Home foreclosures may feel like a bad nightmare from the past — something you recall every so often, but you push the thought out of your mind the first chance you get. The housing crisis in 2008 was a scary time for many investors, and with home prices rocketing up across the country, the foreclosure era may feel like a blip on the proverbial radar. I’m an admitted contrarian, but I do think that eventually home prices will plummet again, and I think it will represent an opportunity for investors to buy distressed homes at discounted prices. Understanding the foreclosure process will help you capitalize on the opportunity if (in my opinion, when) it happens again.
There are two main types of foreclosure states: judicial foreclosure states and non-judicial foreclosure states, which are sometimes called trust deed states. Basically, if your state is not a non-judicial foreclosure state, then the foreclosure process must involve the courts. There can still be auctions, but it will be conducted by the appointed court. In a non-judicial foreclosure state, like California, the lender can foreclose on the loan by following a process that is specified by the state. (Note: foreclosures happen to loans and not the property; thus, there can be multiple foreclosures open for the same property.) The foreclosure process can vary greatly on a state by state basis, even if they have the same type of general foreclosure process.
California, as I mentioned earlier, is a non-judicial foreclosure state, which means that the auctions for the sale of the properties don’t have to go through a court process. Instead, the foreclosure process is carried out by a trustee who oversees the process for the lender, also known as the beneficiary, from a fiduciary perspective. The entire foreclosure process in California can take months and even years. The longest timeline from the moment a borrower became delinquent in their payments to the moment they were evicted from the house that I have heard of is four years. The person literally lived, without paying mortgage or rent, for four entire years between their last payment and being evicted. If only I were so lucky…
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The Foreclosure Process
Notice of Default
The foreclosure process in California starts by the borrower not paying the lender or beneficiary. Once the borrower doesn’t meet the terms of the loan, then the lender can post a notice of default. The notice of default starts the pre-foreclosure process by creating a public record of the fact that the borrower is in default. The borrower then has the opportunity to make good on their deficit by negotiating a loan modification or simply making the payments. After a certain amount of time with the borrower not making good on the loan terms, the lender can then post a notice of trustee sale. As I mentioned before, foreclosure sales in California are conducted by the trustee company (of which there are quite a few) in a public place, which usually ends up being the county courthouse steps. After that, the lender will set an auction date for the loan on the property.
The sale date of a property can be postponed or canceled. A postponement is very common, as the borrower can easily have a non-profit lawyer employ various stalling techniques. Properties can usually be postponed for up to a year. A foreclosure cancellation means that the borrower is now current with their payments or has worked out a loan modification. If the borrower becomes in default again, then the process starts over from the beginning.
The Property Sale
Once a property goes to sale, there will be an opening bid, which is basically the minimum amount the bank will take for the property. Opening bids can be posted before the sale on the trustee’s website. There is no guarantee that the opening bid will come out more than a few seconds before the sale, however. Oftentimes opening bids are not announced until the moment the property goes to sale. An opening bid can be for any amount that the trustee decides. One possibility is a total debt bid, which means that the opening bid is equal to the amount of money that the lender is owed. Generally, no one bids on a total debt bid because that bid amount is greater than the value of the house. If it wasn’t, then the owner would have likely tried to sell it to make some money because they would have had some amount of equity. Another possibility is a specified opening bid, which is where the beneficiary, or lender, decides to start the bidding at some number that is usually less than the amount owed to them. I have seen specified opening bids go for as low as $1.
The auctioneer is the one who announces the opening bid, whether it has been posted prior or not, and the auctioneer works for the trustee. Auctioneers are not paid well, but they have an enormous amount of discretion and power. Once the opening bid is announced, the auctioneer will ask, “Are there any further bids?” At this point any investor, including the lender himself, can bid on the property with a bid of at least a penny more.
This could be the first time that the investors have heard the opening bid amount, and they are forced to make a decision in a short period of time. Sometimes the auctioneers can delay on a property to give investors more time to decide if they want to bid, but sometimes the property is sold right away. If an investor does not bid, then the property is sold back to the lender, and the property is now what is commonly known as real estate owned or REO. The opening bid is essentially a bid by the lender on their own defaulted loan.
Opportunity for Investors
Hopefully you are still with me at this point. If it sounds like a confusing and onerous process, it’s because it is. That is what creates the great opportunity for investors. There is a tremendous amount of back end diligence work that needs to happen prior to the auction, and there is no guarantee that any of the properties scheduled for a particular day will actually go to sale. There were consistently around 500 homes in Contra Costa and Alameda Counties scheduled to go to sale the day before the auction, and only about 5% of those 500 homes actually went to sale. There was tremendous attrition and inefficiency in the market. Anyway, stick with me for the last part of the auction process.
Most times if a bid was placed above the opening bid, then it came from a third party investor. In order for an investor to purchase a property at the courthouse steps in California, they have to bring cash or cashier’s checks for the full amount of the purchase price. In a lot of states, investors just have to put down a deposit, but California requires the full amount of the purchase price, and there is no refund or escrow period. In other words, when an investor makes a bid for a property at the auction, they better know that they really want the property because all sales are final. There is no opportunity to change your mind. If you bid $1,000,000 on a property by accident, you are out $1,000,000. Yes, I have seen this happen — the “buyer” tried to take his checks back and run away…
The bidding process when there are multiple bidders happens very fast and can be very different based on which auctioneer is selling the property. As I said before, there is a tremendous amount of discretion given to the auctioneer. They can give investors a lot of time to bid — or practically no time at all. They can require checks to be signed before the property is pronounced sold, or they can stop all bidding after the third and final call to allow an investor to sign his checks in peace and with the security of knowing the property is his.
If an auctioneer wants the checks to be signed prior to declaring the property sold, then it creates this situation where the property has been declared third and final bid, but another investor can still jump in. In these scenarios the “winning” bidder is furiously trying to sign their checks to finalize the sale. Regardless of how the auctioneer conducts the process, when the property is pronounced sold, then the third party investor hands over the signed cashier’s checks and gets a receipt in return. It is a weird and oddly inadequate feeling to hand over a million bucks and get a crumpled piece of yellow paper back.
Receiving the Deed
Anyway, a couple weeks later, sometimes longer, a deed will arrive in the mail. This is an anxious time for an investor because there are a lot of things that can go wrong until the deed is recorded under the investor’s name. The trustee can rescind the sale because of a mistake they made, a late bankruptcy filing can cloud title, and other legal steps by the person who lost their home can be taken. The trustees can be lazy and irresponsible, and they make mistakes often, so having a property rescinded is not uncommon. If a property is rescinded, then the investor gets their money back, but it usually takes about 90 days, and the trustee doesn’t pay interest. Once the deed is recorded, however, the property is yours to do with as you please.
The whole foreclosure process is fraught with problems and challenges for investors. There are lazy and incompetent people in positions of power, there is an incredibly inefficient and random system of communicating information about properties going for sale, there is an attrition rate of 95% from the day before the auction to the day of, and there is generally a lot of risk. There is no guarantee of property condition, occupancy status, and the loan going to sale could be a second and totally worthless, so the investor needs to do their own title check. This entire process needs to be managed prior to the auction and oftentimes with no knowledge of what the opening bid is.
However, this inefficiency creates opportunity for investors because many people don’t have the ability, commitment, or patience to filter through this process and find the good deals. I will post next week about how to create a process to purchase foreclosures and keep your sanity — or most of it, anyway.
Have you obtained properties via foreclosure? What was your experience like?
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