1) Bid at the foreclosure sale

2) Buy an REO from the lender

3) Negotiate a sale with the distressed property owners

The Foreclosure Process

When borrowers fail to make their scheduled mortgage payments, or when owners fail to pay their property taxes or some related obligation such as homeowners' association fees or special assessments, transfer a mortgaged property without lender approval, or undertake renovations that diminish the value of the property, because a contract is shirked, foreclosure can occur.

A legal "notice of default" or a "lawsuit to foreclose" (depending on the state) is typically filed to initiate a foreclosure. This formally announces to the property owners, other parties who may have legal claims against the owners or their property, and the public in general that legal action is moving forward to force a sale of the property. This notice is delivered to the borrower at least one month before a sale (typically between 60 to 180 days) and subsequently posted on the Internet or in newspapers as public notice.

In response, the borrower can do several things to prevent or delay the process.

1) Workout the loan with the lender and perhaps reinstate or even refinance their mortgage defaults.

2) File a legal defense against the lender and in turn drag the process into court and delay it for a year or longer.

3) File for bankruptcy and automatically stay the action. Bankruptcy courts have even been known to annul a foreclosure sale that has already occurred.

Okay, but with no loan workout, and when legal defenses or delaying tactics are ignored or run out, the sale date arrives and the property is auctioned to the highest cash bidder. Thus bringing us to the first way you might profit from foreclosures.

The Foreclosure Sale

Though foreclosure sales typically lose money for lenders, lien holders, and property owners because foreclosed property sells at a price lower than market value, foreclosure auctions are not that easy because they are not a typical market value transaction.

No information about the property is given other than its legal description. You must pay cash. There is no "contingency" allowance for financing. The property is sold "as is" with no guarantees or assurances about the title, condition, environmental hazards, or even that the property will be conveyed free of occupants (you may inherit the owner, tenants, or squatters).

It's true that savvy bidders can turn big profits at the auctions, but there is a caveat. Never bid blind at a foreclosure sale — you have to do your homework.

REOs

Lenders that win the bid at an auction classify and sell the property as an REO ("real estate owned"). Thus bringing us to the second way you can profit from foreclosures — purchase an REO direct from a mortgage lender.

Since lenders often want to remove REOs from their books as quickly as possible, they may grant buyers favorable terms such as low or no closing costs, below-market interest rates, and low down payments. Moreover, when the property needs fix-up work, lenders are prone to accept offers at a discount price. Lenders don't give REOs away, but you can get good deals.

You can find REOs by attending and following up after foreclosure sales, or by contacting a real estate agent who markets REO listings.

Distressed Owners

Lastly, you can profit from foreclosures by buying property from distressed owners.

Divorce, job loss, accident, illness, business failure, and other setbacks do cause people to miss mortgage payments and get into foreclosure. You may be able to help them salvage their credit record and some equity, while at the same time secure a bargain for yourself.

But the "get rich quick" gurus greatly exaggerate the possibilities of profiting from property owners who face foreclosure. The reality is that when you talk with property owners in default, you're far more likely to uncover a minefield of problems requiring skill and creativity then just a simple deal.

Owners who are in foreclosure, for instance, typically owe more on their mortgage than their properties are worth. This means you must talk the lender into a "short sale". The lender must be willing to reduce the balance due on its loan so you are able to receive a reasonable profit for agreeing to make up delinquent payments and take over the loan. This is not easy.

Furthermore, many who face foreclosure contend with the claims of multiple creditors. You must be sure that none of those creditors has filed a lis pendens, or the IRS a tax lien. If so, you will have to clean it up to gain clear title.

Moreover, before you finalize a pre-foreclosure purchase, be sure to thoroughly inspect the property and accurately estimate the costs of repairs, renovations, and perhaps environmental cleanup. You will never profit from foreclosures if you gloss over property inspections and make only an eyeball guesstimate of expected costs.

Finally, bear in mind that someone facing foreclosure will not be an easy person to deal with. So don't act like a shark. Instead of a "Here's my offer-take it or leave it" approach, why not take a sensitive, empathetic, problem-solving approach. You're more likely to come up with a win-win agreement.

Here's to your success.