Buying a foreclosed home can be tricky

Question: My wife and I have learned much from your column over the years. Thank you. We have questions regarding purchasing a foreclosed home.

We made an offer on a home before foreclosure and it was declined. Apparently our offer was not enough to pay off all lien holders. The home is to be auctioned on the courthouse steps in a few weeks, and we offered them the opening bid. We have read that the home will become (real-estate owned) if no one bids on it. Does that mean all lien holders fall away and only the bank remains? Would the bank be more open to our original offer after the auction? Why didn’t the bank counter? Is it because of the other lien holders? What is the process from the bank’s point of view.

We want to buy in this market and get the best deal possible. We still want the home, but do not want to bid on the courthouse steps. Can you shed more light on buying foreclosed and pre-foreclosed homes?

J.S, Camano Island

Answer: As reports of the increasing foreclosure rate around the country continue to appear in the news, more and more people will start thinking about trying to get a “steal of a deal” by buying a home from a homeowner who is in foreclosure.

I don’t watch much late-night TV these days, but it’s only a matter of time before the “Get Rich Quick” guys dust off their old “Buy Foreclosed Homes for Pennies on the Dollar!” infomercials again — if they haven’t already.

But it’s much harder to buy a home in foreclosure at a bargain price than they would have you believe.

As your letter points out, most homes in foreclosure are “over-encumbered.” That means the homeowners owe more on the house than it is worth. This is a very common problem because back payments, penalties and accrued interest charges are added to the mortgage loan balance; and there are often second mortgages and other liens on the home as well.

And to make matters worse, home values are dropping. Many homeowners, especially the ones who recently purchased their homes with little or no down payment, have seen the equity in their homes totally wiped out.

That’s why it is very, very difficult to find a good deal on a home during the 90-day “pre-foreclosure” period that takes place between the “Notice of Trustee Sale” and the foreclosure auction on the courthouse steps.

You might have to look at more than 100 more homes in pre-foreclosure before you found one that had enough equity left to make sense as a buying opportunity.

When a home is sold at the foreclosure auction, the liens are paid off in the order that they were recorded against the property. For example, let’s assume a $300,000 house in foreclosure has a $280,000 first mortgage balance due (including late payments, fees and interest), a $20,000 second mortgage balance, and $15,000 in other liens. That’s a total of $315,000 in liens on a house that is worth only $300,000 at fair market value.

At the foreclosure auction, the lender holding the first mortgage makes an opening bid equal to the total amount it is owed. In the example above, that would be $280,000.

If nobody else makes a bid on the house, the lender gets the house for the total balance owed and the “junior lien holders” get nothing. Their liens are wiped off the property records. If somebody bid the price up to $300,000 then the first and second mortgage ($20,000) holders would be paid off, but the last lien holder would be out of luck.

Now, here’s the catch: If you want to go to the foreclosure auction to buy the house for just over the opening bid (assuming no other investors are there to bid against you) you need to have the full purchase price in cash on the spot! There’s no time to run out and get a new mortgage to buy the home. That’s why only professional investors typically show up at the auctions.

Your best bet is to contact the bank right before the foreclosure auction and tell them you will buy the house for a little over their minimum bid price if they end up getting the house at the auction.

Now keep in mind that banks are not stupid. They are not going to sell the house far below its fair market value. They have real-estate owned (REO) departments whose job is to fix up and sell the properties that they take in foreclosure and get the maximum value out of them. They typically list the homes for sale with a real estate agent.

You might be able to convince the bank to give you a bit of a discount by arguing that you will save them the time and expense of marketing the home with their REO department.

But don’t be too disappointed if you miss out on this deal. This is a buyer’s market with home values dropping and the number of homes for sale increasing as the weather warms up. There should be plenty of good deals on the market this spring and summer without having to resort to buying a home in foreclosure.

Mail questions to Steve Tytler, The Herald, P.O. Box 930, Everett, WA 98206 or e-mail to economy @heraldnet.com.