How Foreclosures Happen

The word "foreclosure" means "to stop" or "to prevent." Today we are familiar with the word primarily because of its use with reference to mortgages. In law, to foreclose a mortgage means to cut off a borrower (also called a "mortgagor") from his right to redeem a property. Foreclosure provides the legal means by which a property owner may be stripped of that property because of his failure to live up to the terms of the contract he made when he borrowed money and pledged his real property as security for the loan.
Now then-a word about banks and mortgages. Banks do not give mortgages. That is surprising to many people, but it is nevertheless true. Banks loan money and take back mortgages as security for the loan. Thus, if your friend tells you that he "got a mortgage from the XYZ Savings Bank," he may be using the accepted parlance to describe the exchange that has taken place, but he is not quite correct. This is an important point to bear in mind, for reasons that will become clear as we go on in this chapter.
Purchase money mortgages are usually signed at a closing where the seller simultaneously gives a deed to the purchaser. At that time, the purchaser executes papers that are then given to the title company representative, who sees that they are recorded in the local county clerk's office. Of course, the papers being recorded are the deed to the property and the mortgage papers, which pledge the property as security for the loan.
The party doing the mortgaging or pledging is the new owner-and, in this instance, he becomes the mortgagor. The bank, which is the one to whom the property is pledged, becomes the mortgagee. People often confuse these terms because they regard the bank as the one owning the mortgage.
Many of the words used in real estate have their roots in English law, which was in turn based on Roman law. In Latin, "or" denotes a person performing an action; "ee" is the one receiving the action. Hence such terms as mortgagor/mortgagee, grantor/grantee, offeror/offeree, and so on, are all common in real estate transactions. We will be referring to mortgagors and mortgagees quite a bit in this book. I hope this brief summary has cleared up .for you which is which; if you need to review the last few paragraphs before proceeding, please feel free to do so.
Although the underlying principles extend back to English Common Law, today's foreclosure procedures can be affected by state, county, and even local municipality laws. Unfortunately, there is no national code for foreclosures; things would be a great deal simpler if there were! If you are going to get involved in purchasing at foreclosure sales, it is absolutely imperative that you research the local laws. What follows in this book is an outline of the procedures in most localities, but there can be-and are-many local variations.
You could inquire of local attorneys about what to look for in purchasing foreclosed properties. Alternatively, you could consult a knowledgeable real estate broker in your area. A word of caution is in order here, however. Make sure your" expert" really is an expert in the field you need to learn about. An attorney who specializes in real estate may be able to help you but he may also be essentially ignorant of foreclosure proceedings if these are not his specialty.
People are not likely to volunteer that they do not know something; this is a common human failing and one you must be wary of. No doubt you've had the experience of stopping to ask someone directions-only to find that you've been led well out of your way, although with the best intentions. How much better if the person had told you that he simply didn't know! My experience with attorneys is that they will seldom admit when they are unqualified to offer advice in a given area and will often offer advice that they believe to be correct, but that is in fact completely different from the advice you might have obtained from a more knowledgeable practitioner.
What other persons can you consult about local variations in foreclosure procedures? The clerk of the court is an excellent bet. If you can get him or her to talk to you, you'll very likely get some very sound advice. Some of these officials regard themselves as servants of the public and are an invaluable resource. Others will be more difficult to talk to. If you can find a clerk who is willing to share his or her expertise, you will likely get assistance from that clerk's staff, as well. This can be an invaluable aid.

Making sense of the terminology

In some states, there are mortgages. In others there are deeds of trust. A deed of trust differs from a mortgage in that the trustor (borrower) hypothecates his _,legal title on the property to a trustee who is the actual legal title holder while the debt obligation exists. The process is a pledge of the property to a third party, in order to ensure that you, the borrower, will make the payments as agreed.
The deed of trust is an instrument favored by banks since it makes applying the foreclosure, process considerably easier should the need arise to do so. No judicial approval is required to begin foreclosure; in effect, the receiver (a term we'll learn more about later) is already appointed. In many areas, the deed of trust carries with it something called the "right of redemption."
Right of redemption is a process whereby the defaulting mortgagor can regain title to the property by fulfilling specific legal requirements. Although the property has been foreclosed, this foreclosure is revocable and can be overturned. The process is' similar to an appeal. Rights of redemption exist only in certain specific instances; we'll review them later in the book.
In post-World War II real estate, the mortgage form most widely used was the one approved by the Federal Housing Administration. It is in these forms that the power to remove persons from title through the foreclosure process is established.
There are five covenants in the mortgage instrument you should know about. (The word "covenant" means "promise" or "agreement.")

