FFORTUNES IN FORECLOSURES                                                                                             By                                                                                David A. Chodack Yes, there are fortunes to be made dealing in Foreclosures and other distressed properties. The whole idea of Foreclosures is to buy properties for less than their true market value, preferably a lot less.      By definition, Fair Market Value is established when a willing Buyer and a  willing Seller, neither one acting under undue pressure, agree on a price. Well, a Seller facing foreclosure or some other type of distressed sale is automatically under pressure. Therefore, Fair Market Value goes out the window and a Fair Price is whatever you can negotiate. There are pitfalls to buying Foreclosures and Distressed properties, though. Like anything else, you have to know what you are doing and that's what this manual is all about. First of all, what state are you in? There is no such thing as a national foreclosure law or policy. Each state sets its own rules and they vary. Therefore, the first thing to do is to familiarize yourself with the rules and regulations in your state. MORTGAGE OR TRUST DEED First of all, is yours a Mortgage state, or a Trust Deed state? In states where they use mortgages, a lender must go to court and get a judge's order  in order to foreclose on a property. In some states, this is a fairly simple, automatic process. In other states, it can take months or even a year or more. Obviously, the more time a property owner has, the less pressure he will feel to sell quickly. Therefore, you want to know how long it takes in your state and what the exact procedures are. How much pressure is the property owner under? In some mortgage states, the property owner even has the right to redeem the property after the foreclosure. You might buy a property in foreclosure and have to sell it back to the original owner - at a profit, of course - if he wants to redeem the property within a specified period of time after the foreclosure sale. Naturally, this can take a lot of the pressure off a property owner. If he/she feels that he/she can get the property back even after the foreclosure sale, then he/she may not feel quite as desperate, so you want to know the full situation. In Trust Deed states, Foreclosure is an automatic, non-judicial process. The formal title to the property is held by a Trustee, appointed by the Lender, until the Borrower, or Property Owner, has paid off the Trust Deed. If the Borrower defaults on the loan, then the Trustee can foreclose without going to court. They don't need a Judge's approval and the entire process takes about four months from start to finish. There is no Right of Redemption, either. Once the property is sold at a Foreclosure sale, that's it. It's gone. The owner will probably never get it back. If they want to, they have to cut a private deal with the Buyer. The Buyer is under no obligation to sell it back to them. This puts tremendous pressure on the property owner. Once the property actually goes to Foreclosure, it's gone, along with any equity the owner may have built up.. EQUITY This brings us to the next important question: How much equity is there, if any? If there is no equity, then why would you want the property? For those of you who may not be familiar with the term. Equity is the difference between the amount  the  property owner owes - including any late fees, penalties, Foreclosure fees, back payments due, etc. - and the Fair Market Value of the property. This is what it's all about. This is what you are after. If there is not enough Equity in the property, then walk away and find another one. Don't waste your time. The whole point of buying Foreclosures and Distressed Properties, is to pick up free Equity, to be able to turn around and resell the property for an immediate profit,, or to be able to rent it out and sit on it for a while until it increases in value and builds even more Equity. For example, if a  property owner owes $70,000 against the property and the Fair Market Value is $100,000 - that's what you should be able to sell it for - then there is $30,000 Equity in the property.. This does not mean that you will make a $30,000 profit if you turn around and resell it.  This is a common mistake which many novice investors make. You are going to have sales-related expenses. Either you will have to pay a real estate commission or pay for advertising if you want to sell the property yourself. You will also have Closing Costs when you buy the property and again when you resell it.  all together, these costs could end up eating as much as $10,000 or more, of that $30,000 Equity. Therefore, you have to figure in the costs, before deciding whether you really want to buy the property. THREE STAGES OF THE FORECLOSURE PROCESS The next question you need to ask yourself is when you want to try to buy the property. There are three distinct stages to the Foreclosure process. Each one requires a different strategy and approach. THE PRE-FORECLOSURE STAGE This is when you have to deal directly with the property owner. He/she knows he/she is in trouble. Maybe he/she is behind in his/her payments and/or property taxes. Maybe he/she has received formal notice from the Lender or the Trustee that  the Foreclosure has begun or is about to begin. But, at this point, the property owner is still in control and has a chance to sell the property before it's foreclosed on. This means they can still save their credit rating and possibly, even save some of their Equity. For example, if the property is worth $100,000 and they owe $70,000, they might try to sell you the property for $75,000 or $80,000. They can also avoid the negative consequences of going through foreclosure this way. Your job is to try to get as much of that Equity as possible, for yourself, by paying as little as possible for the property. But how do you even find out about property owners who are in trouble but haven't yet been foreclosed on? There are several ways. First of all, Foreclosure is a matter of public record. Once the property owner falls behind in the payments and