3 Stages Of CA Foreclosure: When And How To Score Big
I often get questions about if we “do short sales”, need to have cash up front when we buy, can buy on terms (creative financing), along with other questions that indicate to me that many people either do not have a general understanding of which stage of foreclosure we are currently buying.
Therefore, I think it is important to give a general explanation of how foreclosure works in California (most states are very similar), define the 3 distinct stages when investors can buy, and talk about the advantages and disadvantages of each stage.
We can begin with a general definition of “foreclosure”. As defined by Wikipedia, foreclosure is a “proceeding in which a bank or other secured creditor sells or repossesses a parcel of real property due to the owner’s failure to comply with an agreement.”
There are two broad categories of how foreclosures are conducted in the United States; judicial and non-judicial. California is a non-judicial foreclosure state, which means no court action is required to foreclose on someone’s property.
Rather, a trustee (a third party entity hired by the lender) is granted the “power of sale” by the borrower when the home loan is made. This means that this trustee has the right to sell the borrower’s property and use that money to pay the lender back if the loan payments aren’t made. Therefore, there are three parties involved in this process, the lender (beneficiary), the borrower (trustor), and the trustee (described above).
Of course, the lender cannot just sell the borrower’s property out from under them without due process.
…Foreclosure consists of three distinct phases. Any investor who plans on profitting from foreclosure should have a basic understanding of the three stages…
Let’s give an example:
Let’s say John takes a loan (incidentally, even though we loosely call it a mortgage, technically in non-judicial states they are called “deeds of trust” – in judicial states they are called mortgages). John borrows from Big Bank, Inc. to buy his house. After a year or so, John loses his job and can no longer make the payments. Usually after several months of missed payments, and many attempts to call John and try to work something out, Big Bank will decide enough time has passed and initiate foreclosure.
Stage 1-Buying Preforeclosures
The first step that is required by California law is to publicly record a “Notice of Default (NOD)” with the county recorder’s office. This is a public document that must include certain information such as the address of the property in default, the loan number for the loan in default, loan balance, and amount of payments behind. The NOD is sent to the county recorder’s office to be recorded (filed in a place where anyone in the public can look it up) by Big Bank’s trustee (usually a third party company that specializes in processing foreclosures). Click here to see an example of an actual Notice of Default:
www.farbelowmarket.com/sample-nod.asp
Once this document is recorded, John is now, “in foreclosure” (also known as “preforeclosure”). Big Bank can now take no action against John for 3 months- during this time John has the full right to make up his back payments and get caught up, but the pressure is on…this could be a good place to find motivated sellers! It’s a good chance to bail someone out of trouble and make a profit, win-win.
To find these homeowners, you can get copies of NODs by physically going to the recorder’s office. A far more convenient way to do this is to subscribe to foreclosure list company. This company compiles the information (do not confuse this with “free” or junk foreclosure lists). The data list we used for many years was from a company called County Records Research, but we switched to a brand new little known web based service called Foreclosure Radar this year. This service revolutionized the “foreclosure list” – and is more of an interactive website than a static list. Radar tracks every foreclosure in the state of California, maps it, provides and estimation of value, AND allows you to export the lists for mailings or to import into your database. It is a mindblowing website, and it is our preferred foreclosure service – it is also the least expensive. Others include Redloc, ForeclosureS.com, and Dataquick.
Here’s a link to Radar:
(Caveat: Even with the time-saving availability of list companies, I strongly encourage all investors serious about buying a foreclosure to visit the County Recorder’s Office for their county and browse foreclosures, deeds of trusts, and a treasure trove of other documents. It is the only way to really get a feel for how it works. Here is a link to all county recorder’s websites in California!:
http://co.el-dorado.ca.us/countyclerk/other_rec.html
To buy a property (it’s not a foreclosure, because the bank has NOT completed the foreclosure) at this stage, you would contact John by either sending mail, going directly to his house and knocking on the door, and/or researching John’s phone number and trying to contact him. You are “rescuing” John from foreclosure by paying off his back payments, and buying the house for a big discount from John.
I’ve personally extensively done all three (mail, door, phone), and I can tell you mail is very low percentage because the homeowner gets buried in mail from other investors, lenders, lawyers, etc. You must mail HUGE quantities of mail to make this work, and with the constantly rising price of postage, it can get pretty costly.
