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The investment quandary as to the best method for acquiring foreclosed property at heavily discounted prices inevitably surfaces at the same stage in the real estate cycle every ten to twenty years. After housing booms and home prices correct back to affordable levels, real estate investors are suddenly inundated with an almost overwhelming supply of potential homes to choose from. These prospective buyers peruse city blocks searching for evidence of distressed properties that might lead to investment opportunity by taking dead lawns, unpaid utility notices, and default notices all into account. They investigate “For Sale” signs with “Bank Owned” or “Foreclosure” riders attached. Technologically savvy bargain hunters browse websites online to identify properties in default. These opportunists also compare notes with one another at various social functions, water coolers, chat rooms, and anywhere else real estate is spoken. Here they may learn that in order to obtain the most lucrative price, investors are best served to purchase property directly at a foreclosure sale on the court house steps. Regardless of the preferred method for locating distressed properties, it is imperative to thoroughly comprehend the different foreclosure processes in order to develop and implement a successful investment strategy. If a homeowner fails to make prescribed loan payments to the bank, the borrower is deemed to have defaulted on the loan. If the delinquent payments are not cured in a timely fashion, the lender is permitted to foreclose on the property to acquire title to the home as security for the unpaid debt. For national investors it is important to understand that lending practices and foreclosure procedures vary from state to state. For example, some states are considered “mortgage” states while other states prefer the “deed of trust” method of lending and holding title as security for the loan. MORTGAGES Mortgage states utilize a two party security system where a mortgagor (or borrower) provides a promissory note to a mortgagee (or lender), along with a voluntary lien called a mortgage that serves as security for the borrower’s promise to make the loan payments described in the promissory note. Since title to the property resides with the borrower when the mortgage is created, foreclosures in mortgage states can be relatively lengthy and costly for banks to pursue. Further, mortgages also provide borrowers redemption rights that allow borrowers a specified period of time after the foreclosure and ultimate sale to a third party to pay off the original loan amount and regain title to the property. As a result, buyers at foreclosure sales in mortgage states must be aware that they will often be unable to obtain clear title to foreclosed homes as the previous owner will likely be afforded the opportunity to pay off the original promissory note and reclaim the property. DEEDS OF TRUST A minority of states that include California favor the three party deed of trust system due to the relative cost efficiency and expediency provided to lenders in the foreclosure process. Additionally, lenders are often able to provide buyers of foreclosed property clear title as no right of redemption exists for borrowers. The Deed of Trust process involves a trustor (or borrower) that gives a promissory note to the beneficiary (or lender), and the trustor also gives title through a trust deed to a trustee (neutral third party) as security for the note. The important difference here is that title to the property is held by the trustee rather than the borrower. The trustee is typically a neutral third party designated by the lender to hold the deed of trust during the loan period with the power to more easily administer a foreclosure sale in case of default by the borrower. It is clearly important to determine whether one is bidding on a property that was subject to a mortgage or a trust deed at a foreclosure sale. This differentiation can often be confusing as many real estate professionals and experts in deed of trust states will often casually refer to home loans as mortgages. Many lenders in these states will refer to themselves as mortgage brokers or mortgage companies when they actually originate promissory notes secured by deeds of trust. Deed of Trust states also refer to foreclosure sales as trustee’s sales, where the highest bidder purchases the property in an auction setting. However, purchasing a home at a trustee’s sale can be a risky proposition as the buyer has little or no opportunity to inspect the home prior to purchase. Further, the buyer must pay with all cash as financing is typically not permitted at trustee’s sales. There is also no guarantee that the property is not currently occupied by tenants or a previous owner. Finally, purchasers at a trustee’s sale are not protected against clouds on the property’s title like tax liens from a previous owner’s unpaid property taxes, so title insurance is often unattainable for buyers at trustee’s sales. REAL ESTATE OWNED (REO) If a home is not sold to a new buyer through the foreclosure process, the lender holding the promissory note will often acquire the property and attempt to sell it on the open market to a new buyer. Once title to the home that once served as security for the unpaid promissory note is transferred to the bank, the property is deemed real estate owned (REO) by the bank. The bank will then typically retain a REALTOR® to market the property for sale at a price below market value, remedy any defects on title, remove any tenants or squatters occupying the property, and often retain contractors to repair any major physical defects in existence on the property. Although the typical price paid for an REO property may in theory be slightly higher than buying at a foreclosure sale, purchasing an REO property is clearly a much less risky proposition. REO sales also provide investors adequate opportunity to inspect homes prior to making offers to purchase, and buyers are permitted to utilize financing when purchasing these bank-owned properties. Whether purchasing foreclosed or REO properties, the various risks and rewards associated with an investment may not only depend on the characteristics of the home itself, but also the type of security the home provided to the previous owner’s lender. In order to avoid the displeasure of telling foreclosure horror stories in real estate investment circles, an ounce of diligent research into a property’s financial history can prevent a pound of investment headaches. About the Author:
Brian S. Icenhower, Esq., BS, JD, CRB, CRS, ABR, a California Association of Realtors Director, practicing real estate attorney, a real estate expert witness and litigation consultant, a prosecution consultant of Tulare County District Attorney Real Estate Fraud. He may be contacted at bicenhower@icenhowerrealestate.com, or www.icenhowerrealestate.com
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Real Estate, Housing, Economics, REO, Properties, foreclosure, mortgage, mortgages, investment,
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