The Five Covenants in a Mortgage

These five covenants have received virtually universal acceptance among savings banks and savings and loan institutions.
The first three are agreements that the, mortgagor must adhere to; in the event that these agreements are breached, the other two covenants ate options that the mortgagee must pursue. Why "must"? Mortgagees are really trust officers. The money they've loaned you is not theirs. It belongs to their depositors; mortgagees have no right to take risks with other people's money. They must, therefore, stick to the letter of the agreement.
These last two covenants give the bank the means to foreclose. One provides for the appointment of a receiver; the other provides that, in the event of default, the bank can accelerate payments and ask for the entire balance. The accelerating payment covenant is of great importance to the bank. If it didn't have such a provision, it would be in court continuously, suing for three or four back payments at a time, then repeating the procedure. In essence, when the bank's lawyers take someone to court, they want all of the money; if it can't be paid, they want a judgment against the mortgagor. Until the time that judgment is obtained, the mortgago really is under no threat of foreclosure. But once the judgment has been handed down, the mortgagor has had his day in court-and can be put out of the property.

Forbearance provisions and deeds in lieu of foreclosure

Of course, this book is meant for those who are looking to buy property at foreclosure in the hope of ending a suitable abode at an affordable price, or for those who want to pick up properties at a low price and resell them at a higher price. I mention this because it's possible that someone in financial difficulty may be reading this in hopes of finding some ll1iraculous weans of halting the foreclosure process. While such problems are’, not the main focus of this book, a few words are probably in order about the perspective of the original homeowner; in this situation.
The Federal Housing Administration has, a program, which the FHA alone may invoke a mortgagor, who is in temporary difficulty. It is called a' forbearance provision. Under this arrangement, the mortgagor would ask the FHA to agree to a, schedule whereby the mortgagor could pay a portion of the money owed-provided the terms are acceptable to all parties. Subsequent payments would then be mad_ directly to the FHA. In these cases, the FHA replaces the banks and usually has a local representative who follows , up and ,represents the

FHA as a local property manager.

Selling the property

After a judgment is handed down against the mortgagor, a time is selected for the public sale of the property. If the mortgagor cannot redeem the amount of the judgment award before the sale, that's, it. No more delays, no, more compromises; the sale will be held.
You, will remember that one of the covenants we examined earlier had to do with the appointment of a receiver; this is where that provision comes into play. The court can appoint someone (usually a lawyer) to conduct the sale of the mortgagor's property. That person is known as the receiver.
Ordinarily, real property, cannot be transferred unless both grantees (purchasers), in the purchase deed sign the new transfer deed. Of course, no one who is having his home taken away is going to volunteer to sign a deed over to someone", else. The receiver has the authority (granted by the court) to sign a valid deed transferring the ownership to a new purchaser.

What are the root causes" of foreclosure proceedings?

Why, exactly, do foreclosures come about?
The two biggest reasons are marital discord and business failures. To be sure, there are also cases where people lose jobs and bills pile-up, but these are not the typical foreclosure cases. In such situations, people will usually make remarkable efforts to weather the adverse -Conditions: refinancing the debt; taking a second job, or-in the case of a spouse who had previously not worked-finding employment for the first time.

The most common reason for foreclosure is dissolution of a marriage, generally involving abandonment by the husband. The next most common reason for foreclosure is the once promising business venture that fails. In these cases, the homeowner is usually mortgaged to the "hilt and has been completely overwhelmed by debts. Foreclosure is usually the only option available to the bank in such a situation.
In years past, when people found themselves in serious financial difficulty, they were able to sell off their home or refinance the mortgage in order to consolidate debts. In this way, they were able to combine many smaller loans with high monthly payments into one debt and reduce their monthly outlay. They might even be able to payoff many of the debts and scale down to a smaller home with a more manageable monthly payment. This solution is less common today for one main reason: home prices have fallen sharply in many regions; In case after case, the existing indebtedness simply exceeds the present market value of the home; foreclosure is the only solution.
This trend is leading to a plethora of bank-owned properties. That is the result of a foreclosure sale that produces no buyers! If there are no buyers at the sale, the bank becomes the owner. From this point on, the bank is free to make whatever deal it wants.

"Why can't they work with me?"

Perhaps the hardest thing for a defaulting mortgagor to understand is the bank's refusal to accept partial payments. But this really is not a solution to the problem. If the bank accepts partial payment on a. home loan in default, it establishes as accepted procedure something that is completely contrary to sound banking practice. Furthermore, if it can be established in a future legal action that the bank has in the past accepted partial payments, the court might hold the practice to be acceptable and decide that the bank's action constitutes a waiver.
Remember, the legal process is based on law, but is subject to interpretation of that law. In contractual, relationships, it is very common for courts to view the failure to pursue the due process of an agreement as a 'waiver. Bankers don't want to open the floodgates in this area; they are quite insistent about following the mortgaging agreement to the seller when faced with a clear-cut case in which foreclosure is in order.
The bank's point of view on such matters often comes as a surprise to laymen. For instance, banks really don't like collecting late charges-::-even though doing so would seem to represent a financial advantage for them. But the reality is that a high percentage of late payments is a sign of a sloppy operation. Banks want to know that payments are received on time; their business is predicated on the use of money .they receive at certain predetermined intervals. If they don't receive the money on title, the business will not be run as efficiently as it should.
Banks, we must remember, are in. a fiduciary position. That means they are trustees of the money their depositors leave with them. Banks must be accountable at all times to the people who have placed their trust in them:
Perhaps the past rash of abuses in the savings and loan industry makes you question the accuracy of the foregoing. The fact is, scavengers exist in all walks of life, and business and government are no exception. The fact that there are bad examples does not mean that abuse is standard practice. There will be instances of misconduct, but on the whole the principles of operation remain sound. Most financial institutions act as the trustees that they are.

