Foreclosure Investing - The Basics

Foreclosures, short sales and Real Estate owned by financial institutes (known as REOs) look like the same thing: someone can't pay their mortgage and a property is being taken away. But the truth is, they are all fairly different from each other. Investors and people looking for a good deal on a home often look at buying foreclosures because they can often buy the property for the amount owed, picking up the home owner's equity for free. However, it's not quite as easy as it seems. If you walk into the investor market wanting to "do foreclosures," you could wind up in trouble unless you have a clear understanding of what each term really means. For example, while all short sales are foreclosures, not all foreclosures are short sales. To further complicate matters, REOs are not short sales either, but some intended short sales can end up as an REO. Let's start at the beginning, then, with three basic definitions:

1. What is a Foreclosure?

When a property is in foreclosure, all that has happened is that the owner has stopped making payments, and the lender has given the borrower a written Notice of Default that the payments must be brought up to date or the property will be sold off. The notice is a public document (which is why so many websites offer foreclosure lists). It normally takes about two missed payments for a lender to issue a Notice of Default, but not always. If the owner doesn't respond to the Notice of Default or make the payments needed to reinstate the mortgage, the lender can apply to the courts to take back the property. Once the title to the property has been transferred back to the lender, it can then auction the property off or otherwise dispose of the property. But even after a lender has taken possession of a property they can't auction it off right away. Every state has a different period of time where the property's former owners have the right to come up with all of the back payments to reinstate the mortgage. Foreclosure auctions are usually public. In fact in Reno, where I lived before moving to Phoenix, foreclosure auctions are *still* done on the front steps of the Courthouse once a week.

2. What is a Short Sale?

A short sale happens once a home is in foreclosure, but before the property goes to public auction. With a short sale, you are negotiating directly with the lender, who hopefully will agree to take less than what is owed on the property. That can make short sales even more attractive to investors, because there is an opportunity to get the same home, but for less. The idea here is that you are saving the lender time and money by stopping the legal foreclosure process and taking the property off the lender's hands. There are pitfalls to short sales, though. For example, if there are multiple mortgages on the property, you've got to strike a deal with all of the lenders, and that might mean your potential profit is severely curtailed. And, even if a lender does agree to your offer up front, they have until the closing to change their minds. A real estate agent I talked to recently told me that in her area one particular lender was allowing deals to go all the way through to closing but would then refuse to complete the transaction at the very last minute. She said while it was something real estate investors were fairly casual about, it was very hard on people who were buying with the intention of living in the property.

3. What is an REO (Real Estate Owned)?

Say the foreclosure process goes all the way through to the auction, but no-one bids high enough to meet the lender's price. In that case, the foreclosure completes and title transfers to the lender. So in this case, Real Estate Owned means the property is owned by the lender. Some see REO homes as the best way to buy a distressed property because the seller is already out of the picture. It's just the investor, the investor's agent, the bank and the bank's agent who are negotiating the transaction. Some REOs can be purchased directly from the lender. That's what my husband and I did, and we got a fantastic deal, because the bank wanted the property gone. The bank is designed to be a landlord, and doesn't want to be. However, other investors have found that the savings aren't necessarily there, and that lenders want close to the full selling price. This is especially true in areas where home values have fallen further than lenders want to acknowledge.


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