Second, you could go right to the homeowner’s home and knock on the door. Most investors don’t have the guts to do it…and yes, it takes a very thick skin! The borrower is often not in the mood to talk to you – but sometimes they couldn’t be nicer and just want someone to talk to, especially someone knowledgable in the foreclosure process. Obviously rapport building ability is the most important skill here. Still, the hit ratio compared to the amount of work doesn’t cut it for me (although a mail/door combo works better than either alone).
The system that was far and away the most superior for us from 2002-2005 was the telephone. After getting our system dialed in (no pun intended), I was able to reach a very high number of homeowners in a very short time. We managed to buy some amazing deals over that period of time.
Using online skiptracing services, the same services that collection agencies use (Accurint, Merlin), we would “track down” the homeowner’s phone number. Sometimes we would call neigbors, parents, even exes to find unpublished or cell phones! It was actually a very fun job, playing private eye for a living! By using the phone as leverage, we could contact far more trustors in a much shorter time than we ever could have by trying to knock on doors.
In the latter part of 2005 I noticed that it got increasingly harder to find a deal directly from a homeowner because there were fewer and fewer properties that were worth more than the loans! In 2006 it became VERY difficult, I was literally running out of homeowners to call. I increased my target area to three counties and I was still running out – I would literally sit there not sure what to do next! By the end of 2006 I knew our goose would be cooked if we didn’t change our approach.
There are a number of very well known “gurus” out there getting rich selling materials and bootcamps on how to make money buying from people in foreclosure. This leads me to believe they are not in the actual arena.
It’s a great stage to work, I did little but that for 5 years; we mailed every letter out there, knocked hundreds of doors, and called (or attempted) to call thousands of homeowners.
It worked great up until about a year and a half ago. I’m not saying that a great deal can’t be found, but I am saying that landing these kind of deals SYSTEMATICALLY AND REPEATEDLY when investors and lenders are swarming over the extremely few homeowners with equity…well, just do the math. If anyone out there is currently having success actually buying preforeclosures on a regular basis in this market (I am referring to So. Cal. only), I would love to know what I’m missing.
PROS
Terms, terms, terms!! With a couple thousand dollars for a deposit, we would have the owner deed the house to us right at the “kitchen table”. The house would usually have over $80,000 in equity. We would give them a promissory note for the rest and immediately take out a hard money loan for all our rehab costs! These weren’t “no money down” deals, they were “get $30,000 in your pocket along with house that is $80k-$100k below market” deals! It doesn’t get much better than that! When we sold the house, the homeowner would then get the rest of their money we owed them. Why would they agree to such terms?…because the foreclosure sale was usually within 3-4 days of our meeting.
Dealing directly with the seller - It is almost always easier to get screaming deals from seller then from brokers representing the sellers. It is easier to ascertain the seller’s real hot buttons, build rapport, and make offers face-to-face then through an agent. I think it is also more difficult for a seller to shoot you down face to face then it is through a representative.
Extremely motivated sellers
CONS
Title issues – tax liens, judgments, child support. They are all little bonuses that come with a house someone deeds you, so you have to be careful. You really need to be good at researching title – often no time for escrow or title insurance!
Legal minefield – need special contract language when buying from people in foreclosure
5 Day Cooling Off Period -After all your work they can drop out for 5 days with no questions asked
Liability- When they find out what you sold for, they could claim being taken advantage of. The media loves to hate unscrupulous investors, but I’m willling to bet there are just as many shady sellers!
My Rating On A Scale of 1-5 In The Current Market: 1.5.
Stage 2 – Buying At The Foreclosure Auctions
After Big Bank Inc. files the NOD, they are pretty much powerless for the next 3 months. When 3 months elapses, they must then file what is called a “Notice of Trustee’s Sale” (NOS). This means that Big Bank (technically the trustee on behalf of Big Bank) can now schedule a foreclosure auction to sell the property to the highest bidder. Big Bank hopes that an investor (or many) will show up to this auction and put a bid on the property that is high enough to pay back their loan. If the bid is high enough, Big Bank will get all of their money back, the investor gets the house, and other liens will get paid off, and if there is STILL any money left over, John the homeowner will get it.