The Foreclosure Proceedings

The melodramas of a bygone age depicted a Simon Legree-type of mortgagee who wanted nothing more than to wrest the old homestead from Little Nell and her poor elderly parents. The cliché has "now become quite familiar: the mustache-twirling villain who says, "Pay the mortgage by five today-or else!" The impression left with the audience was that the cold-hearted man had given the loan solely for the opportunity of stealing the old homestead away from the poor-but-honest landholders.
Then there's the stereotype of the Western power broker whose goal was to accumulate land so he could exercise political power over the entire community. You probably remember the fellow in those old late-show westerns wearing the black hat. This villain was usually surrounded by a covey of evil looking henchmen who gloated at news of blight, fire, or other devastation, gleeful at the opportunity to snatch land from unfortunate farmers. Here, too, the idea was apparently to give the loan only to have the chance to take over the security in case of default.
These stereotypes have been circulated widely; they work much better as entertainment than they do as models for sound financial practice. The conventional sources of mortgage financing-banks and savings and loan institutions-are interested in good investment return on good investment risks secured by good investment property. When they are compelled to foreclose and take a property back that is an indication that a serious mistake has been made. Most businesspeople know from personal experience that mistakes can be quite costly; no one goes out of his way to allow one to occur.
Let me qualify that: There may be a few mortgagees whose interest in granting loans is to await the default and then acquire the property through foreclosure, but they are very much the exception to the rule. Most lenders who loan money under riskier-than-normal conditions 'are looking for a higher-than normal rate of return.
This brings us to one of the primary axioms of investing, which goes as follows: The greater the risk, the higher the return. Agencies that grant mortgage loans where the fainthearted will not are usually referred to as "hard money" lenders. These individuals will take greater risks-for a price. They want a markedly higher return on their investment. However, as a broad-but reliable-rule, they do not want to acquire the property .
Too many people forget that banks are selling a commodity. That commodity is called "money." It may be difficult to think of money as a commodity, but that is nevertheless what it is. Money is bought, sold, traded, exchanged, and assigned. When we go to the bank, hat in hand, to ask -for a loan, what we are doing is asking the bank to permit us buy the product it sells.
Do you walk into a retail store and ask, "Won't you please take a moment out of your busy schedule and allow me to buy a pound of sugar from your store?" Of course not. Well, that situation is essentially no different from the one you face at the bank when seeking to borrow money. At the end of each day, the loan officer goes into his boss's office and boasts, "I just gave out two million dollars today!" The boss replies, "That's great, George. Keep up the good work and we'll break last month's record."
Given the way mortgage banking is set up today, there is no shortage of mortgage money out there. There are a number of reasons for this.
Although you make your payment to the Penny Savings Bank, it is not really the mortgagee. Most of the money being loaned today is being sold off in what's known as the "secondary market." This is the alphabetical mélange you've heard referred to as Fannie Mae and Freddie Mac. These quasi-governrnental agencies are the Federal National Mortgage Administration and the Federal Home Loan Mortgage Corporation. These are public offerings sold by public subscription through C stockbrokers. You may have heard someone say something along the lines of, "Invest in Fannie Maes; they're high-yield investments secured by real property." What is really being described are the mortgages that are originated by most banks.
The public purchases these offerings; the resulting money is the source for new mortgage agreements. In years past, savings banks could allocate a set amount for mortgage purposes each year. At the beginning of the year, they were more generous in their approvals and amounts being offered. As the year progressed and the allocated sums were being exhausted, the banks would retrench and refuse loans or offer lesser amounts in order to stretch funds further. Today, that problem is alleviated; the mortgages are being sold in the secondary market to Fannie Mae and Freddie Mac.
But why, you may ask, are you making your payments to the Penny Savings Bank? The answer is that it has retained the servicing of the mortgage for a fee. That's why the loan officer is so happy when he tells his boss about two million more dollars going out the door. As a businessperson, how would you feel about your organization receiving one-half percent per month of each new loan, with more loans being made each day? It adds up!
You may also have heard of something called the "float." That's the period of time that money (for instance, your mortgage payment) passes through a bank and does not incur any outside expenses. This, too, adds up, and is another reason banks really do want to lend to you: you're helping them just as much as they're helping you. However, if you don't make your payments on time, they have to send their money to Fanny and Freddy; they're not floating your money, they're paying your debts.
This should serve to illustrate why the worst thing you can have on a credit report (from a bank's point of view, at any rate) is a history of chronic late mortgage payments. Banks who see this profile don't want to know any more. They can make their decision immediately: No!
Many people feel this is unfair. "After all," they say, "I do pay up. I may not pay right on time, but I've never received a lawyer's letter. They've never had to chase after me." Stop and think, though: If you were a landlord with a mortgage to pay, would you be happy shelling out money to the bank each month without having received your rent?
Receiving a letter from a lawyer is a sign, not of having committed a minor, oversight that the bank wants corrected, but of having entered into the realm of the serious problem debtor. If you get a letter from a lawyer, you are in trouble. Lawyers don't do anything without being compensated, and rightly so. When you hear from a lawyer, it means, the bank has decided to commit its resources to the problem of getting you to pay the money you owe on time.

