What is 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 to during a grace period determined by 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 or by buying back the property at the public auction. These are also known as bank-owned or REO properties (Real Estate Owned by the lender).
This process allows for three opportunities for finding bargains on foreclosure homes.
Pre-Foreclosure (NOD, LIS):
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. The buyer has time to research the title and condition of the property and can realize discounts of 20-40 percent below market value.
Auction (NTS, NFS):
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.
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.
Before you buy
You'll need to make sure you're armed with the resources you'll need to find and buy foreclosed homes. You can start by searching free on RealtyTrac's foreclosure database, which includes pre-foreclosure and auction properties across the country and a nationwide bank foreclosures list.
Buying foreclosure properties at the Sheriff's Sale (or Auction as it's commonly known) is one of the best and quickest ways to make big profits in the distressed real estate business. However, it can also be the easiest way to lose.
The sale of a property comes at the end of the foreclosure process when the defaulting property owner cannot repair their financial problems with the lending institution.
There are 2 types of foreclosure, "judicial" and "non-judicial." In basic terms, the "judicial" process requires the lender to file a suit against the borrower and the "non-judicial" process does not. The judicial foreclosure is a much more lengthy process due to the restrictions and schedules set forth by the courts. For our purposes, we will focus on the "judicial" process since it is the method used in New Jersey.
The process starts with the mortgage document, a security instrument used to pledge the property as protection against the loan.
When a default occurs, the lender attempts to end the homeowner's rights of possession. The lender must file suit and prove in court that it has the right to sell the property to recover its loss by virtue of the default and as stipulated in the signed security instrument. If awarded a final judgment from the court, the mortgage company will proceed with the foreclosure process and the property will be scheduled for sale.
The properties are sold at public auction under the direction of the court in the county where the property is located. The winning bidder of this auction will receive clear title to the property (excluding taxes owed and other municipal liens, more on this later). About 80% of the time the successful bidder is the lender, the original mortgage holder.
Attorneys are usually there to represent the lenders in the bidding process. Get to know these attorneys because they can provide you with the judgment amounts and other information before the sale, giving you extra time to plan your strategy. There will also be investors, onlookers and other curious individuals observing the proceedings.
Occasionally, a lien holder of the property will appear trying to salvage what they can from their remaining interests. Rare but certainly possible, the homeowner may show up to bid on their own property. Remember, the owner has 10 days to redeem the property for the full judgment amount. In the event of redemption, all prior liens will become active again. In other words, it's like reversing the foreclosure process; you're back to where you started with only the foreclosing lien holder paid off.
The biggest reward to buying properties at the Sheriff sale is the high profit potential. If there is a substantial difference between the fair market value of a property and its final judgment amount at sale, you can really win big. Typically, the largest monetary rewards will come from the proper application of this investment method.
Sales are usually advertised 4 - 6 weeks in advance. In some counties, this information may be available 6 - 8 months or more before the sale (tip –information available this far in advance can drastically differ from the properties that eventually end up at sale because the owners are only 3-4 months behind at this point and it is relatively easy to cure the default). By the time they reach the sheriff's department you have at least 1 month before the sale.
In New Jersey, all owners are entitled to 2 adjournments for a period of 2 weeks each. The owner can take them all at once or in 2 separate intervals, usually giving you 2 months from the publication/release date to do your research.
You will need to research the property, the condition of the loan and the condition of the owner. Why the owner? If you can work out a satisfactory arrangement with them, you might be able to save yourself the trouble of going to the auction. If you meet with the owner and cannot work out a deal, take careful note of the property's condition while you are there. This will give you a competitive advantage over other bidders at the auction.
You should go to the courthouse and observe the process a few times before going to bid on your property. It's certainly a good idea to familiarize yourself with the local auction process.
For instance, certain counties do not announce the judgment amounts of their properties and if you are not careful, you might end up paying over the amount necessary to purchase.
Buying at the courthouse can be very dangerous for those who do not do their research properly.
The large cash outlay required to buy the property is the biggest deterrent for most potential bidders. Certified checks and sometimes cash will be required to bid on these properties (call ahead to find out details).
