Save your credit : The Basic of a Foreclosure 

Short Sales and Foreclosures are inter-related. Under  Basics of a Short Sale  we see that a Short Sale is a mechanism by which a lender may avoid a mortgaged property going into foreclosure auction by accepting a calculated cost in the form of a discount in order to avoid a far greater unknown loss that could be incurred if the foreclosure were to end up in am auction of the mortgaged property.

A Foreclosure terminates all rights of a mortgagor covered by a mortgage agreement to redeem his mortgaged property. It is an option set in motion by the lender to frustrate the house owner from exercising any further claims on the mortgaged property and to transfer absolute ownership of the estate (property) upon himself or the lending institution as the case may be.

A foreclosure in other words is a situation that arises with the lender serving a Notice of Default (NOD) on the borrower (mortgagor), for failing to cure his mortgage even after the grant of an extension of time after he had failed to meet the repayment installments on his mortgage loan, which in most States in US is a period of three consecutive months.

The period of an impending foreclosure or the actual critical period that precedes a foreclosure is called a pre-foreclosure period. There are two stages of a pre-foreclosure period. (1) Where the borrower is in default of loan re-payments and (2) where the same situation still exists further aggravated by the issue of a Notice of Default (NOD) on the borrower by the lender effectively preventing the house owner from redeeming his property from that point onwards.

A foreclosure is a legal process which is the normal redress sought by lenders in about 50% of the States to recover their loan balances due on mortgages. Commencing from the time the NOD is served on the borrower by the lender, followed soon by a complaint being filed in a law court, summons will be issued on the borrower requiring him to respond to the complaint within 20 days.

Once the borrower files his answer challenging the complaint in full or in part, the courts is given another 40 days to get back to the mortgagor (borrower) on his reply. If again the borrower sees some loophole in the charges levelled at him he’ll take advantage of it to adopt delaying tactics to buy more time by taking another 20 days allowed to him to reply again. In this manner the ball may keep on being struck back and forth from one court to the other over a long period of time which may extend up to one year and even more in some cases. 

Due to the long delays in the settlement of lawsuits of this nature, nobody likes a mortgage foreclosure. It is a situation the lender is forced to create when he feels that all other avenues of recovering his debt from the borrower have run out and are exhausted. However, both parties (the lender and the borrower) will prefer to settle their dispute outside courts if possible in a no win – no lose compromised situation for both. It in such a scenario that the intervention of a third party in the form of a new buyer / investor may be welcomed by one or both parties.

How does a foreclosure inclusive of its two pre-foreclosure periods affect the chances of a Buyer (or prospective Investor) from striking a Short Sale with the original lender?

Obviously, no lender will be interested in doing a Short Sale as long as the borrower is just one or two installments behind on payments. The lender would expect and hope that the homeowner will make a valiant effort to save his house going to a foreclosure by updating his payments in arrears.

The best time to do a short sale from the point of view of a buyer is when the mortgage is in the second stage of the pre-foreclosure.

It is the stage that both the lenders as well as the homeowners are at their weakest and most vulnerable. The reasons being that with regard to the homeowner, with more than 3 payments behind on his payments and the Notice of Default hanging over his head, he will be looking in all directions for any straws to grasp in a last bid for his survival; and as for the lender, this is the time he will be applying the highest pressure on the borrower (homeowner) for settlement while trying to grab almost anything short of a long drawn out legal procedure.

The Investor / Buyer is at a higher advantage for negotiating a short sale especially if  the mortgaged house is in a bad state of repair. The lender knows that he will have a hard time in disposing that house at a worthwhile price because of the very low demand for houses needing extensive repairs. This reason will make him inclined to give a good discount to the buyer/investor.

Another possible gold mine for a prospective investor in the reality market is a property in its second or third mortgage. This situation is called “over leveraged” or “up-side-down mortgage” meaning that the price obtainable from the sale of the estate is insufficient to cover the mortgages. Just as much as a lending institution fights shy of hanging on to a property with a rickety old house almost breaking apart or an over leveraged property, there is a possibility that an inexperienced amateur investor too may look at it from the same angle. But on the contrary, this may be a sweet deal to a savvy investor who can see through and beyond the external manifestations.

The reasons being that with regard to the up-side-down mortgage situation, the lender knowing very well that the second mortgage will get wiped out if the property goes for a foreclosure auction, would be easily persuaded to part with the property for a song on the maxim that something is better than nothing.

Further, with regard to the house being in bad shape needing extensive repairs, an investor who is clever at manipulating situations may study the latest trends of market values fetched for similar lands in the neighbourhood, and decide to demolish the old house entirely and do a re-sale of the property as a bare site with a very handsome profit margin.

There are further finer points, which are beyond the scope of this introductory chapter on foreclosures, and we will cover them comprehensively in greater detail in separate articles. 

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