The stages of foreclosure

From. this point onward, let us assume you are a homeowner having financial problems. Exactly how will the foreclosure proceed?
Well, when you call the lawyer to explain why you haven't paid, you will not receive much sympathy. The lawyer is there to protect the bank's interest, period. Many mortgagors believe the lawyer should be able to at least show some understanding of the , circumstances surrounding the back money owed. He won't. He is interested in one topic on\y: when you intend to pay up.
If you can't make an agreement with .the lawyer, you will be on your way to the first stage of foreclosure. You will be served with a summons. After service (the process by which you are physically presented with the ,summons), the attorney will file papers with the county _clerk. (In this book I will refer Jo the county clerk's office Frequently, although in some areas the place where deeds and mortgages are registered may go by a different name,. such as the office of the 'land registrar.)

This progressed and the allocated sums were being exhausted, the banks would retrench and refuse loans or offer lesser amounts in order to stretch funds further. Today, that problem is alleviated; the mortgages are being sold in the secondary market to Fannie Mae and Freddie Mac.

Now your credit is a matter of public record. All the credit reporting services will have access to the current status of your debt, as will anyone who consults the records of the county clerk. There are publications that publish all the Lis Pendens filed in a given area, and these will list not only the bank's filing against you, but also those of any of your other creditors who have filed.
Your mortgage payment record is now out in the open and in the files of numerous credit reporting bureaus. (Unlike instances of Lis Pendens, late payments to a bank don't normally show up on a credit report unless specifically requested of the mortgagee by the credit reporting organization.) At this point, any attempt you make to borrow from public crooit sources will be met with a negative response.
When the attorney decided to go ahead with the foreclosure action, he asked his title company to prepare a search. Since the
. deed and mortgage are typically recorded at the same time, the mortgage is usually the first obligation against the property. If the title company that recorded it delayed the recording of the mortgage for some reason, it's possible that something could have been recorded against the former owner-or even the present owner-during that interim period. (The recording company would be responsible in such a case.)
For our purposes, however, we will assume that the first claim against the property is the mortgage. Any subsequent mortgages, judgments, or liens (other than tax liens) are classified as junior obligations. All of these parties must be served with papers in the foreclosure action so that they may have the right to bid in to protect their interest. The Lis Pendens papers will join all of them as defendants; all their names will become part of the public record relative to this case. In" other words, it will be public knowledge that you owe money to, and have not paid, all the parties. If the foreclosing party was negligent in notifying the junior lien holders, those creditors not joined in the action would have a valid claim for repayment against the new owner.
. Could such a claim affect" someone who purchases the property at the foreclosure auction? Yes! That's why title insurance is essential.
To Enforce money judgments, the. defaulting parties must be served personally. That's one of the main reasons foreclosure actions take so long-the mortgagor must be tracked down and handed a piece of paper. Often, the mortgagor will. not want to be served. In other cases, such as that of the husband who has left his wife and family, the problem becomes even more complex.
How is such an issue resolved? Each jurisdiction has_ its
own laws and rules. Generally, if a person cannot be located; and if all reasonable efforts have been made to find him a procedure for publication will suffice. This consists of , a public notice printed in the classified section of the local newspaper; no doubt you have seen such notices yourself.
Most jurisdictions require public notice whether or not the
mortgagor(s) have been served. This is to put the public on notice that the property is to be foreclosed and that parties with a legitimate claim against the property should come forth.
On completion of the publication _process, the foreclosure action will be permitted to proceed. In many instances, the mortgagors have left the premises and have rented the property to tenants from whom they have been receiving (and pocketing) rent payments. If the names of these tenants are known, the action will stipulate them in the notice. If the names are not known, the tenants will be served as John Doe and/or Jane Doe.
As a general rule, tenants of a building that is being foreclosed enjoy no special rights to remain. Most standard leases provide that the premises must be vacated in the event of foreclosure. Many of these tenants took the property on a lease purchase option, with option money paid to the defaulting mortgagor. These people are, quite frankly, in a very unfortunate position. They have a right of action against the landlord. of course, but at this stage he or she is likely to have other problems- e.g., the money owed to the bank and other creditor&-and is not the best target for a successful lawsuit.
In my fifty-plus years in the real estate business, I've run across a number of shady characters who've taken over prop6l'ties by one means or another from troubled owners, then turned around and rented them out at what appeared to be a terrific value. They collected the rents for as long as they could, paid the mortgagee nothing, and laughed all the way to the bank. Such episodes only reinforce a valuable principle: If something looks too good to be true, it probably is. That goes for any number of "dream" real estate deals you may come across. Ask for references if you have any doubts about the propriety of an agreement or offer.

