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 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 properties are also known as bank-owned or REO properties (Real Estate Owned by the lender).

Foreclosure Opportunities

Pre-Foreclosure:
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 the 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.

Next Step: How to buy a pre-closure

Public Auction:
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.

Next Step: How to buy via public auction

Bank-Owned (a.k.a. REO):
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 re-sell the property to recover the unpaid loan amount. The lender will typically clear the title and perform needed maintenance and repair; however, the discount for these REO homes is typically less than a pre-foreclosure or auction property discount. 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.

Next Step: How to buy an REO

Finding and filing properties
Develop a system to keep track of properties that interest you. A good tracking system is important since most pre-foreclosure buyers pursue many properties sometimes over a period of several months.

After you find a property online, it’s a good idea to drive by the property to get a better idea of the property’s condition and the type of neighborhood. For some buyers and investors, driving by the property facilitate a casual meeting with the owner or yields a wealth of unexpected information from a talkative neighbor.

Confirming pre-foreclosure status
When a property enters pre-foreclosure, the owner usually has at least 2-3 months to reinstate the property by paying off the amount in default. The reinstatement stops the foreclosure process, so it’s important to find out if a property has been reinstated before proceeding. The best way to check if the property has been reinstated is to call the trustee or attorney assigned to the foreclosure. The trustee cannot typically answer questions about the property; they can just let you know if the property is still in foreclosure or not.

Researching the potential bargain
Find out as much as you can about the estimated market value of the property, how much is owed on the property and if the owner has any other liens against the property. This is all public information and you can research on your own with the county recorder. This process should not take more than a day or two, because you don’t want to delay long before contacting the owner in default.

Contacting the owner in default
You or your real estate agent should initiate contact with the owner to express your interest in the property. Before you expend the time and effort to contact the owner, make sure you’re fully prepared to buy.

If the owner has decided to list the property for sale, you can simply contact the listing agent. Once the property is listed with an agent there may not be as much bargain potential, but you can still negotiate a good deal because you know the owner has a limited amount of time to sell before the bank repossess the property or sells the property at public auction.

In most cases, the owner has not listed the property for sale, so you will need to pro-actively contact them. In this case, contacting the owner can be tough, but the potential bargain is greater because you’ll be cutting out the listing agent’s commission.

Contact the owner by mail to start. The basic message to communicate to the owner is that you’re interested in buying the property and you want to work out a purchase agreement that benefits both parties.

Don’t be surprised if the owner does not respond to the mail immediately. In most states, the owner has several months between the initial foreclosure notice and the public auction. During this time the owner will consider all the options available, including refinancing or selling. An owner’s first reaction is usually not to sell. But if no other options work out, selling is a better option than losing the property at public auction.

Many successful pre-foreclosure buyers and investors send quite a few postcards to properties in their area before they find an owner who is interested. It’s not uncommon to send out several postcards to the same owner during the foreclosure process. The owner may be more interested to sell as the auction date looms closer. If the owner doesn’t respond to postcards, some buyers and investors will try to reach the owner by phone or in person. If you do this, be prepared for a possible rude response as these methods of contact are more inherently confrontational. And always keep in mind that the owner in default retains ownership rights to the property during the pre-foreclosure period. If they are not interested in talking with you, it’s time to leave.

If the owner rejects all of your contact attempts, you may still have a chance to purchase the property at public auction, which occurs if the owner doesn’t sell or pay off the amount owed during the pre-foreclosure period. You could also call the trustee periodically to check if an auction has been scheduled.

Negotiating a purchase agreement
Once you have made contact with the owner, you should meet with them for further discussion about the property. As part of this meeting, or a later one, you should arrange to walk through the property to make sure it meets your criteria as a buyer.

Because owners in foreclosure may not have the money to make repairs to their property, you might be willing to buy the property “as is.” But you still want to keep a tab of estimated repair costs and subtract them from your purchase offer. Your willingness to put some “sweat equity” in the property after you purchase it will increase the chances of realizing a good bargain.

If you and the owner both agree to proceed, you need to negotiate the terms of a purchase. These negotiations will involve you, the owner and the foreclosing lender. A real estate agent can be a valuable resource during the negotiating process.

If the loan in default is assumable, you may be able to pay off the amount in default and take over payments under the current terms of that loan. If not, you will need to pay off the full amount owed on the loan. If the property has other liens placed on it, you’ll need to make sure those are cleared out as part of the purchase agreement. If the owner has equity in the property above and beyond the liens, then you can offer to split the equity with them, allowing them to walk away with cash and you to acquire a property below market value.

