What's the "Best Way" to Buy a Foreclosure?
By Alexis McGee

So, you just want to buy a foreclosure? You want it to be "simple and easy", and at the same time, "a great buy"? So you ask, "What's the best way to buy a foreclosure?"

I wish I could answer with "it's easy, just do this &"

But I'm sorry; I'm just not going to lie to you.

(By the way, you won't see me on late night television touting my "simple, easy way to buy a house for pennies on the dollar". I sometimes wonder how those guru guys sleep at night.)

So please, sit back and read this next line twice, if not, three times:

Buying foreclosures is NOT easy, and there is NO one "best way" to buy a foreclosure.

The key to ANY "great buy" is a motivated seller. Someone who wants cash more than they want to keep their house. Someone who wants to sell you his or her home more than you want to buy it (you must have good "walk away" power). Once you have a motivated seller, you are half way to your goal of buying a house at a price below market value.  You can buy from:

1.       "Pre-Foreclosure Owners" (Notice of Default or Lis Pendens filed) are folks "in foreclosure" who have time before they lose their home, equity and credit in a foreclosure auction.

2.       "Foreclosure Auctions" (Sheriff or Trustee Sales) are the way lenders get their bad loans paid in full. They set the opening bid for the house at the unpaid balance of their defaulted loan in default.

3.       "R.E.O. by Lender" (Real estate owned") is property that has been foreclosed and "repossessed" through a foreclosure auction and now the lender wants to get rid of it.

So, which of these three ways is "the best way" to get a deal? Well, it's up to you to decide. I'll just lay out the ground rules and then you can let ME know which option you think, is "best" for YOU. Okay?

1) Pre-Foreclosure Owners:

Once a Notice of Default, or Lis Pendens has been filed, the owners are now "in foreclosure" and must do something, or risk losing their property, all their equity and their credit, through a foreclosure auction.

Months before the auction (trustee or sheriff sale) you should contact the motivated owner whose home is in foreclosure directly, and offer to purchase their home by "paying them cash for their equity". Mention the benefits they will realize when the decide to sell, such as -- "stopping the foreclosure", "preventing further damage to their credit" and "getting a fresh start". Be friendly and un-intimidating.

Do not insult or offend them with patronizing comments like "how did you get in such a mess?" or "Why in the world did you do THAT?" Remember that you are buying their home and you need them to like you (and your offer) and to want to sell you their home. You must show them how your offer is a "win - win" proposition for both of you.

If they are not ready to sell now, do discuss all their "options" with them. Keep the door open for future discussions. You never know when someone in foreclosure will decide it's time to sell his or her home. But when they do decide, you want them to talk to YOU and no one else. This relationship must be established early on, starting with your first contact, and reinforced through your repeated follow-up visits.

The #1 reason many investors do not succeed in buying "pre-foreclosure" houses is they simply do not follow up with the motivated sellers! Do not make this mistake!

Once the homeowners agree to sell you their home, you will "do the math" to determine the MOST you can afford to pay for the property, BEFORE you meet with the sellers. Make sure you have enough cash available to make up their back payments (and stop the foreclosure), plus give them some "walking money" to close the transaction (and move them out!).

The amount "of cash" you give the seller is totally based on your negotiation skills (obviously less is better from your standpoint -- but not too low. Getting rejected outright and NOT buying the property at all isn't good either).

Make sure your offer is contingent upon and "subject to" all existing liens, loans, etc. as listed in your purchase agreement, and that it is the entire list of all debts. Make certain that the terms for repayment are accurate, and that you have the right to approve or disapprove the current status of all loans and of title.

Successful foreclosure purchases must conform to your state foreclosure laws. Do make sure you read up on, and are familiar with, these state laws in advance of writing your offer.

Normal purchases include full title insurance provided by the seller, as well as the buyers' complete inspection of the property's physical condition.

The best part of buying directly from the owner is that you have an EXCLUSIVE deal. Contrary to popular belief, there is RARELY ANY COMPETITION when you buy a home in foreclosure, directly from the owner.

Once a motivated seller decides to sell his property, he just wants to get it over with quickly and easily. The idea of the seller calling many investors to get the best offer just isn't consistent with reality. Once you are in -- YOU'RE IN! There'll be no "pack of bidders" to worry about, such as you what you would encounter if you waited for the Foreclosure Auction.

2) Foreclosure Auctions:

A few weeks (or in some areas a few months) before the auction, the lenders representative (Trustee or Attorney) files an "Auction Notice" (Trustee's sale or Sheriff's auction) of intent to sell the property to the highest bidder at a public sale. The opening bid is set by the lender and is based on the full amount owed on the loan (to include principal, interest, late charges, penalties and foreclosure fees allowed by law), as of the date set for the auction.