Are you getting what you think you're getting?

A notice of a foreclosure sale sets forth all the creditors, but you really won't know from the text alone whether it's describing a first mortgage lien or a second mortgage lien. If it appears that a relatively small mortgage on a fantastic piece of property is being offered, go to the county clerk's office and ask to see the recorded papers. The terms of the sale will be recorded there.
The terms of the sale will tell you if there are any prior mortgages. If you purchase a junior mortgage lien, you are acquiring it subject to the first mortgage lien. Let's take a look at an example of how this might work. You may. buy what appears to be a $250,000 house for a $50,000 foreclosure bid and find that there's a $1'>'70,000 first mortgage on it, which you now own as well. It may very well be that the first mortgage is in serious default, and If you don't bring it up to date, you'll be out of title soon as well!
A "due on sale:' mortgage acquired by. the foreclosure process is transferable; you won't be called in to pay it up or replace it. (We'll discuss this type of mortgage in more detail later on in the book.)
With the' advent 'of "home equity" mortgages, which are usually second mortgages, you'll find that a lot of those foreclosure actions involving "bargain" amount sums on quality properties are dated from 1986 forward. The chances are very good that such proceedings represent defaulted second mortgages. On the other hand, if a foreclosure action shows' a mortgage origination date of 19;]2 or some such other distant, date, you can count on its being a first mortgage and worthy 2fsyour attention.
The notices of the pending foreclosure will often will show the names of the mortgagor's attorney and receiver. They usually will not yield all the information you might like about the proceeding; all they will disclose is whether and when the sale will be held, or if it has been adjourned4for some reason.
If you call the offices of the attorneys mentioned in the notice, you may find yourself annoyed at how uncooperative the secretaries seem to be with regard to answering your queries. Remember that a law office exists to provide legal services; that is all. The staff at the office mayor may not know the answers to your questions, but if they were to answer all the public calls they get about the sale, they wouldn't get their own work done. They are being paid, not to provide hotline service, but to prepare the papers and conduct the sale.
The obligation to determine the priority of the lien is yours. If the property sounds promising to you, do the research or have it done for you. You can go to the county clerk's office and conduct a title search yourself, but you are probably better advised to pay the minimal fee necessary to have a professional do the job. There is a small army of researchers who are familiar with the filing systems and personnel at the various facilities; these researchers can usually be found through referrals from the offices of the county clerk. Another option is to have a local attorney conduct the search for you. Either approach represents a minimal investment that is probably worthwhile, considering the potential damage that can be done to your interests if there is a "cloud on the title" -a gap in the chain of ownership or an unpaid tax assessment or other lien.
If you're a novice who is doing this for the first time, you must be mindful of the position of the mortgage that's being foreclosed. If it isn't a first mortgage, then there are possibly other mortgages or recorded judgments that predate the subject mortgage.
Hiring someone to research the property for you is risky because you may not be the prevailing bidder and you've spent for naught. Go to the Recording Office and ask the clerk about the procedure. He or she will probably be very happy to help you. That's part of the job and you needn't feel guilty about asking for help.

Contacting Mortgagors Prior to the Sale

Let' & assume that your aim is to purchase a home for yourself. If you become aware of someone in financial difficulty in an area where you'd like to live, you would do well to contact the mortgagor directly. By contact directly, I mean just that: Go to the house, knock on the door, and speak to the people face-to-face. Don'! rely on the phone.
If a Lis Pendens has been filed, chances are that the mortgagors have been contacted by local real estate outfits and investors. As someone who simply wants to buy the home as a domicile, you stand a better chance that they do because home owners in financial difficulty are likely to feel that the investors and brokers are" out to steal" their home.
This is why I am advising you to go straight to the .poor. Let them see you, meet you, and learn that you are not in the business of buying or selling homes. They'll feel safer dealing with you.
After all, an investor or broker speaking to a homeowner is approaching the person on what is basically a "wholesale" purchase. He will be looking to turn it over for a profit; you, as a user, will be prepared to pay a somewhat higher price. Your message will have an easier time getting through.

