The advantages to buying properties from homeowners in default can only be measured by the individual buyer. Some do not see enough reward, some think it's too risky, while others are plagued by moral issues. Are you helping the troubled homeowner or taking advantage of his misfortune?

Both the lender and the homeowner lose in a foreclosure action. Neither want it to happen. Both parties are motivated to resolve the situation. Motivated parties are key to the process.

The investing window of opportunity opens the day the Notice of Default (or Lis Pendens, depending on the state). This is the notice of pending foreclosure proceedings. The window closes the day the property is sold at auction. The time between these two events enables a buyer to work with the homeowner and lender to create a workout strategy or a purchase of the property from the homeowner before the sale date.

The amount of time the window remains open depends solely on state and local laws, as well as the behavior of the property owner. Some states sell properties within 90-120 days from the first notice of default. In New York, the process can take a year or more.

As for the moral question, keep in mind that by dealing with a homeowner in default, you not only help him, you generally rescue the loan and maintain the value of the property (and surrounding properties) as well. If there is enough equity in the property, there is the potential to work out an arrangement that satisfies all parties and allows for a handsome profit.

That's what pre-foreclosure investing is all about: buying the equity in the property, working out an arrangement with the lender and the homeowner, then selling the property for a profit.

Investors follow these basic guidelines to ensure a successful purchase and sale:

Locate loans in default

Evaluate Properties

Contact homeowner

Calculate your offer

Close the deal

Locating Loans in Default

The Lis Pendens or Notice of Default is the first public notice (document) that announces a loan in default, so it makes sense to start there. You can access these notices directly through county records in the State/County Foreclosure section.

Evaluate Properties

You know the default amount from the notice of default information. Now you must estimate the property's market value. You can also purchase a sales comp report through Electronic Appraiser to get a list of homes that have sold recently in the area. Subtract the default amount from the estimated market value to determine the gross equity in the property. This figure also reflects your gross profit potential. If there is little or no difference in the amount of debt and the market value, move on to another property. If there is a big difference, there may be enough equity in the property to make a sizeable profit.

This is easier said then done. The homeowner is probably being bombarded with letters and calls from attorneys and bill collectors and has creditors showing up at his door. The only way to contact the homeowner is by phone, mail or in person, and chances are you will have a difficult time getting in touch with him.

Start with mailings. Indicate in your letter that you are a private investor looking for property in that part of town. Let the property owner know that you may be able to help him with his financial problems.

Demonstrating an understanding the homeowner's dilemma will help your efforts. Indicate in your letter that you may be able to stop the foreclosure, save his credit rating and provide cash for use in paying his bills and/or for relocating.

Be professional and gracious in your correspondence. Invite the homeowner to call you at his convenience. If you don't hear from him in a reasonable amount of time, say three or four weeks, follow up with another letter, perhaps worded a bit more urgently. As you get closer to the auction date you may want to send two or more letters per month.

Follow up with phone calls if you can. Be courteous, never pushy. Never interview the owner on the phone. Merely state that in order to determine whether or not you can help him, you will need to meet with him at the property. Make sure he understands that the meeting will be more productive and less time consuming if he will have the loan, mortgage and insurance documents available, as well as the foreclosure notices.

If you are going to make an offer on the property, you must have the loan, ownership, and debt or lien information. You can get much of this information directly from the County records. You must also assess the condition of the property and the property owner. Combined with the market value and the default amount, you have all the ingredients necessary to formulate your offer.

If you feel comfortable with it, you can visit the property in person. You may be confronted by an angry homeowner. Be polite and leave if you are asked to. Never, under any circumstance, snoop around, inspect or generally trespass unlawfully on somebody's property.

Meeting the Homeowner

Use common sense and dress appropriately, something casual but not sloppy. Be sympathetic. Does the homeowner need cash? Is he waiting for a bailout? Will he go bankrupt? Find out. Review the loan and mortgage documents. Verify the loan amount, monthly payments, interest rates, taxes, etc. Review the insurance policies as well. Get all the pertinent information you can. Ask the owner if there are any other liens or judgments he may be aware of.

