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How Does a Foreclosure Work?

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How Does a Foreclosure Work?

In today’s economy, the worst since the Great Depression of 1929, more and more homes are falling into foreclosure.

According to the Mortgage Bankers Association (MBA), the U.S. is “embroiled in the worst foreclosure crisis in recorded history. In 2007, more than 14% of subprime borrowers are defaulting and prime borrowers are beginning to follow suit.”

Many Americans refer to themselves as ‘homeowners’. Most ‘homeowners’, however, do not unconditionally own their home … they, in effect, borrow it from a lender (or a number of lending institutions).

If homeowners fail to make the monthly payments specified in the mortgage agreement, the lender has the legal right to repossess and sell the house in a process referred to as ‘foreclosure’.

Foreclosure is usually not an option homeowners choose. The homeowner is most often a victim of job loss, increased credit card interest rates, illness, divorce or necessary relocation.

Nor is foreclosure a simple process: the lender cannot simply evict the homeowner and take possession. Various state laws and regulations protect both parties from unfairness and fraud.

The Foreclosure Process

Although the laws vary from state to state, the basic foreclosure procedure is the same:

  1. The homeowner fails to make mortgage payments.
  2. The lending institution files a public ‘notice of default’.
  3. If the homeowner pays the defaulted amount within a time period specified by state law, the homeowner reclaims the property and foreclosure ends.
  4. If the homeowner does not pay the defaulted amount within a time period specified by state law, the lending institution takes possession and sells the property to pay off the original debt.

The Three Phases of a Foreclosure That Present Opportunities for Buyers

Phase #1 Pre-Foreclosure:
The first phase is before the lender takes the property back. This is the pre-foreclosure phase. In today’s housing market a lot of homes in this stage of foreclosure are sold through a short sale process. I’ll explain the pros and cons of buying a home in this phase of foreclosure in a minute but first let me tell you the other two phases if foreclosure.

Phase #2 Foreclosure:
The second phase is when the lender finalizes the foreclosure and takes the property back. Before the lender puts the home up for sale some will try to sell it to the highest bidder on the court house steps. There are a lot of drawbacks to buying a foreclosure in this phase.

If you’re buying a home to live in then this phase of foreclosure is NOT worth the amount of hassle and risk it presents for the amount of savings it offers. For that reason I’m not going to talk about this phase of foreclosure much in this article but I may explain some of the risks involved in an article in the future. Let’s move on to phase #3…

Phase #3 Post-Foreclosure:
The third phase is when the lender puts the home up for sale with an agent. In most cases this is the best phase of foreclosure to buy a home. That’s simply because it has the least amount road blocks and risk. Let’s break down the advantages and disadvantages of the 1st and 2nd phases now…

What is a Pre-Foreclosure and How Does It Work

Because there are so many foreclosures in today’s housing market lenders are taking longer and longer to finalize the foreclosure paper work. That’s why a lot of homeowners in distress are selling their home before they are foreclosed.

In most cases the homeowner doesn’t have equity in the home and is forced to do what is called a “short sale. A short sale is when the lender accepts less for the home than they are owed. You can still get a great deal on a short sale or pre-foreclosure but there are defiantly some pros and cons that go with it.

Advantages and Disadvantages of Buying a Pre-Foreclosure or Short Sale

The biggest advantage of buying a pre-foreclosure or short sale is the savings. In most cases you can buy one for 80 to 90% of market value and sometimes you will pay more or less. A lot of variables come into play so it’s impossible for me to give you an accurate idea of the savings.
The biggest disadvantage of buying a pre-foreclosure or short sale is how long the process takes. If the homeowner doesn’t have equity in their home then you will have to buy the home through a short sale.

Most lenders can take three to six months to accept an offer. It’s hard to get updates on your offer and you may have to go months without knowing if your offer will be accepted or not. If your offer is not accepted and you want to make another offer on a short sale it could take three to six months all over again.

If you can’t wait for three to six months to hear back from the lender then buying a foreclosure through the short sale process is NOT for you.

Advantages and Disadvantages of Buying a Foreclosure From a Lender

There are a few great advantages of buying a foreclosure directly from the lender after the foreclosure process has been complete.

  1. You can normally buy the home for 10 to 20% less than market value.
  2. The lender will normally accept or decline your offer within 1 to 2 weeks. So you can close on a home that has already been foreclosed on by the lender a lot faster than a short sale.

The biggest disadvantage with buying any foreclosure is how many buyers you have to compete with. There are a lot of buyers seeking to get a deal by buying a foreclosure. In most cases there will be 3 to 15 buyers making an offer on a foreclosure.

It’s not uncommon for a buyer to pay too much for a foreclosure because they get caught up in the buying frenzy.

Summary

While buying a foreclosure presents opportunities for home buyers, they also present considerable challenges. If you have any questions about buying a foreclosure please don’t hastate to contact me about them.


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