Pros and cons of investing in real estate foreclosures

Expert reveals tips on how, when to buy
By: Robert J. Bruss: Inman News
A few days ago, while cleaning out a file cabinet, I found a copy of my book, "How to Earn Big Profits from Foreclosure and Distress Properties," which I wrote way back in 1992. It has been out of print for years so don't try to buy it. As I glanced over the book, I was shocked at how much has changed since then and how much easier it is today to find and profit from foreclosures.

Although the basic foreclosure procedures remain virtually unchanged, thanks mostly to the Internet it has become much easier today to find and profitably acquire foreclosed properties.

While recently reading an excellent new book on this topic, "The Complete Guide to Investing in Foreclosures," by Steve Berges, I learned approximately one out of every 22 houses is in the foreclosure process. As I drove down the street yesterday, when I counted 22 houses, I asked myself, "Which of these owners is behind in their mortgage payments?"

Of course, not every house or condominium that enters the foreclosure process goes to a lender's foreclosure sale. Especially in the last few years, thanks to a robust real estate market in most communities, the majority of houses were either sold or refinanced to prevent foreclosure losses.

However, as mortgage interest rates slowly rise, and fewer buyers can qualify for new mortgages, the number of home foreclosures is expected to rise in 2006. But good times or bad, there are always foreclosures. Somebody profits from every foreclosure sale, it might as well be you.

WHAT CAUSES FORECLOSURES? Each situation is different. But the most common causes of foreclosure losses I've encountered include divorce, illness, death in the family, unemployment, drug and alcohol addictions, mental problems, bankruptcy, and relocation.

Foreclosures happen in all neighborhoods, ranging from the very best to the very worst areas. Personally, I've acquired properties in all stages of foreclosure, usually with very little out of pocket cash.

HOW THE FORECLOSURE PROCESS WORKS. The start of a foreclosure occurs when a borrower fails to make their monthly mortgage payments for one or two months. After 45 days or so, if the borrower doesn't respond to the lender's polite default letters, most lenders begin the foreclosure process.

Although some borrowers stall their home loan lenders, most realize failure to reinstate the loan can be a costly mistake. Here are the three basic foreclosure steps, and the bargain-buying opportunities:

1. LENDER RECORDS A LIS PENDENS LAWSUIT OR NOTICE OF DEFAULT. The official foreclosure process begins when a home loan lender records either a lis pendens lawsuit (which means litigation is pending) or a notice a default.

The lis pendens lawsuit is used if a mortgage is involved, whereas a notice of default is recorded when the lender's security instrument is a deed of trust. The lis pendens lawsuit often results in a judicial sale of the property. But a notice of default can result in a nonjudicial trustee's sale.

However, the borrower usually has three to six months to cure their loan default and reinstate it before the property goes to a foreclosure auction. Texas has the shortest reinstatement period, which can be as fast as 21 days.

This reinstatement period creates the first opportunity for a home buyer or an investor to contact the defaulting owner to see if the property can be purchased, often at a bargain price for a quick sale. Some defaulting homeowners are willing to sell for just a few thousand dollars of their equity so they can "move on" with their lives.

Because time is of the essence, foreclosure buyers during this reinstatement period usually purchase "subject to" all existing liens, such as a second mortgage, mechanics' lien, property tax lien, judgment lien, and IRS income tax lien. A purchase during this "pre-foreclosure period" enables the buyer to obtain title insurance so there are no title surprises.

2. PROS AND CONS OF BUYING AT THE FORECLOSURE AUCTION. Frequently, a property is "over-encumbered" with total mortgages and liens that exceed the property's market value. In that situation, it doesn't pay to buy during the pre-foreclosure reinstatement period because the defaulting borrower has little or no equity.

In that situation, if the borrower doesn't cure his/her default, the best time to buy may be at the foreclosure auction. The big advantage is most junior liens recorded after the obligation that is being foreclosed are wiped out by the judicial or nonjudicial foreclosure sale.

However, unpaid property taxes and IRS income tax liens are not wiped out.

Disadvantages of buying at the foreclosure auction include (a) no opportunity to inspect the property interior, (b) competition from other bidders, and (c) cash (or cashier's checks) are required. Sorry, your Visa, MasterCard or American Express card are not welcome.

3. BUY AFTER THE AUCTION FROM THE FORECLOSING LENDER. As frequently happens, no bidders show up at the foreclosure sale. The title then goes to the foreclosing lender.

Institutional lenders then call it REO (real estate owned) property, which they usually want to unload quickly, sometimes at a bargain price to mitigate the lender's loss.

My personal technique for buying REO property from lenders is to immediately send a FedEx overnight letter after the foreclosure auction to the lender's president with an offer to buy the foreclosed property. I enclose a substantial deposit check to show my sincerity. Although my FedEx letter has never reached the lender's president (as far as I am aware), it does get referred to the REO or other appropriate department.

If the house is in especially bad condition, I include a remark such as, "Have you seen this property lately?" or "I hope the city inspectors haven't condemned the property yet." When possible, I include a photo showing how bad the house looks.

The foreclosing lender's usually prompt response is to accept my purchase offer, counteroffer, or reject it. But some lenders insist on marking the foreclosure up to full market value and listing it for sale with a local real estate broker, thus incurring a sales commission.

HOW TO FIND FORECLOSURE LISTINGS. In many cities and counties, there are local legal and private subscription newspaper lists of foreclosures. Many of these lists are now available on the Internet.

Good sources include www.foreclosures.com and www.RealtyTrac.com. Local real estate attorneys and title officials usually know the best local foreclosure information sources. More details are in my new special report, "Foreclosure and Distress Property Profit Secrets," available for $5 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet PDF delivery at www.bobbruss.com.