Generally, you usually have to pay off the sale amount within 30 days from the date of purchase. You may not be able to inspect the property before bidding on it. In this case, there is little chance you will be able to assess the property damage and replacement costs. This ends up hindering your ability to determine true market value, maximum bid amount and potential future profit.
If you happen to be the successful bidder, you may have to evict tenants currently residing in your new property. This could take several months (typically 3-4 in New Jersey). This also interferes with your plans to repair and quickly sell the property for a profit. This delay increases your carrying costs (monthly payments and other bills) and erodes your profits.
At times, there may be land use problems with a property such as zoning or environmental issues like petroleum contamination or toxic waste. A clue to avoiding a problem property is when the lender's representative fails to appear or bid on the property. If the lender does not want it, then you do not want it either.
Failure to research properties leads to over-biding at the sale. Too often properties are purchased for much more than their value. This, accompanied by the tendency to get caught up in the heat of the moment and over-bid, known as ‘'auction fever'', results in large over-payments and even larger future losses.
Your most important concern should be the possibility of other liens or judgments. As the successful bidder, you replace the homeowner's position in the property. Any municipal liens and previously owed taxes will also have to be paid. (The foreclosure process wipes away all secondary liens such as mortgages and judgments except for taxes and specific municipal liens)
Make sure you listen to the announcements being read by the representative for the lender. The announcements typically have all owed taxes and municipal liens that are included with the sale. If a lien shows up that you were not aware of, you might change your maximum bid price at the last moment.
The first mortgage holder is not the only one who is foreclosing properties. If a third lien holder forecloses, the process will not wipe out the first and second lien holders. Buying this property means you buy these liens as well. Typically, first mortgages are the largest liens on properties.
The only way to be sure that this is a first mortgage holder foreclosing is through a full title search. The cost of the search is minimal compared to the potential loss from not investigating the condition of the title.
Evaluate the properties and determine their profit potentials. Do this by determining the market value using comps, appraisals and brokers' opinion of price. Call the local tax collector to find out if there are any taxes owed or even tax liens on the property. Find out if the town also provides water/sewer. If so, inquire about outstanding bills. Subtract the final judgment amount, taxes and municipal liens from the market value. If there is a significant difference, you may have a winner.
Inspect the property if you can and assess any damages or repairs you might have to make before re-selling the property. Deduct those expenses from the profit you calculated earlier.
Calculate your profit potential by starting with the price you can sell the property for in its final condition. From this amount subtract any repair expenses, costs you will incur while holding the property (loan payments, taxes, insurance), closing costs you will incur when you sell the property, the broker's commission if you intend to sell your property through a broker and other taxes and/or municipal liens.
Your sub-total so far, is your expected sale price of the property known as, the "net to you" after you sell.
Deduct the default or final judgment amount from your last sub-total. This is your gross profit potential, hypothetically the most you can make assuming all goes well.
Determine your maximum bid amount. The lowest you can bid is the final judgment amount. The highest you bid is the ‘"‘net to you'"‘ amount. Any amount over that break-even point results in a loss. Determine the minimum profit you want to make and then subtract your desired profit amount from the ‘"‘net to you'"‘ figure. That is your maximum bid amount.
Going to the Sheriff's Sale or Foreclosure Auction
Prepare for the auction by phoning ahead to find out any details and to make certain that the sale hasn't been postponed. Determine the requirements for purchasing properties, how much deposit is needed, when the balance is due and what type of payment is required.
Attend the auction and arrive early. Properties are sold very quickly, sometimes within minutes. Pay attention and register yourself as a bidder if necessary.
Listen carefully for your target property to be announced for sale. Observe the bidders. Know your competition. Do not announce your intentions to anyone there. Never bid more than your pre-determined amount.
The successful bidder will receive a deed, the type of which depends on who is conducting the sale and state law. Record your new deed and obtain title insurance as soon as possible.
Remember to research properties and their liens thoroughly. Calculate your expenses and profit margins. If you cannot inspect a property, leave yourself a little extra room and some extra cash.
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