Inspect the property with the homeowner. Never comment on the owner’s lifestyle, just the physical condition of the property. Point out the obvious defects or items in need of major repair. Use an inspection checklist and record your information and estimated costs of repair.

Make no promises at this point. Make no offer or give the homeowner any money. Make an appointment to meet with him again if you think you want the property.

Determine the net equity in the property. This is the difference between the market value and the default amount plus liens and repair amounts.

Negotiate with the lien holder. You may offer to satisfy the lien for 20% of the amount. Chances are the lien holder will lose everything when the property sells at auction. Buying out the lien puts more equity in the property and more money in your pocket.

Remember to include closing costs in your calculations for the purchase and sale if you intend to flip the property. If you plan to resell, also included the carrying costs, the mortgage payments and taxes and insurances, while you hold, and repair. Also include a seller's commission if you use a broker.

Calculate every legitimate expense associated with buying, repairing, carrying and selling the property. If a large enough figure remains, you may have a very nice deal. This bottom line figure has to pay the homeowner for his property and produce a profit for you.

How much do you offer the homeowner? Some investors itemize every expense, show their calculations to the owner and offer to split the profits. Some itemize the expenses and pay the owner the remainder on the bottom line. The investor then earns his profits by the reduction in lien amounts as negotiated, savings in repairs by doing them himself, negotiating a lower seller's commission, or selling the property himself. Others still make offers based on the bottom line, and negotiate from there.

When the owner decides to sell, you will both need to sign an Equity Purchase or Real Estate Purchase and Sale Agreement. All parties recognized in the mortgage contract must sign.

Check with your attorney before signing any contract and make sure he is knowledgeable in real estate equity purchases.

Investing experts agree that the terms of the agreement must be clearly stated in the contract. Leave nothing to verbal understandings. Your best defense against future problems is the manner in which you present your evidence. Have everything documented properly.

Make sure to include the following in your purchase agreement:

A "Subject to" clause that allows you to bow out of the deal if something is not as originally agreed upon. This could be for unknown damages, general condition of the property or loans, termite damage, etc.

A statement that allows you to show the property.

A statement indicating that the property has to appraise at a certain value.

A statement stipulating that the property must be vacant, all tenants and possessions out by the specified date.

An agreement between buyer and seller that the payments for the current loans equal "X."

A statement indicating the sale is subject to the condition of the loan and/or encumbrances against the title.

A statement indicating the buyer shall pay all closing costs.

A statement indicating the seller shall: "Deed the property to the buyer... Authorize the buyer to record said deed at the appropriate time... Be aware that the buyer may resell the property... Be aware that the purchase price may be below market value... Leave the premises in good condition and pay for damages incurred after the contract has been signed and before the seller has left... Agree to pay for any damages or repairs necessary as discovered by termite and roof inspections... Vacate the premises on the date specified."

A statement indicating all net proceeds paid to seller will be paid at closing.

Closing

Inform your attorney that you have a signed contract and that you need representation at closing. Have him prepare a Release of Lien, to be recorded at or just prior to closing, if you have negotiated a settlement with a lien holder.

Arrange your financing. If you assume the loan and have been in contact with the lender, make sure the foreclosure process is stopped before the sale date.

Order your certified appraisals and inspections as required before closing. Order the termite and roof inspections as well. Verify from a title search that there are no other lien holders against the property.

If all goes well, you probably just bought real estate well below market value.

Buying at the auction

Advantages

Disadvantages

Researching properties

Going to the auction

Buying foreclosures at the sheriff's or trustee's sale (or auction as it's commonly known) is one of the best ways to make big profits in the distressed property business. It is also the easiest way to lose your shirt.

