Focus on Foreclosure, Part 1
Profit from Foreclosures by Preventing Them

By Jordan Taylor

Foreclosures are on the rise in the U.S. , creating tremendous opportunities for savvy investors. In this first of a three-part series, Jordan Taylor looks at how to profit from foreclosures by preventing them.

What makes foreclosures so appealing to many real estate investors is that it's not a one-size-fits-all strategy. You have three basic choices when it comes to foreclosure investing: preforeclosure, at the auction, and after the auction. Let's take a look at what's involved in preforeclosure investing.

Preforeclosure refers to the period when the homeowner is in default and the lender has begun the foreclosure process. Most homeowners in this situation are facing a financial crisis of some sort: divorce, death, job loss, high medical bills, or some other circumstance that has made them unable to make their mortgage payments. Increasingly, we are seeing people facing foreclosure because they bought their home with a "teaser" mortgage that started out with low payments. When the introductory period was over and the payments adjusted to the market rate, the homeowners couldn't manage the higher amount.

These people are in distress and are usually confused and frightened. Lenders typically don't bother explaining borrowers' rights and options; they just want to collect their money. You have the opportunity to help homeowners avoid foreclosure, salvage their credit rating, and get on with their lives—and you can make money by doing it.

Build your business by helping others

Preforeclosure investing makes everyone involved a winner. The homeowner is able to avoid foreclosure and get out from under the burden of a house he can't afford; the lender doesn't have to go to the expense and trouble of foreclosing and then getting rid of the property; and you get a potentially profitable investment.

In many cases, you'll be able to work with the homeowner to negotiate a discounted price for the property. To make this happen, there needs to be sufficient equity in the property for you to buy it below market value, pay off the mortgage, and if possible, let the seller walk away with some cash. Then you can keep the house and rent it, sell it to another homeowner at market price, or quick-turn it to another investor at a discount.

If there is not enough equity in the property or if the house needs too much fix-up work to allow you to make a profit if you pay what's owed, consider a short sale. This is when the lender is willing to take less than what is owed on the property. Lenders will consider short sales to avoid foreclosure because it makes sense for them. In a foreclosure, the lender has substantial legal costs, as well as expenses to sell the property once the foreclosure is complete. It makes good business sense for lenders to consider accepting less than the balance due on the loan to avoid the time, expense, and hassle of a foreclosure.

Of course, while it makes sense, don't expect lenders to make the short sale process easy. You're going to have to prove to the lender that this route is best and that it will likely be the only way to stop the foreclosure. Most lenders will provide you with a package that lets you know what you need to do to complete the short sale process. It's important that you follow the instructions carefully and move quickly. Remember, the foreclosure process will continue until you reach an agreement with the lender, and you don't want to lose a great deal because you didn't do the paperwork fast enough.

Another issue to consider in the preforeclosure phase is that of junior liens. It's very common for homeowners in financial trouble to have second mortgages, home equity lines of credit, and other junior liens that total the market value of the property or more. When a property is foreclosed, lenders are paid in order of their ranking in the loan documents. If the first mortgagee (lender) forecloses, there may or may not be any money left over for junior lien holders. But what if you have a $190,000 property with a first mortgage of $140,000 and junior liens of $60,000? That first mortgagee may not be receptive to a short sale offer, but the junior lien holders may be happy to agree to a discount to help you put together a deal that means they will get something rather than nothing.

A key to successful preforeclosure investing is to build trust with the homeowner so that you can gather the information you need and move quickly to put together a deal that everyone will agree to. Though it takes patience and perseverance, the payoff can be substantial.

But what if the preforeclosure deal doesn't work out? Next month, we'll look at how to buy foreclosures at the auction.