Foreclosure investing rises, but it isn’t for the squeamish

In May, RealtyTrac, a leading online market for foreclosure properties, reported that foreclosure rates were up 4 percent in April from March levels, but up 65 percent from April 2007.

There’s that old saying that one person’s misfortune is another person’s happiness. But in these troubled t

imes for the mortgage industry, those who consider investing in foreclosure properties should not only understand foreclosure and the importance of cash in the process, but the emotional element unique to this kind of investment. After all, each foreclosure represents someone who has lost a home.

With the rise in foreclosures, you’ll definitely hear more about how “easy” it is to invest and make a killing. But in reality, those who deal regularly in foreclosures know that making a profit can be tough, and that’s true even for with close ties to lenders and lots of experience. Here’s a look at the foreclosure process and how it works.

What is foreclosure? A foreclosure happens when a buyer defaults on their payments and the lender takes formal legal action to seize the property. Foreclosures have accelerated not only due to the economy, but because many homeowners couldn’t handle adjustable-rate mortgages that moved to higher payments than they could afford. State rules govern this process, but generally, when a lender decides to foreclose it files a notice of default or a lis pendens (Latin for “lawsuit pending”). This document is a public record, and for buyers it’s the first step in locating a property in foreclosure. A buyer can look online for properties in default, but it’s important to double-check these listings.

Do all troubled properties have to be in foreclosure to be sold? Actually, no. You will hear about “pre-foreclosure” or “short-sale” properties put up by lenders who have entered into agreements with homeowners who elect to give up the property to avoid a foreclosure on their credit report. You will also hear about such sales being done by intermediaries who claim expertise. Some are legitimate, some are not. Check them out.

How do people invest in foreclosure properties? First, you will see buyers coming in at the “pre-foreclosure” stage. Second, you will see buyers going after REO (real estate owned) properties still on a lender’s books. Third, you’ll see foreclosures auctioned at the courthouse or in private auctions, depending on how the lender wants to market such properties. Each process has its own conventions for inspecting the properties. Sometimes prospective buyers get time to inspect what they might buy, other times little or none.

Can I borrow to buy foreclosures? If you have to borrow money to buy foreclosed or other troubled properties, you might not want to get involved. While the typical purchase of a home involves mortgage financing that takes weeks to secure due to credit checks, the sale of foreclosure properties is typically a fast-moving process that requires no-strings financing. Bottom line, lenders like cash. There’s another good reason to enter this process with cash instead of debt. Even sophisticated foreclosure investors are often surprised by property with greater damage than they anticipated.

How do I educate myself? Start with some solid advice about your personal finances and your tax situation. A certified financial planner professional can help review your circumstances and how prepared you might be for this investment risk. Beyond that, it’s a process of learning how lenders deal with pre-foreclosure and foreclosure property and how public officials and private auction houses handle the auction process. Generally, this is knowledge that will take time to obtain. Be patient, take the time to study the process and don’t spend a dime until you do.

Erin Eddins is a chartered financial consultant and a member of the Financial Planning Association. Reach her at erin.eddins@standard.com or 425-212-5986. This column was produced by the Financial Planning Association and is provided by Erin Eddins.