What is a Foreclosure?
Foreclosure is a process that allows a lender to recover the amount owed on a defaulted loan by selling or taking ownership (repossession) of the property securing the loan. The foreclosure process begins when a borrower/owner defaults on loan payments (usually mortgage payments) and the lender files a public default notice, called a Notice of Default or Lis Pendens. The foreclosure process can end one of four ways:
- The borrower/owner reinstates the loan by paying off the default amount during a grace period determined by New York State law. This grace period is also known as pre-foreclosure.
- The borrower/owner sells the property to a third party during the pre-foreclosure period. The sale allows the borrower/owner to pay off the loan and avoid having a foreclosure on his or her credit history.
- A third party buys the property at a public auction at the end of the pre-foreclosure period.
- The lender takes ownership of the property, usually with the intent to re-sell it on the open market. The lender can take ownership either through an agreement with the borrower/owner during pre-foreclosure, via a short sale foreclosure or by buying back the property at the public auction. Properties repossessed by the lender are also known as bank-owned or REO properties (Real Estate Owned by the lender).
The 3 Stages of Foreclosure
Stage One: Pre-Foreclosure (Notice of Default, Lis Pendens):
Buying a property in pre-foreclosure involves approaching the borrower/owner and offering to buy the property outright. The borrower/owner can walk away with something to show for any equity in the property and avoid a bad mark on his or her credit history.
In the pre-foreclosure stage, investors will likely be able to do the most good for the distressed homeowner and for themselves. Pre-foreclosure is where further damage to the home owner's credit rating can be forestalled and the home may be transferred at a mutually-agreed-upon price before it is necessary to get the lender involved. The buyer has time to research the title and condition of the property and can realize discounts of 20-40 percent below market value.
Before initiating the foreclosure process, the lender may send a warning of impending foreclosure to the borrower, but this is not required in New York.
When processing a foreclosure through the court system, the lender files suit against the borrower for the amount in default. The borrower is notified of the foreclosure proceedings and is required to appear in court to respond. In addition, a lis pendens (notice of pending lawsuit) is recorded.
If the borrower does not appear, the court can rule against the borrower, allowing the foreclosure sale. If the borrower appears, the court considers the case before ruling whether the property can be foreclosed on. If the court rules against the borrower, a foreclosure sale is scheduled. The foreclosure proceedings leading up to the court ruling usually take 7-9 months.
Stage Two: Foreclosure (Notice of Foreclosure):
If the loan is not reinstated by the end of the pre-foreclosure period, potential buyers can bid on the property at a public auction. Buyers often are required to pay in cash at the auction and may not have much time to research the title and condition of the property beforehand; however, a public auction often offers some of the best bargains and avoids the unpredictability of dealing directly with the borrower/owner. The sale is usually scheduled at least 4 months after the court ruling. The notice of sale must be published in a general circulation newspaper once a week for at least 4 weeks prior to the sale.
The sale is usually scheduled at least 4 months after the court ruling. The notice of sale must be published in a general circulation newspaper once a week for at least 4 weeks prior to the sale.
In New York, foreclosure sales are made by public auction, usually at the county courthouse. The property is sold to the highest bidder and anyone, including the lender, may bid. The winning bidder typically has to pay 10 percent of the final bid at the sale and the remaining balance within 30 days. When the full amount is paid, the winning bidder takes ownership of the property. Borrowers have no right of redemption after the sale.
Stage Three: Post-Foreclosure (Real Estate Owned):
If the lender takes ownership of the property, either through an agreement with the owner during pre-foreclosure or at the public auction, the lender will usually want to re-sell the property to recover the unpaid loan amount. The lender will then typically clear the title and perform needed maintenance and repair; however, the potential bargain for these REO homes is typically less than a pre-foreclosure or auction property. Bank foreclosures can become government foreclosures if the loan is backed by a government agency such as the Department of Housing and Urban Development (HUD) or the Department of Veterans Affairs (VA). In that case the government agency would be responsible for selling the property.
Refer to the foreclosure notice to determine the name of the lender as well as the balance owed on the mortgage. Lenders are typically extremely willing sellers, because an REO on the books is an obvious sign of having made a poor lending decision. Both the overhead and losses involved with an REO -- reflected in both the added reserves a lender must maintain as well as any potential property management fees incurred -- means the bank is likely a willing negotiator.
Advantages of Purchasing Foreclosed Real Estate
§ Low prices. Foreclosures sometimes sell for 30 to 50% below their true market values. More modest discounts of 5 to 10% are more common, but foreclosures are almost always priced lower than homes in the traditional real estate market.
§ Great fixer upper homes. Many foreclosed homes are 'fixer upper homes' that need repairs, renovation, and tender loving care. By investing a little sweat equity, most homebuyers find that they can make significant profit by reselling the home after some relatively quick and minor repairs.
§ Lower closing costs. The banks and government agencies that sell foreclosed homes are in a hurry, which means that they are often willing to accept lower offers on down payments, financing options, closing costs, and all the other miscellaneous costs associated with buying a home. Many sellers will come right out and offer buyers great deals and contract terms simply to sell the house quickly.
§ No move-in delays. Most foreclosures are vacant, meaning that you can move in almost immediately after purchasing the home, without having to wait for the previous owners to move out.
§ Flexible financing. When banks sell foreclosed properties, they're often willing to offer very flexible financing terms to sweeten the deal and sell the property more quickly.
§ Profitability. Because foreclosures are so inexpensive, they're great options for resale, equity-building, renting, and other investment purposes. You can easily make a tidy profit, and quite possibly make your personal fortune by wisely investing in foreclosed properties.
Disadvantages of Purchasing Foreclosed Real Estate
With so many advantages to buying foreclosed homes, why isn't everyone doing it? Because there are some important disadvantages to doing so. The disadvantages are manageable, but only if you're well aware of what you're getting into before making an offer on a foreclosed home.
· Liens and liabilities. Foreclosed properties may have liens from unpaid taxes or liabilities regarding the property title. These hassles can increase the paperwork burden and make the process of buying foreclosures more expensive. Fortunately, a little preemptive research and help you avoid these time wasters.
· Former homeowners. Sometimes the former owners of a foreclosed property are in denial and refuse to move out of the home. If you're the unlucky buyer, evicting them will be your responsibility. But again, doing research in advance and working with a professional real estate agent can obviate the situation.
· Property condition. Many foreclosed properties are in good condition in beautiful neighborhoods, but some are rundown and reflect the financial difficulties that the previous owners were facing. The latter require significant repairs and renovation, which is fine if you want a fixer upper, but it's not something you want to discover after purchase. Be sure to give the home a thorough inspection before buying it, so that you won't be unpleasantly surprised by leaky roofs and septic tanks after purchase.
· Different buying procedure. When buying a home in the foreclosure market, you'll find that you need to do more research and paperwork and exercise more caution than you would in a traditional real estate market, because foreclosed homes are sold as is, without any guarantees. But given the profit-making potential of these homes, the extra paperwork seems a small price to pay.