the Lender or Trustee wants to start the Foreclosure Process, they must send a Notice of Default. This is a notice that the property owner has violated the terms of the Mortgage or Trust Deed agreement and must cure the default or face Foreclosure. This document gets recorded and is available for viewing in the public records. You can go down to your county court house and search these records for Notices of Default which interest you. The notice will tell you the address of the property, the amount of the loan being foreclosed on, the Lender or Trustee involved and how much the property owner owes in back payments, late fees, Default fees, etc. This is the amount which must be paid off to cure the Default and stop the Foreclosure process. Once you have the Notice of Default, you can try to contact the property owner directly. In some cases, you will find that the address listed on the Notice of Default is a mailing address only, such as Post Office box. Other times, it will be the property address, or a different address completely. If all you have is a mailing address then you have to try to contact the Property owner by letter. Be straightforward and tell them what your are interested in. They already know they are in default, so you don't need to waste time telling them that. Get to the point. You want to buy their property before it is foreclosed on. If you have a real address to work with, you might try contacting the property owner by phone, or even in person, bunt be discreet. Put yourself in the property owner's position. The chances are, you will not be the only one contacting them and so they may not be happy to hear from them, even though you feel you are bringing them good news. Be polite and upbeat and stress that you want to help them and give them a fair deal.  If they're not interested, then move on to the next property and maybe leave them a card or some way to contact you if they change their mind. THE FORECLOSURE SALE If you can't cut a deal with the property owner, then you can always wait for the foreclosure sale. This too, is a matter of public record and by going back to the county courthouse, you can find out when and where the Foreclosure sale will be held. It has to be in a public place, or at least a place which is accessible to the public, usually the court house steps (Literally) or the Trustee's office. There are a couple of advantages to waiting until the foreclosure sale and the main one is that any Equity the property owner had, is wiped out.  The Lender or Trustee is under no obligation to sell the property for a high enough price to save the property owner's Equity and no incentive to do so. The Lender can not make a profit at the Foreclosure sale. The Lender can only recover any money owed, including principal, back payments, late fees, Foreclosure fees, etc. Any excess goes to the property owner. This means you might be able to buy the property for the $70,000 which is owed, plus the fees. This may be less than you would have had to pay the property owner before the Foreclosure Sale. The bad news about buying at the Foreclosure sale is that you have to pay in cash and you may not really know what you are buying. The cash is what scares away a lot of prospective buyers. Not too many people have the kind of cash needed and most Lenders won't even consider a loan until you take title to the property. The answer for many investors, is to borrow money short term, anywhere and any way they can and then get a mortgage as soon as they do have title. If you are really getting a good deal on the property, then this should be relatively easy to do, because you will have plenty of Equity. The real challenge when you buy property at the Foreclosure sale is to know how much Equity if any, you are really getting. More than one naïve investor has been shocked and disappointed to find out that they had really bought a Second or even Third mortgage at a Foreclosure sale and so instead of getting a free and clear property with lots of Equity, they have bought a property encumbered with loans that they are responsible for. HUH? The way this works is really quite simple. When someone buys a property and takes out a loan, this is known as the First Mortgage and it is recorded as a lien against the property which must be paid off before the property can be sold. Then, once they won the property, they may decide to tap some of their Equity, by taking out a Second or Third (or Fourth, Fifth, etc.) These loans are known as Junior Loans and they are subordinate to the Senior Loan(s) What this means, is very simple. The property owner has a property has a property worth $100,000 at Fair Market Value. He/she has a First Mortgage for $70,000, but then he/she also has a Second loan for $10,000 and a Third Loan for $5,0000. You see a Foreclosure sale notice. It tells you there is a $5,000 mortgage against the property and the Lender or Trustee is foreclosing because of non-payment. With back payments and penalties, the Lender is owed a total of $7,000. Wow! You get all excited. The property is worth $100,000. The Lender is only owed $7,000. That leaves about $93,000 in Equity. You are even more excited when you are the only bidder at the Foreclosure sale and get the property for $7,000! But then your joy turns to grief, as you learn that you are now responsible for that $70,000 First loan and the $10,000 Second loan. They did not go away just because the Third loan foreclosed. The former property owner may have been making his payments on those loans and so they are not in Default - or maybe they are about to go into Default and just haven't done so yet) But in any case, the First loan and the Second loan are both ahead of the Third loan and so they stay with the property even after the Third loan is Foreclosed on. Suddenly, your great deal is not so great anymore. This same principle applies to IRS sales, Sheriff's sales and other Distressed property sales. You are bidding on the property subject to any existing liens and mortgages. The one exception to this rule, is Property Tax sales. These wipe out all existing liens and mortgages and convey free and clear title. The reason for this is