Owners might be more willing to work with you if you are flexible to help them out in creative ways that address their situation. You could offer to let them stay in the house for a certain amount of time (possibly paying rent) until they find a new place to stay. You could offer to pay their housing costs for the first month or more after they leave the property. If you’re purchasing the property as an investment, you may let them stay and pay rent until you decide to resell the house. There are myriad ways to work out an agreement that benefits both parties. Remember, just selling the property during pre-foreclosure allows owners to avoid a foreclosure-marred credit history, making it easier for them to find a new place to live.

While negotiating the purchase agreement with the owner, you should also contact the foreclosing lender and any other lien holders. You want them to know you plan to purchase the property and satisfy any liens against the property. You also may be able to negotiate a lower payoff amount to satisfy the debts owed. Since you’re saving them the trouble of pursuing and collecting the debt owed them, some foreclosing lenders and lien holders will clear liens on a property for less than 100 percent of the amount owed. This is another way to realize a bargain during pre-foreclosure.

The goal for you as a buyer is to purchase a property at least 20 percent below full market value, although better deals are often possible. When determining the final purchase offer, you should also take into account the rate of real estate appreciation in the area and the potential for increasing the house’s value by making repairs and improvements.

Closing the deal
Once you’ve arrived at an agreement with the owner in default, the foreclosing lender and any other lien holders, you can put the agreement in writing. If you’re not familiar with how to draw up a purchase agreement, you should have a local real estate agent or real estate attorney help.

Any purchase agreement should make closing the deal contingent on a full title search conducted by a title company or attorney. The purchase agreement should also allow for a professional inspection of the property before closing the deal.

An escrow company, who acts as a third party, can manage the transfer of money and property ownership. Assuming that you have your financing secured, this should be a fairly smooth process.

Contacting the bank
You or your real estate agent should initiate contact with the bank to express your interest in the property. Before you expend the time and effort to contact the bank, make sure you’re fully prepared to buy.

At this stage of foreclosure it’s more likely the property will be listed for sale on the Multiple Listing Service (MLS), so make sure you or your agent checks the MLS. If the property is listed for sale, you can contact the listing agent directly. Keep in mind that the potential bargain often diminishes if a listing agent is involved.

If the property is not listed with a real estate agent, you’ll need to take some pro-active steps to contact the foreclosing bank directly. The bank’s main focus is not selling property, which means you may need to do some digging to find the department or person at the bank who manages repossessed property.

When you call the foreclosing bank, you should ask for the REO (Real Estate Owned) department, bank-owned homes department or asset management department. Be patient and persistent at this point because it may take some time to get through to this department.

If you have trouble contacting the bank by phone, another option is to overnight or fax a letter to the bank stating your interest in the property. Some buyers and investors include a check made out to a local escrow company to get the bank’s attention. This check is usually a small percentage of the total purchase price and should be refunded if no transaction takes place, but it shows you’re a serious buyer.

Negotiating a purchase agreement
Once you make contact with the bank’s asset manager or REO officer, you should arrange to walk through the property (with your agent if applicable) to make sure it fits your criteria as a buyer. If both you and the bank agree to proceed, you should start negotiating the terms of the purchase agreement. A real estate agent can be a valuable resource during the negotiating process.

If state law allows a redemption period for the owner after the bank takes ownership of the property, you may have to wait until the end of the redemption period – several weeks or several months, depending on the state. During the redemption period the owner can regain ownership of the property by paying the total amount owed to the bank plus any applicable foreclosure expenses.

The bank’s primary goal is to at least break even on all the costs that it has sunk into the property. That includes the unpaid balance of the loan, the expenses associated with the foreclosure proceedings, other liens and repairs to the property. Your goal as a buyer is to purchase the property below market value, minus any estimated repair costs. This is often possible if you contact the bank quickly and are a prepared buyer ready to make a purchase.

In the recent real estate market, buying directly from the bank has not been as profitable as buying during pre-foreclosure or at the public auction. That’s not to say there aren’t good deals available. And many buyers and investors prefer to buy directly from the bank because it’s typically a more predictable process than buying during pre-foreclosure or at a public auction.

You’ll probably get a better bargain if you’re willing to buy the property “as is,” meaning you’re willing to buy the property in need of repairs disclosed by the seller. Of course you’ll still want to figure estimated repair costs into your final purchase offer.

Banks may be more willing to sell at a below-market price if they have a glut of foreclosures, which are non-performing assets from their perspective. If you’re an investor or buyer looking for more properties to purchase, you should let the asset manager or REO officer know to contact you in the future if the bank needs to quickly unload foreclosure properties.