The sale of the property comes at the end of the foreclosure process when the defaulting homeowner can't repair his financial problems with the lender.

When a default occurs, the lender will attempt to end the homeowner's rights of possession to the property. The lender must show that it has the right to sell the property to recover its loss by virtue of the default and as stipulated in the signed mortgage agreement. The lender will proceed with the foreclosure and the property will be scheduled for sale.

Properties are sold at public auction in the county where the property is located. The successful bidder becomes the new owner of the property. Much of the time the successful bidder is the lender, the original mortgage holder.

Attorneys will be there to bid on the property for the lender. There will also be investors, onlookers and curiosity seekers observing the proceedings. Occasionally, a lien holder will appear trying to salvage what he can from his claim. Rare but certainly possible, the homeowner may show up to bid on his own property.

Advantages

The biggest advantage to buying properties at the auction is the high profit potential. If there is a large difference between the market value of a property and its final judgment amount or opening bid at auction, you can really win big. Typically, the largest cash rewards come from the proper application of this investing method.

Sales are usually advertised 4 - 6 weeks in advance. In some states, this information may be available 6 - 8 months or more before the sale. This gives you ample time to research the property, the condition of the loan and the condition of the homeowner. Why the homeowner? If you can work out a satisfactory arrangement with the homeowner, you can save yourself the trouble at the auction. If you meet with the owner and can't work out a deal, you should at least take careful note of the property's condition. This gives you a competitive advantage over other auction bidders.

You can go to the auction and observe the process as often as you like before going to bid on your property. It's certainly a good idea to familiarize yourself with the auction process.

There usually isn't much competition for properties sold at auction. Sometimes no one shows up to bid on a property, perhaps due to transportation problems or inclement weather. This creates fantastic opportunities for the diligent investor.

Disadvantages

Buying at the auction can be very dangerous for those who do not do their research properly. Horror stories abound.

The large cash outlay required to buy the property is the biggest deterrent for most buyers. Certified checks and sometimes cash will be required to bid on properties.

You may have to pay off the sale amount within 30 - 90 days. In some states it's a matter of days. In Palm Beach County, Florida, for example, the successful bidder must pay for the property in full by 3 p.m. on the day of the purchase. That's just six hours from the time the bidding starts to the time you must pay for the property in full or risk losing your cash deposit.

You may not be able to inspect a property before bidding on it. In that case, there is little chance you will be able to assess the property damage and replacement costs. This hinders your ability to determine the true market value, your maximum bid amount and your profit.

If you are the successful bidder, you may have to evict tenants currently residing in your new property. This could take several months. This also interferes with your plans to repair and quickly sell the property for a profit. This delay increases your carrying costs and erodes your profits.

There may be land use problems with a property such as zoning or environmental issues like petroleum contamination or toxic waste. A clue to avoiding a problem property is when the lender's representative fails to appear or bid on the property. If the lender doesn't want it, you don't want it either.

Failure to research a property correctly leads many to over-bid. Too often properties are purchased for much more than their value. This accompanied by "auction fever," the tendency to get caught up in the heat of the moment and over-bid, results in large over-payments and even larger losses.

The most important concern perhaps is the possibility of other liens or judgments. As the successful bidder, you replace the homeowner's position in the property. Any problems clouding the title are your problems now. This includes other mortgages, mechanics liens and taxes.

At the sale, the first lien holder can nullify all other liens if he's the successful bidder. Junior lien holders must buy out senior lien positions and be high bidder to gain possession of the property with clear title.

The first mortgage holder is not the only one foreclosing properties. If a third lien holder forecloses, the process will not wipe out the first and second lien holders. Buying this property means you buy these liens as well. Typically, first mortgages are the largest liens on the property.

Researching Properties

The only way to be sure that this is a first mortgage holder foreclosing is through a full title search. The cost of the search is nothing compared to the potential loss from not investigating the condition of the title.