How do you find properties that are facing foreclosure?
One way is to go to the county clerk's office and read the postings.
Another method is to follow the published notices in the newspapers. If you're interested in a particular location, you'd do well to buy the local weekly publication for that area. IT there's a foreclosure in that town, the chances are good that it will be published in the local weekly.
When you read the notice in the local paper, it will feature the name of the bank's attorney. Let me caution you once again not to attempt to call this person for information about the sale. You're probably better off calling the bank directly; ask to speak to someone in the delinquent mortgage section. Even here, however, you should be resigned to the fact that people will not go out of their way to get information for you. The reason I am proposing you call the bank at all is that it is possible someone may know the case well and be able-and willing-to pass along information requiring no research to unearth. In the end, however, there is really no substitute for your own efforts at the property or the county registrar's office.

Lease arrangements

If you are an investor and you encounter a situation where the party is a solid citizen, one approach you might take is to purchase the property and lease it back at a rental that will cover the mortgage payment plus a fair return on your investment.
"Defaulting party" and "solid ,citizen" may at first appear to be contradictory. There are times when individuals who actually represent very good risks are incapable of obtaining refinancing_ through more conventional means due to unusual circumstances or temporary setbacks. In such a case, you will have to make your own judgment and decide accordingly.
At any rate, in these circumstances you will own the home; the prior _owners are, tenants who are renting with _n option to buy. The title will be in your name; you will have assumed the mortgage. You will have taken the deed from the prior owners and signed a lease with them that will give them an option to purchase; they are now tenants and subject to the provisions of a valid lease. If they don't pay under these conditions, the removal process is not the, cumbersome one of foreclosure. When tenants don't pay rent, the procedure available to you is the simpler one of eviction.
The option purchase price should be the same price you paid for the property. If you give them. a higher price, you could be guilty of usury. Current case law illustrates that setting an option to purchase at a later date and at a higher price constitutes exceeding the legal rate of interest.
But why go to the trouble at all if you can't charge more? In these circumstances, the sign you pay to bring the mortgage current plus ‘the existing mortgage balance should be far below the value of tile property. (If it isn't, don't buy in the first place.)

As we have seen, if your new tenants default, you are the owner of a bargain property. If they stick to their word and make the payments, you're getting a very healthy return on your money plus twelve or twenty-four months amortization on the mortgage, which increases your yield.
In the event of acquisition, you've also saved closing costs, since the bank has already gone along with the transfer of the mortgage. It's a great deal for you either way.
Let me offer a scenario that should show exactly how this process can work.
Let's assume that the property is worth, in your opinion_ about $150,000. There is a first mortgage of $90,000, with monthly payments of $1,050 including principal, interest, taxes, and fire insurance. The homeowner needs $6,000 to bring his mortgage current-and has other loans on which he is in arrears that total $14,000. This makes a total need of $20,000.
You bring the mortgage current and payoff the debts, which had monthly payments totaling $650. You take a deed and give him a lease with an option to purchase the property in a year at a price of $11000-which is what you paid for it.
($90,000 + $20,000 = $110,000.)
At this point he has been paying $1,050 plus $650 on his debts, for a total of $1,700. Your rental figure will be based on the $1,050, plus a respectable interest return on your money.
Consider: You've paid out $20,000 plus costs for abstracts, recording, and legal services of $1,500; the total here comes to $21,500. You want 12 percent on your money, which is 1 percent per month. On that basis, you would need $215, plus $1,050 to pay the mortgage. That means, in this case, a monthly rental of $1,265, which would pro1;>ably be a reasonable rent. (Even if you wanted 15 percent on your money, or 1-"1/4 percent per month, that would be $268.75 plus $1,050, _r $1,318J5, which even if higher than the going rental rate is likely to be acceptable to your new tenant under the circumstances.)
The rental rate has nothing to do with usury,; or anything else. It's a lease-not a purchase. Options are paid for by investors all over the world. This usually involes a good faith deposit, which is forfeited if the option is not exercised. In this case, you've given him an option to ,buy; it is not necessary to consider the additional rent as an option.
Basically, you're giving the person a chance to get out of a hole. You've cleaned up his indebtedness, ¥reduced his monthly charges, and provided him with a chance to get back on his feet.
If you stop and analyze the transaction I'm suggesting, .
you'll see it really isn't a true sale. You're loaning money to stop the foreclosure, then giving the person a chance t6 pay you back. Of course, if he defaults on the lease, you can, evict for nonpayment, and the house’ is yours, clear of any encumbrance (As we will soon see, however, you are best advised to spell all this out-specifically, the fact that the option ,to buy the home is canceled if rent is not kept current-with absolute clarity in your agreement.) "
You have an excellent chance t6 own a house for less than its true value, in these cases. Don't let it appear that you _re looking to do him out of his home through a tricky device.
If the term is for one or two years and he is not prepared
to go through with the purchase, extend the term for one more year. When the final expiration is over, he can't accuse you of any wrongs'. You haven’t over backwards to help him. He is the defaulter, not you.

