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Thursday, February 16, 2006

Money Magazine's Foreclosure Article

There is a fairly good article about foreclosure investing on Money Magazine's website. I tend to agree with most of what they say, although the article, like all mainstream articles I've seen about foreclosure investing, plays up the negative aspects of the industry. Unfortunately, there is also a huge mistake in the article, from a source that should know better.

Talking about buying at foreclosure auctions, the article says:

Auctions are by far the riskiest way to invest, says Rick Sharga, vice president of marketing at foreclosure listing site RealtyTrac.com. "You are buying the property sight unseen, and you will be responsible for any taxes, liens or second mortgages still on the property."
This is simply not true and Sharga should know better, given the company he works for. First, there is no need to buy a property sight unseen. Auctions are announced in advance and the properties up for sale are listed. It is true you may not be able to get into the property and do a complete inspection, but you do have the opportunity to at least look at the outside, possibly peer in the windows, and formulate an educated guess at to the condition - a far cry from "sight unseen."

Second, while you will be responsible for taxes (which are not an unknown amount - you can get any amount due from your tax collector's office), you are NOT responsible for any second mortgages or liens provided they were recorded after the mortgage that is foreclosing! A foreclosure wipes out all liens recorded after it (again, except for tax liens, which always must be paid). If fact, if you look at the liens against a property, you will never see anything titled "First Mortgage" or "Second Mortgage." There are just mortgages. The "first" or "second" designation refers to the date the mortgage was recorded. The one recorded earliest is the first, the next one is the second, etc.

If the first mortgage is foreclosing and you buy the property, you may have to pay some of the second mortgage if you agree to buy it for more than is owed to the foreclosing lender. For example, a property has $100,000 due on the first mortgage and $20,000 due on the second mortgage. You win the property at auction for $110,000. You pay $100,000 to the holder of the first mortgage and the remaining $10,000 to the holder of the second mortgage. That's it. You are not responsible for completely paying off the second mortgage because when the first mortgage foreclosed, all subsequent liens were wiped out. This is why second mortgages are riskier, from a lender's point of view, than a first mortgage - there is a possibility that they will not get paid off if the property goes to foreclosure. This also explains why sometimes the holder of the second mortgage will go to the auction to bid up the price of the property so that it is high enough to ensure he gets paid.

3 comments:

SLOMONEY said...

A good practice for foreclosure properties, is to get a preliminary title report from your title company. This will tell of any exceptions to title and any liens on the property. This will have a major effect on a property and what its worth.
~SLO Money

rsharga said...

Shaun:

Thanks for taking the time to outline the steps a prospective buyer needs to take in order to make sure they are making a "safe" purchase at a foreclosure auction.

My comment about auctions being the "riskiest" type of foreclosure purchases really needs to be taken in context, as it was one line during a much longer discussion with the Money magazine writer.

My intention was to alert potential buyers that the worst way to buy a property is to simply show up at an auction and start bidding. If the entire article had been about buying a property at an auction, we could have covered a lot of the details you mentioned, as well as some potential problems that you didn't (evictions, redemption periods, etc.); and even discussed bidding strategies.

If an interested buyer takes the steps you've identified and goes to the auction well-prepared, they will have mitigated much of the risk. For others, buying directly from the defaulted home owner during the pre-foreclosure phase, or from the bank after a property has been foreclosed on might be a better experience.

Shaun said...

Hey Rick! Thanks for clarifying your interview comments! I'm relieved to hear you know more than the Money article let on :-)

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