This is one of the few methods neither Cindy nor I have ever used to purchase a property. In the 1990s when it worked well we didn’t really have that kind of cash. From 2000 to 2006 we were able to get MUCH bigger discounts going directly to the homeowners, not to mention those guys are hard core professionals. You will get your lunch eaten if you don’t know what you are doing. One of their favorite games is bid all the way up to market value just to discourage newcomers! There are other “tactics” used that I just won’t go into here – suffice it to say, they are an elite group.
So, the second stage where an investor can buy a foreclosure is by being the highest bidder at the public foreclosure sales. The investor must have all cash (usually in the form of cashier’s checks) at the sale.
PROS
Huge discounts
No messy negotiating with homeowners
Very little liability if any
Big returns – with higher risk comes higher returns
Great for adrenalin junkies!
CONS
Big cash requirements
Higher risk - bidders usually can’t see the inside of the house before paying cash for it!
Title issues
Evicting the homeowners
My Rating On A Scale of 1-5 In The Current Market: 3.5 if you have the cash to spare and want extremely aggressive buying (higher risk, higher return), 4.5 if are experienced.
Stage 3 – Buying From The Bank’s Inventory
If no investors show up to the auction, title to the house is then transferred to Big Bank via a “Trustee’s Deed”. This can be confusing because the security for the loan is called a “Deed of Trust”, but they are completely different.
The property then becomes what is know as Real Estate Owned (REO), repos, foreclosures, bank properties, lender inventory, etc. The loss mitigation department then usually contacts that bank’s broker/Realtor for that area to get the house cleaned up, listed on the market, and sold.
I don’t envy today’s bank brokers. They often have to deal with the homeowners who didn’t get the memo that the house is GONE along with some other pretty harsh conditions.
They sometimes have to remove debris, overgrowth, squatters (and much worse) before they can try and sell the property. They also have to do this out of their own pockets until the banks reimburse them. The brokers don’t make any money until the property sells, which we know takes a long time in this market, and the banks are not usually realistic about price.
We slowly started making offers on bank properties towards the end of 2006. We didn’t really start hitting it hard until January 2007, and we didnt’ get really good at it until May or June. We annoyed (understatement of the year) a number of brokers because we had to come in low, and almost none of our offers were getting accepted – so this had the effect of adding paperwork to brokers who were already over burdened and very stressed out.
However, I knew from watching REOs and seeing the data that we were in for it BIG TIME, and we kept the offers coming. We learned which properties worked the best, what we could get away with asking for (credit for repairs, closing costs, etc.), and we started getting some of our offers accepted in June.
We stayed vigilant because I knew it was a MATHEMATICAL CERTAINTY that the banks would become overwhelmed.
Sure enough, in August, our persistence started to pay off. We also developed relationships with the brokers (whose tune changed REAL fast when our offers started going through). Now they love us and every now and then call us BEFORE LISTING THE PROPERTIES!).
(By the way, I VERY often get asked if we can buy direct from the bank. It used to be that you could, but I have yet to hear ONE case of someone buying from the bank- it’s become very impersonal because of institution size and because of technology).
It is our contention that this will be the place to buy for the next 3-5 years (absolutely, positively for the next 2 years).
PROS
No title issues
Can take your time and thoroughly check out the property
Currently the most motivated sellers on planet Earth
Can sometimes use conventional financing
CONS
No terms
It’s like negotiating with a black hole – even the broker usually has no idea who they are talking to.
Red tape – we’ve had offers accepted THREE times now, and it took over a month for the bank to sign the acceptance!! We had cash, the property was dropping in value, and we couldn’t GIVE them our money! (one property was listed for $149k, and they countered us at $160k…????) they are basically a mess, but that can be a very good thing as well ; – )
My Rating On A Scale of 1-5 In The Current Market: 6!!
I hope this helps you have a grasp on the foreclosure game. I have found in all markets it is the best game in town. There are many avenues other than foreclosure buying i.e. “We Buy Houses” signs, direct mail to farm areas, vacant houses, etc., and we’ve bought houses with all of the above methods. But I would debate with anyone, anytime, anyplace, that the path of least resistance is where the greatest motivation to sell is, and right now that is the lending institutions.
Be Happy and Prosper,
Kurtis