"Due on sale" clauses

In instituting the leasing arrangement I've described, there is a problem you might run into-one that has to do not with the mortgagor, but rather with the mortgagee: the "due on sale" clause. If you encounter this clause, you are best advised to visit the bank and talk with the officials there about your proposal to buy the property.
A "due on sale" clause guarantees the bank the right to demand all moneys owed it when the property changes hands. The clause was first instituted some decades back because, although interest rates had risen substantially over the years, existing mortgages were being transferred with no approval needed-and with interest rates well below the current market. Older mortgages, particularly those that were VA-guaranteed or FHA-insured, were being transferred to new owners at older, lower rates of interest-with no credit check. With a "due on sale" provision, banks could ask for a higher rate and approve the creditworthiness of the new purchaser.
If you are creditworthy and are attempting to set up the kind of leasing arrangement I am describing here, the bank will probably approve the arrangement and waive the clause. It is possible that the rate of interest it is currently receiving is in today's range. If you can offer the bank the hope of avoiding a foreclosure and commit believably to making all the payments yourself, you will probably be seen as a knight in shining armor.
That's one less foreclosure to make.
Speak to the bank about transferring the mortgage to you. The likelihood is that, given today's environment, the bank will listen to you happily.

Who will you be dealing with?

People facing foreclosure fall into several categories. Let's take a look at a few of them here.
We spoke earlier of the absentee husband who takes off and leaves the family to fend for itself. Unfortunately, there's usually nothing you can do for the unfortunate wife. Any transfer of property would require both signatures, and that's not going to happen if the husband is nowhere to be found. When banks face a situation like this, they accept that the foreclosure process is going to take some time.
All you can really do in this case is to keep in touch with the bank and monitor the progress of the foreclosure. Eventually, all the formalities of the judicial process will have been advanced, and the sale will take place.
Another category is the businessperson whose once promising venture has fallen flat. The reaction here to your offer to buy the property is likely to be one of interest. After all, you are offering the individual-who is probably quite familiar by now with dire warnings from authorities concerning unpaid debts-a way out that is more in the socially acceptable order of things. So you stand a good chance of being heard out, at the very least.
Of course, individual reactions will vary. You will also have to take into account that this person has probably been under a good deal of stress in recent months. Tact and an easygoing, non threatening manner are essential.
A third category is the mortgagor who has simply never learned fiscal responsibility. An era of easy credit has made him a voracious consumer, and by that I mean he will simply keep consuming as long as people will permit him to consume. One day he discovers that the people who extended him the easy credit want to be repaid.

..

"The main problem with him is identifying all the potential obstacles to your purchase of the property. When you first start your discussions with him, he'll likely tell you that all he owes is his mortgage and his credit cards. But if you take the effort to probe and, ask whether he owes anything to, for instance, Household Finance, you may get an "Oh, yeah, that's right" kind of response. With this persorl, it will be wise for you to leahi.' how to check the judgment rolls in the county clerk's office. You might then find that those finance company debts are judgments-and that there's one from the phone company and one from an insurance broker as well. RJle number one with this person: "'Do not give him one red cent before all searches are completed, title insurance is purchased, and all necessary papers are signed by the parties in interest. Not a down payment, not a hundred-dollar gesture of good faith, nothing. (Your best bet is to deal exclusively with an attorney representing this individual.)

Why you are in the driver's seat

Remember, you're dealing with' a situation that will deprive a person 6f the right to live within his h6me._That may be an extreme idea to most people, but to the courts and authorities it's simple enough. The mortgagee hasn't been paid, and there is a binding contract"';-the mortgage agreement that states exactly what is to happen under that set' of Circumstances. The contract says, in essence, "I'm loaning you money; you have to repay me or I can take action to enforce any claim by foreclosing on the property. If you agree to this arrangement, sign here," The courts and authorities aren't particularly interested in whether or not this represents a pleasant development for all parties; if that really is the, mortgagor's signature on the document, they are interested in disposing of the case as efficiently as possible. Sooner or later, the mortgagor will realize that.

What is an order to show cause?

At one time, I had a lot of rental properties and managed many of them personally. When I did not receive rent payments, I would invoke the judicial process. Invariably, I would get a default judgment, but before I could execute it, I would receive an order to show cause. Why? The tenant would go to the local Legal Aid Society with a tale of woe about how inadequate my facilities were (which was completely untrue); the legal stalwarts would then take me to court to make me prove why I was justified in evicting the tenant (in other words, "show cause"). They'd also describe all my purported ulterior motives for putting the tenant out. (Actually, the reason was always quite straightforward: he or she would not pay the rent.) Time after time, this amounted to nothing more than a delaying exercise; it never changed anything. But each time I was stuck with at least another month of no receipts and continuing expenses.
Your situation will be much different from mine, of course. You think you've bought a property, and you want to take possession. You may be asked to show why you are justified in doing so by the court through an order to show cause.