simple. Lenders are presumed to have direct control and responsibility for whether or not borrowers pay their property taxes. In fact, almost every mortgage has a clause giving the Lender the right to Foreclose if the Borrower does not pay the property taxes and maintain insurance. On the other hand, there is no way that a Lender can force a Borrower to pay his/her income taxes or avoid law suits and judgments, any more than Lender can stop Borrowers from taking on Junior loans. Therefore, the Buyer must beware and do his/her homework and know what he/she is buying. The simple way to get around this, is to do your homework. Go to the Courthouse research the property and find out what liens are against it and which loan is Foreclosing before you bid. Finding out which loan is Foreclosing is the real key. Since the Third loan is subordinate to the First and Second loans, it does get wiped out if one of them forecloses. In other words, if that property has three loans and it is the First loan which is foreclosing, then you might really get that property, free and clear of encumbrances, for only $70,000, plus any back payments and fees. You don't have to worry about the Second or Third loans. It is just as if they did not exist. This is the chance people take when they loan money for Junior mortgages. This is why they usually charge more money. Assuming that it is the First loan which is foreclosing, then you may be able to buy that property for $70,000 plus any back payments, fees and charges, but don't expect to get it for less than that. If no one bids the minimum amount needed to pay off the loan, the back payments and fees, then the lender will take over the property and this gives you the third opportunity to buy it. THE POST-FORECLOSURE SALE - REO'S When Lenders can not get anyone to bid the minimum at a Foreclosure sale, they take the property themselves, for the amount of the outstanding loan, plus any back payments, fees, etc. and the property becomes what'' known as an REO, or Real Estate Owned by the Lender. It is now the Lender's property to be resold at a profit if possible. Now, you might wonder how the Lender is going to sell a property for a profit after the Foreclosure sale, when they couldn't even get anyone to buy it for their cost at the Foreclosure sale? The answer is simple. Terms. The Lender is now free to sell on any reasonable terms. The Lender doesn't have to be all-cash any more, in fact the Lender can sell the property for no money down, just to get rid of it. Lenders generally don't like to carry REO's on their books, so many times, they will be flexible with the terms. The key is to convince them that you are a responsible borrower. The last thing a Lender wants is to sell the property - at any price and terms - and then have to take it back a second time. Therefore, if you go to see a Lender about REO's, be prepared. Bring your financial information with you. Find out as much as you can about that particular Lender and their overall portfolio of REO's. Many times, you can wind up getting the property you want at the terms you want, simply by offering to take one or more REO's  that they don't want as part of the package. The more you know, the stronger your position will be. One investor I know goes out to see every REO a lender has within a hundred mile area. She takes pictures and detailed notes. Then when she goes to negotiate with the Lender, she is armed with facts and figures and pictures to show the bad condition of some of the properties. It's a lot of work, but she makes more than $1 million a year doing it. PROFITING FROM THE PROPERTY Finally, we come to the big question. You bought the property, now how are you going to profit from the property? Are you going to sell it for a quick profit? Are you going to hold it for a rental? What are you going to do? Too many  investors have found out the hard way that owning property doesn't automatically make you rich. You have to either sell it or get an income from it. Again, this means doing your homework. What is the Resale market like in your area? Is it a Seller's market, or a Buyer's market? What is the Rental market like? What are the chances of getting a mortgage that will cash you out, so you can hold the property without keeping any of your own cash tied up? What are the chances of renting the property for at least enough to cover the payments? These are all things you should know before you even start looking at Foreclosure properties and one other thing we haven't even mentioned and that's the condition of the property and what it will take to rehab it. Almost all Foreclosure properties will need some type of work. The only question is what kind of work, how much it will cost and how long it will take to do it. The longer it takes, the longer the property will be sitting vacant, unsalable and unrentable, costing you money. It all comes down to numbers. Either they work or they don't. You buy the property for $70,000, plus $3,000 in Foreclosure fees and Closing Costs. You need to spend another $5,000 and a month fixing it up. That brings your total cost for the property to $78,000 plus one months' rent. If you resell it , you will have another $1,000 in closing costs, so at $80,000 you won't have a $10,000 profit, you will just about break even.  Anything over $80,000 is your profit. The property was worth $100,000 when you bought it at the Foreclosure sale. You put $5,000 and a month's worth of work into it, so it should now be worth at least $110,000. If not, you wasted your time and effort.  You sell the property for $100,000 and get a quick sale. In the worst case scenario, you pay $6,000 commission and $1,500 in closing costs and still walk away with $12,500 profit. Or, you take out a loan for $80,000. Your payments with taxes and insurance are about $800 a month and rent the place for $1,000 a month   It's all possible when you do your research first. No, you won't get rich on one property, although you will occasionally run into the $100,000 property you pick up for $20,000 or $30,000. You are going to get rich buying many properties. It's not a get rich quick scheme, just the best business in the world.