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Article of the Month for March 2003 Printer friendly version

Foreclosure Risk Factors

There is no doubt that foreclosure investing is a lot riskier than more conventional forms of real estate investing. There are certain irreducible risks involved that can't be avoided, no matter what you know and do, unless you avoid buying foreclosures altogether. However, the probability of an outright, total loss due to the occurrence of an irreducible risk pattern is small enough to be tolerable to the knowledgable professional.

Almost all losses though, for both the professional and novice alike, can be avoided if they do their regular research rather than just "winging" it or cutting corners.

  1. Losses and errors usually revolve around three broad areas:
    1. Mistakes about the amount of equity available . . . what's left over after subtracting remaining senior liens from the actual market value of the property.
      1. Did you overlook any senior liens because you forgot to check for:
        1. Unpaid property taxes, bonded assessments, association dues, etc.
        2. Subordinations to subsequent liens.
        3. Involuntary liens (judgments, IRS, etc.)
        4. Pre-existing, older liens and/or unpaid back payments and penalties on same.
        5. Mistook an "all-inclusive" trust deed (AITD) for the senior lien.
      2. Did you over-value the property because:
        1. You didn't use or ignored applicable comps.
        2. You didn't bother to make a cursory check of its exterior condition or setting.
        3. You misjudged the extent of necessary rehabbing.
      3. Did you look at the wrong property because:
        1. You did not verify and match the street address with the property's legal description. You assumed that your foreclosure notice service was always correct and accurate.
        2. You weren't aware that some owners falsify their street numbers to put off process servers, etc.
      4. Did you just assume you'd be getting 100% title and therefore:
        1. You did not verify that ALL owners had signed the trust deed being foreclosed upon.
    2. Legal (non-compliance) issues.
      1. Many authors and lecturers, trying to appeal to the largest possible audience, tout the great bargains that can be had for hardly anything by dealing directly with owners in default before the trustee's sale takes place. The recurrent theme is that such owners are under so much pressure that they will make someone a fantastic deal to avoid losing everything. However, the California legislature has passed two very restrictive statutes to protect home owners in just such a circumstance. Read the statutes carefully, practice meticulous compliance and work closely with a title company that'll issue unconditional title coverage.
        1. Civil Code 1695 - "Home Equity Sales Contracts"
        2. Civil Code 2945 - "Mortgage Foreclosure Consultants"
    3. "Hidden" issues not found in the title record.
      1. Zoning changes, sewer moratoriums, health/building code violations, boundary disputes, "bootleg" improvements, pre-foreclosure legal disputes, etc. •

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