Real Estate Note Investing: Foreclosures
Let’s start by really understanding the foreclosure investsing process because this is where things get a little bit nuanced. And if you’re buying or plan to purchase non-performing loans or NPLs, this single lesson will equip you with the knowledge that typically takes investors years to learn. In 2010 I began learning a great deal about the foreclosure process and how it differs across the US from state to state. I was working on a portfolio of roughly 12 hundred NPRs, and I needed to understand the status of every foreclosure in that portfolio that we had just purchased. It consisted of personally calling dozens of foreclosure firms across the country and talking to attorneys about the cases.
Let’s start by really understanding the foreclosure investing process because this is where things get a little bit nuanced. And if you’re buying or plan to buy non-performing loans or NPLs, this single lesson will equip you with the knowledge that typically takes investors years to learn. In 2010 I began learning a great deal about the foreclosure process and how it differs across the US from state to state. I was working on a portfolio of roughly 12 hundred NPRs, and I needed to understand the status of every Foreclosure investing in that portfolio that we had just purchased. It consisted of personally calling dozens of foreclosure firms across the country and talking to attorneys about the cases.
I can’t tell you how valuable this activity was in terms of understanding the nuances of the foreclosure process. I discovered a lot of reasons why foreclosures get put on hold or even canceled. I found which types of files have a higher probability of the borrower filing bankruptcy at the last minute. And I learned effective bidding strategies as a lender taking a loan to a foreclosure sale. This is key to optimizing the proceeds when a third party buys the property at auction. With that being said let’s talk about the differences between judicial and non-judicial foreclosures.
Foreclosure is the action of taking possession of a mortgaged property when the borrower fails to keep up on their mortgage payments. A Judicial Foreclosure involves filing a lawsuit, which is done in civil court to obtain a judgment against the borrower. This includes the right to foreclose against the property and force its sale. Judicial Foreclosure is typically more expensive than a non-judicial foreclosure and generally is more time consuming as well. A judicial foreclosure may also provide what’s called a right of redemption after the property is sold at auction. This allows the borrower to repay the lender after the foreclosure sale within a specific timeframe. That timeframe varies from state to state but is typically six months or less. This allows the borrower to reacquire title to the property.
Now let’s cover some basics on non-judicial foreclosures. A non-judicial foreclosure involves what’s called a Notice of Default or a NOD. A NOD is sent to the borrower by the lender’s foreclosure attorney. The NOD indicates the borrower is in default on their loan and outlines the time in which they have to cure the default. If the borrower fails to cure the default, the property is noticed for sale. The successful bidder at the foreclosure sale will now own the property. That successful bidder could be a third party investor, or it could be the lender. At this time title is also conveyed from the trustee to the new owner through a document called a trustee’s deed. If there are no bidders at the trustee sale, the property reverts or comes back to the lender, and the property is then considered real estate owned or REO.
The country is somewhat divided with most judicial states in the East and most non-judicial states in the West. There’s also a fair number of states where both types of Foreclosure can be conducted: judicial and non-judicial. Like all exit strategies, there are pros and cons to foreclosing. In some cases the best outcome is to modify the loan and get the borrower back on track which we’ll cover in another lesson. There are other times when the Foreclosure is the best option for both the lender and the borrower. When a borrower can no longer afford the obligation of the mortgage (and taxes, insurance, maintenance, etc.), there is something to be said about getting out from under that burden, which creates an opportunity for the borrower to start fresh elsewhere.
That’s easier said than done. Some borrowers don’t always see it that way, and sometimes the Foreclosure is the only option for the lender because the borrower can’t or won’t pay. It’s essential to be aware of the stall tactics used by borrowers to delay or stop the Foreclosure. As concerns over predatory lending practices grew over the past decade, the courts began to sympathize with borrowers, and there was a rise in what’s called foreclosure defenses, which challenged a foreclosure investing. Contested foreclosures can be extremely costly to the lender, and you should approach those with caution. I had a client that spent over two hundred thousand dollars on legal bills just fighting a single borrower. It took him four years in Florida. There were a lot of reasons a borrower can contest a foreclosure, disputing a payment history is one of them. This basically consists of the borrower questioning the proper application of their payments.
Another borrower dispute has to do with compliance. When a loan is sold, the borrower must be notified of the change in ownership through what’s called a Truth in Lending Act letter or a TILA. A defense used by some borrowers is to suggest they weren’t properly notified with this letter, and there are also ways a borrower can suggest flaws in the foreclosure summons. A borrow or their attorney might argue that the note was lost and that the lender doesn’t have standing. Standing refers to having a sufficient stake in the outcome in this case to foreclose.
A temporary restraining order or TRO is another way to contest a foreclosure. This is a process undertaken by a borrower through a judge, which stops the lender from foreclosing. It can often be followed by the borrower actually suing the lender. Now a qualified written request or QWR is when a borrower requests correspondence from the mortgage servicer. The communication generally asserts that the servicer made an error often with respect to applying for the mortgage payments. Bankruptcy is yet another way to block Foreclosure.
So we’ve covered a lot of information about foreclosure investing in this lesson. Let’s recap. The foreclosure investing process is complex and nuanced. Judicial foreclosures can be costly and time-consuming, especially compared to non-judicial foreclosures, and lenders should be familiar with a host of foreclosure defenses and look for ways to limit lender liability.
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