Often times the auction is delayed by mutual consent of the lender and the borrower, and a new auction date is scheduled. Do make sure you check with the lender's representative (Trustee or Attorney) the morning of the auction, to confirm that it is still scheduled and to also confirm the amount of the minimum opening bid.

Before you attend any foreclosure auction, you'll need to complete a ton of research. Since these purchases are "as is" with no warranties given and no title insurance provided, and in most cases (varies state by state) you need "all cash" (in the form of certified funds), you really know very little about what you are about to bid on.

You must do a "complete title search" to examine the state of title and to determine what position you are bidding on at the auction. You can do this yourself (expect NO help from the County Clerks) or you can hire someone to do it for you. A reputable title officer charges $300-$400 for each preliminary title report they complete (these are NOT the same as a "property profile" which is FREE and worthless to you).

This can get very costly, especially if you decide NOT to buy a few houses. Most professional foreclosure auction bidders are also very good title researchers, and they have learned from another professional, how to do this very tedious task.

Now, you ask, "why do I need title information?"

If you are planning to bid at a foreclosure auction for a "first mortgage" most junior loans/liens will be wiped out at the auction and you will not be responsible for them. This is great news, if the owner in foreclosure had a ton of loans and, therefore, not enough equity for you to be able to purchase from him directly. Now you have a chance to buy the house, for less money, at the auction!

BUT some liens are NOT wiped out – such as Property Tax Liens and any Federal Tax Liens (plus other exceptions that cannot be described in this column).

This is also important information for you as the bidder, isn't it?

What if you are planning to bid at a foreclosure auction and you thought that opening bid of $50,000 sounded GREAT on a $200,000 house? You may be GRAVELY MISTAKEN. Your $50,000 winning bid, could be for the "second mortgage" (NOT the "first" as above). The winning bidder at this auction pays the $50,000 cash, and then AUTOMATICALLY ASSUMES the debt of all SENIOR LOANS/LIENS on the property.

What if the first mortgage on this house was $200,000? OOPS! You just paid $250,000 for a house worth $200,000. OUCH!

You will also need to inspect the property, to determine the amount of repairs needed. If you are buying from the owner directly, you are invited inside, and can easily do your inspections. But what if the owner losing his home at the auction is hostile, and won't talk to you, or let you in? Are you prepared to peek inside windows and hope for the best? What if the house is totally wrecked when you finally buy it?

Lastly, you can expect competition at the foreclosure auctions. Anyone with money, and who may be afraid of, or just not good at talking to owners in default, will go to the auctions. Often times there is a crowd of people, who all may bid up the same property. In "hot real estate markets" like we've had for some time, investors will pay more for houses at auctions than I would (my maximum is 70% of market value).

You can see what other investors have paid for properties at the foreclosure auctions in Northern California in our monthly "Pirate Comps" column. Check it out -- it will surprise you!

3) R.E.O. (Real Estate Owned) by Lender:

These are properties that went to sale at foreclosure auctions, but that nobody wanted. Most likely the minimum bids exceeded what a savvy investor would pay. This is the way that lenders take ownership of defaulted properties and these are also known as R.E.O, or real estate owned. The lender no longer has a bad loan to collect on - they now have a property that is a non-performing asset and which they must sell.

In "hot real estate markets" like we've been in for some time, R.E.O. lenders will simply fix up the property, list it with a Realtor and sell it to a homebuyer for full market value. The R.E.O. lenders have essentially become OUR competition.

But once they start getting more and more properties back and can't keep up with the fix-up for resale process, they will start selling their properties "as is" for a discount again. When will that happen? It's hard to say. But I can say this:-- it is NOT HAPPENING NOW -- and I would recommend you NOT work R.E.O. leads at this time.

R.E.O. lenders currently are NOT motivated sellers. They will not be motivated sellers until they have a ton of bad loans and a large R.E.O. inventory (which they don't have at this time).

If you found an R.E.O. property in your area, and it is not in the M.L.S. (multiple listing system of agents), you will want to contact the lender directly by phone. Ask for the head of the R.E.O. Department, or request the name of the actual R.E.O. asset manager handling this property. If you need a current list of over 300 R.E.O. decision-makers, please review our "R.E.O. Key Contacts Directory" at Foreclosures.com.

Ask the Asset Manager if the bank will be selling the property "as is" and if they will discount for an "all cash offer" to an investor. If you get a YES, then that's great! Continue to pursue the property, and line up your money (lender or equity partner).

Make sure you've structured the deal, so you do not exceed 70% of the market value (total of purchase price and all repairs), and you will have no problem finding money partners.

Which Way is the BEST WAY For YOU to Buy a Foreclosure?

If you are asking me, my preference is buying from the pre-foreclosure owner, in today's market. As the market changes, so will my preference of ways to purchase. Which is best for you? That's hard to say, but hopefully now you know why a "quick answer" just wouldn't work!

Happy investing,
Alexis