wages, seized assets and potentially even federal income tax levies.
Negotiating With the Owner: The biggest challenge of buying real estate preforeclosures is getting the attention of the homeowner. Since a Notice of Default is public record, other astute investors have probably contacted the owner as well. Many investors will simply write a letter or send a postcard indicating their interest in the property. Since there will always be competition for a good deal, we do not recommend this passive approach. Rather, we have found it more effective to speak directly with the owner either over the phone or in person. This is the best way to gain the confidence and trust of the owner who is the ultimate decision maker.
In many cases, the best option for an owner in default is to sell the home and get relief from the pressures of financial distress. Unfortunately, many property owners make every effort to hang on to their property for as long as they can. However, with the real estate auction date rapidly approaching the homeowner will likely be motivated to close a sale prior to the auction. As the owner continues to explore his options in the pre-foreclosure period, we recommend you keep in regular contact with him. Make sure he knows you will immediately buy the house as long as he is willing to accept your price.
When speaking with a distressed homeowner, be courteous and demonstrate an understanding of the owner's dilemma. Further, we recommend taking a consultative approach with an objective of reaching a mutually beneficial agreement. By taking a consultative approach, you may ultimately help the owner through the problem while deriving no immediate benefit for yourself. While this may seem discouraging, you may still benefit from the relationship. It is not uncommon for a distressed homeowner to solve his problem only temporarily and ultimately to default on their mortgage again. Having helped the owner the first time, it is quite likely he will seek your counsel a second time. As more deals come your way, you will undoubtedly find yourself in front of several good investment opportunities.
Property Analysis: Before you can make an offer on any type of distressed real estate, you must do your homework. This includes a thorough analysis of the property including a detailed title search to ensure a clear title. Next, you should evaluate the loan-to-value ratio of the property. This ratio compares the balance of the mortgage to the value of the property. The difference between these two variables is the owner's equity or the potential gross profit in the deal. If there is little or no owner's equity in the property, we recommend you go no further. If there is little or no equity in the deal, it will be very difficult to create a true win-win situation with the owner.
If you are buying the property to flip (quickly resell at a profit) rather than keep as a primary residence, you must calculate all the costs to buy, carry, repair and sell the property. If there is still a reasonable amount of owner's equity after subtracting all necessary expenses, you have identified a good investment. So how much should you offer the homeowner? While every deal is different, a very reasonable approach is to split the remaining equity with the owner. This way both parties end up in positive positions.
Closing the Deal: Before you sign any agreement with the owner, double check to ensure the title of the property is clear. Never release any money until your real estate attorney has assured you of a clean title. If everything checks out, you will both need to sign a Real Estate Purchase and Sale Agreement. At this point, you will want to arrange your financing (you may even consider alternative financing or hard money loans) and ensure that the foreclosure process has been stopped. Assuming all goes well, it looks like you just bought some real estate at below market value.