The agreement

If the mortgagor insists that he won't use an attorney in finalizing the sale of the property, you must incorporate a clause in your agreement that says that you have advised him that he should secure the services of counsel but has chosen not to do so.

Make the letter of agreement as clear as possible; spell everything 'out in the most obvious terms. Every component of your agreement must be in layman's language that is impossible to misunderstand, or as close as you can come to that standard. In the event of a later dispute, you will not be able to_ defend yourself effectively by saying, "I assumed he understood."
If you will be accepting payments from the mortgagor and allowing him to remain in the house, for instance, don't write about "foreclosure" or "dispossession." Write, 'if you don't make the payments as agreed, I have the right to go to court and have the judge sign an order that will enable me to have you removed from the house. That means the sheriff will put your furniture out on the curb and you and your family as well."
Blunt? Yes. But you must nevertheless write it in language that anyone will understand, then read it back and ask If it's clear and if there are any questions.
Since you are going tq be an investor, you should not skimp on legal services;, Obtain the services of a competent real estate attorney whose job will be to represent you. You can use this person as the escrow agent to hold your good faith deposit and to advise you in the event you encounter any difficulties. There are localities" where lawyers do the title searches for the company that provides title insurance. In these areas, you may be gble to secure the services of the attorney for_ just a little more than the cost of the search itself.
If there ever comes a time when you are asked to show cause in court, the fact that you used the services of an attorney in framing the agreement will definitely weigh in our favor. Remember, judges are lawyers; they have two reasons for preferring to see the agreement developed in concert the one of their own. First, they are less likely to come across serious errors or omissions if a lawyer has signed off on everything. Second, they are less likely to conclude that one party is taking advantage of another if there is a lawyer involved.
There are many areas of the country where people skip using lawyers when drafting sale agreements. For my part, I always use an attorney. People who ask whether they really need an attorney for this step remind me of people who ask whether you really need a doctor when you go into labor. Of course, more than one beat cop has delivered a baby, but if a complication arises, you do need a competent professional who knows what he's doing. How many people are certain that their situation will be completely free of complications?
You never know what will crop up in a real estate transaction. Include the services of an attorney in your cost acquisition figures.

Additions and improvements

So you must keep an eye out for any improvements that have been made to the property and ask the current mortgagor if he has certificates for same. There is still the "difficulty that he may have one for the garage but nothing for the deck, yet he tells you he has "all the papers." The bottom line is that you should do yourself a favor and hike over to the municipality's building department to see what's on record.
There are firms that will draw plans and specifications for precisely these circumstances. They usually know the local zoning ordinances well and can look at the property and tell you what modifications, if any, are needed. You'll find it very easy to get free-and usually quite reliable-advice in this area since you are likely to use the services of the firm to obtain the permits and certificates once you've acquired the property.
The ordinary catch-up procedure is usually not a big problem; the long-undetected violations of zoning ordinances usually are. (I have seen decks torn out and new ones constructed as a result of these kinds of infractions.) You will have to weigh the pros and cons yourself before committing to the sale.

"Equity sharing"

One method of home sharing and ownership that is often proposed by the late-night television infomercial entrepreneurs is the "equity share" program. This idea is often advanced as a method for handling the party facing foreclosure. It is a bad idea. If you're going to be sharing a title with people who are constantly in financial hot water, you are asking for problems. Any judgments they incur can be attached to the property; that attachment is not in proportion to the other party's ownership.

It is completely against the property. Your newfound partner can strip you of all you own in the property by, for instance, borrowing from someone else, never repaying the loan, and having the case go to judgment.
Equity share programs are all right in certain circumstances but represent a huge no-no when dealing with a party facing foreclosure. These programs are for people who have good credit records but are low on cash. To put the matter bluntly, do you really want to go partners with someone you know to be a deadbeat?
The hard fact is, there are certain people in this world who just have a hard time handling money. When I managed rental properties, I often listened to the tales of woe and became convinced that unusual circumstances had a way of conspiring against basically good people. I tried to compensate by taking an extra month's security from tenants who seemed to have a history of financial problems. It never worked. They used it up. after a while, I noticed that the people who said, "Everything always happens to me!" were usually right.
There really is no precaution you can take against people who are bad credit risks. If you must deal with such a person, do what you have to do and get out. The longer you work with the individual, the more it will cost you.
Painful experience has shown me that these people are constantly in . hot water; even if you solve their immediate problem, they'll be back in trouble next year, next month, and maybe even next week. Unless you're in a completely foolproof position (and who among us can boast of that?), don't get involved on a long-term basis.
You can empathize all you want-but don't sympathize. You can't afford to take their problems on as your own.