Locate properties going to sales or auctions by looking for Trustee Sales, Foreclosure Sales, or Sheriff Sales in the State/County Foreclosure section.

Evaluate the properties and determine their profit potentials. Do this by determining the market value using comps, appraisals and brokers' opinion of price. Subtract the default amount from the market value. If there is a significant difference, you may have a winner.

Inspect the property if you can and assess any damages or repairs you must make before re-selling the property. Deduct those expenses from the profit you calculated earlier.

Calculate your profit potential. Start with the price you can sell the property for in good condition. Subtract any repair expenses. From this number, subtract the costs you will incur while holding the property (loan payments, taxes, insurance). Subtract from this the closing costs you will incur when you sell the property, including a broker's commission if you intend to sell your property through a broker.

Locate any other liens or judgments, and subtract those amounts from your previous figure. Paying off the liens at a discount is one way to increase your profits, assuming you are the successful bidder.

Your sub-total so far, is your expected sale price of the property, less repair expenses, holding costs, liens and closing costs. This is the "net to you" after you sell.

Deduct the default or final judgment amount from your last sub-total. This is your gross profit potential, hypothetically the most you can make assuming all goes well.

Determine your maximum bid amount. The lowest you can bid is the final judgment amount or opening bid at the auction. The highest you bid is the "net to you" amount. Any amount over that break-even point results in a loss. Determine the minimum profit you want to make. Subtract your desired profit amount from the "net to you" figure. That's your maximum bid amount.

Going to the auction

Prepare for the auction by phoning ahead. Make certain that the sale hasn't been postponed. Determine the requirements for purchasing properties. How much deposit is needed? When is the balance due? What type of payment is required?

Attend the auction. Arrive early. Properties are sold very quickly, sometimes within minutes. Pay attention. Register yourself as a bidder if necessary.

Listen carefully for your target property to be announced. Observe the bidders. Know your competition. Do not announce your intentions to anyone there. Never bid more than your pre-determined amount.

The successful bidder will receive a deed, the type of which depends on who is conducting the sale and state law. Record your new deed and obtain title insurance as soon as possible.

Remember to research properties and their liens thoroughly. Calculate your expenses and profit margins. If you cannot inspect a property, leave your self a little extra room and some extra cash.

Experts agree: if you are unsure about the property, don't do the deal!

Frequently asked questions about trustee sales

What is the timeframe for completion of the forecosure?

California Civil Code provides that no sale date may be set until three months from the date the notice of default is recorded. Once a Notice of Default has recorded and three months have expired, the following timeframes must be adhered to: 1) A copy of the Notice of Sale must be posted on the property and also in a public place, at least 20 days prior to the scheduled sale date. 2) A copy of the Notice of Sale must be published in a newspaper that meets Civil Code requirements, once a week for three consecutive calendar weeks, the first publication to be at least 20 days prior to the scheduled sale date. 3) A copy of the Notice of Sale must be mailed to each person as required in the California Civil Code at least 20 days prior to the the scheduled sale date. 4) The original Notice of Sale must be recorded at least 14 days prior to the scheduled sale date. Based on the above, a California foreclosure will be completed within approximately 115 to 120 days from the date the Notice of Default records, provided that there are no delays caused by bankruptcy filings, missing documents, litigation or workouts with the borrower(s).

I am interested in purchasing forclosures at the auction. I know it must be cash/cashiers check, who is the check made out to? What kind of deed will I receive? When will I receive title and access to the property?

The Cashier's Check can be made payable to yourself and then if you are the successful bidder endorsed over to the Trustee. The Trustee will be on the Notice of Sale. If you are the successful bidder the deed you will receive is a Trustee's Deed Upon Sale executed by the trustee appointed to process the foreclosure. The Trustee's Deed is usually prepared within 3-5 days following the auction. You will obtain access to the property upon receipt of the deed, however, if the property is occupied you will need to file an unlawful detainer at your own cost.