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Sophisticated real estate investors will pound the pavement for home foreclosures. Here, the thinking is that properties may be bought for pennies on the dollar, rehabilitated, and rented out or sold off for big profits. Easier said than done.

Mortgage Default

A mortgage is secured debt, with underlying real estate being collateral. Bankers and municipalities may foreclose upon, or seize, property and auction it off to make good on unpaid mortgage and property tax payments.

Mortgage payments are typically due on the first of each month – with a subsequent 15-day grace period. The foreclosure process begins when the grace period expires – without the homeowner remitting full payment to the lender.

After 90 days, the banks will serve a notice of default to homeowners. At this stage, borrowers may still renegotiate terms and payment plans to avoid foreclosure and keep the home. Next, a notice of trustee’s sale is posted prominently on the property, if another 90 days pass without payment. The property is now foreclosed.

The Three Stages of Foreclosure

Real estate investors adjust strategy according to the three stages of foreclosure. The foreclosure process begins at mortgage default.

In pre-foreclosure, the mortgage loan is in default, but the home has yet to be seized. The pre-foreclosure stage lasts for six months, and distressed homeowners will be open to make a deal. Pre-foreclosed homes will be priced to sell at small discounts, while still remaining in good condition. A short sale is also a possibility here if the bank agrees to accept less money than is owed on the mortgage.

Banks and existing homeowners might also negotiate loan modifications that call for lower principal balances, interest rates, and payments than terms of the original mortgage. The home will be auctioned off if no sales or payment arrangements are made through pre-foreclosure. Aggressive investors will mine for deep discounts 20% off market value if they bid cash on property as is and sight unseen.

After the auction, the bank will repossess unclaimed property as real estate owned (REO) holdings. You would then make an offer and close the deal directly with the bank, as a prospective buyer. REO properties are also sold at steep discounts.

Banks are motivated sellers and would rather concentrate upon their core business of taking deposits and making loans, instead of holding real estate.

Financial Risks Versus Rewards

Home foreclosure deals are high-risk and high-reward transactions. Expect foreclosed homes to be in total disarray. Homeowners who default on loans will also lack funds to pay for regular maintenance. Upon eviction, these same former homeowners may immediately become belligerent and damage the home before neighborhood scavengers break in to strip out everything of value.

The speed of the real estate auction format does not allow for proper due diligence. To move quickly, you will likely buy property in cash, sight unseen.

Now, general contractors may estimate a spend of tens of thousands of dollars, so that the home is simply functional and livable again. Expect for quoted repairs and upgrades to run significantly over budget and over time. As a landlord, you will be losing even more money, for every month that the property remains vacant.

Still, seasoned investors may turn outsized profits by exploiting the inefficiencies of a fragmented housing market. With a list of foreclosed properties in hand, prospective buyers should walk neighborhoods at different times of day to assess the area and research comparable sales before putting in a competitive bid.

For real estate, knowledge begins at the local level.