How To Buy Foreclosures And REOs (Part II)

THERE IS ALWAY SOME INVESTOR who gets the bright idea that the best way to buy foreclosures is to buy out the seller-in-foreclosure’s equity before the sale occurs! This violates McMurdie’s “First Man” Rule. (See the Rule below.) Real estate foreclosures have taken place in California for over 150 years. There is close to 900 years of legal precedent and history behind statutes regulating foreclosures. Investors new to foreclosures, discovering the difficulties, suddenly have an epiphany, “why don’t I just buy the seller-in-foreclosure’s equity, own the property, and cure the default!” Brilliant!

One key aspect of foreclosures is a prospective equity buyer, the prospective foreclosure buyer, cannot simply purchase the property without triggering the due-on-sale clause contained in almost all deeds of trust, also triggering possible pre-payment penalties. Consequently foreclosure investors who purchase the seller-in-foreclosure’s equity always characterize themselves as “lenders” in contracts and in dealings with the defaulted seller.

What the equity investor wants to do is sell the house and pocket the equity as profit while paying as little as possible to the defaulted seller. This cannot economically be done paying costs of sale and title, and paying off existing loans. A straight sale will not work. To disguise the transaction, the foreclosure equity buyer becomes a “lender” with the right to take title.

Due to overreaching by foreclosure investors in the 1970s, California enacted perhaps the most draconian home equity sales statutes in the nation to protect sellers-in-foreclosure. It applies to all principle residences, one to four units, with a recorded Notice of Default pursuant to a trust deed. All manner of loans, sale-and-leasebacks, equity sales, and other ‘deals’ whereby the seller transfers title are covered by this legislation. It provides for the owner receiving back the FULL VALUE OF THE PROPERTY from the equity purchaser from the date of the first violation. It also provides the former seller-in-foreclosure with INTEREST ON THE VALUE OF HIS EQUITY from the investor, and other penalties.

Anyone interested in buying foreclosures should be familiar with these California statutes [Civil Code Section 1695 et seq.]. The legislation does provide for legal Equity Purchase (EP) Agreements that protect the seller-in-foreclosure from overreaching by any investor dumb enough to enter into a EP Agreement.

The practical aspect of this legislation is foreclosure buyers should not attempt to in any way to acquire title to a home occupied by a seller-in-foreclosure without observing this law. If the seller-in-foreclosure is not occupying the residence (one to four units), then the statute does not apply. Then the investor can, carefully, buy out the seller-in-foreclosure.

However, there are major legal risks as the seller’s equity of redemption is being given up. Buyers who intend to occupy the residence are also exempt from this legislation.
There are some investors who follow a ’system’ of buying out the equity of sellers-in-foreclosure.

In the current market there are going to be significant number of investors who violate these statutes and lose money. Buying out the equity of a seller-in-foreclosure not occupying the property as a residence should be done on a straight forward purchase contract with all facts disclosed and the agreement of lenders. Any other approach invites litigation. Any equity purchase contract, including those with sellers not in residence, should be in similar form to a Equity Purchase Agreement.

Investors I have met buying the equity of sellers-in-foreclosure are new to foreclosure buying and lack the necessary knowledge to understand the foreclosure process and legally use it. And there are some who prey on immigrants and disadvantaged homeowners.

Remember McMurdie’s Real Estate Rule No. 5: never assume you are the First Man to invent a bright new real estate investment idea. Chances are you’re not. Find out. Buying the equity of defaulted sellers by disguising yourself as a “lender” is not a bright idea. Discover the rules and procedures of foreclosure buying in Parts III-V in this series to follow!