Foreclosures remain high in this market, and many buyers look to foreclosures as a way to get a potential deal. In Washington state, and many other states, a home that is foreclosed is sold at a trustee auction through a process called Non-Judicial Foreclosure. It is called a non-judicial foreclosure because the auction process is kept out of the court system. While judicial foreclosures are technically possible in our state, the costs involved in passing it through the courts is usually not worth the hassle, so virtually all foreclosures happen at a trustee auction. The mechanics of a trustee auction are pretty simple. The bank holding the mortgage on the home transfers the property deed to a company called a trustee, who then facilitates the auction of the property and transfer of the deed. I spent last Friday at one of the local trustee auctions and wanted to give the low down on how the whole process works in our state.
NOTE: Foreclosure laws differ significantly from state-to-state. Some states use the court system and some do not. Your state may be similar to Washington, or it may not. I recommend doing your own research and seeking the advice of local professionals involved in foreclosures if you are serious about participating in a foreclosure auction.
The Trustee Auction
If you’ve been to any sort of auction before, you may be surprised by the environment at a trustee auction. It is a low-key affair that lacks the carnival-like atmosphere you see at other auctions. The auction is required to be held in a public place. In Seattle there is one that happens outside of a trustee’s office building in Factoria, and another that happens outside the courthouse. The auctioneer is an employee of the trustee, and he is responsible for the auction process. Other than cell phones glued to everyone’s ear, it is notably low-tech. The auctioneer carries a stack of deeds to be auctioned, a clip board to track the results, and a bank deposit bag to collect the cashiers checks for the purchases. The auctioneers I’ve seen are quiet and low-key. They don’t even use a microphone, so sometimes you need to strain to hear what is going on. Trustee auctions draw a small crowd of folks. There are a few companies who assist buyers and investors with purchases at the auction, and they attend every week. You’ll also find a small group of folks looking to buy their own home or investment properties, plus a group of onlookers who are curious about the process.
Which Properties Get Auctioned
In Washington, a property to be sold at auction receives two written notices. The first is the Notice of Default, which states that the loan is in default. Thirty days after the Notice of Default is issued, the bank can issue a Notice of Trustee Sale. After issuing the Notice of Trustee Sale, the bank can send the property to auction after 90 or more days.
The most interesting and challenging part of buying at a trustee auction is trying to figure out exactly which properties will be auctioned on which day. Postponements and cancellations of sales happen all of the time. Sometimes they delay the trustee sale because the bank is trying to work through a short sale, and sometimes they delay the auction because an owner is trying to work out a payment plan. The day I was there, there were 127 properties scheduled for auction, and 105 were delayed or postponed. Postponements may happen right up until auction day, so you won’t know for sure if a property will be auctioned that day until the very last minute.
Figuring Out the Minimum Bid
The other challenge with trustee auctions is figuring out the minimum bid. This is the minimum amount that the foreclosing bank will accept at the auction. If no one makes the minimum bid, the property ownership is transferred to the bank. How do banks set their minimum bid? Prior to the auction, banks hire an appraiser or broker to help them determine a fair market value for the house. They determine what the home will sell for if they have to sell the home as a bank-owned property, factoring in their foreclosure and marketing costs, and also factoring in what they are owed on the property. If the amount owed the bank is high, and they believe that it will sell for a decent price as a bank-owned property, the minimum bid is often set high enough that it will not garner any bids at the auction.
To determine your bid at an auction, you need to know the bank’s minimum bid. This is an elusive piece of data. In most cases it is not determined or published until a few days before the auction. In fact, many banks don’t name their minimum bids until the auction is actually underway! You’ll see the auctioneer frequently stop the auction process and take a call on his cell phone. What he is doing is receiving the minimum bids from banks for properties further down his list. Sometimes you won’t know the opening bid for a property until it comes up at the auction, so you need to be prepared for whether or not you are interested in bidding at a particular price.
Qualifying for an Auction
When a property is auctioned, the auctioneer reads off the legal description of the property and some required legalese and then asks if anyone wants to qualify for the auction. What does qualifying for an auction involve? You need to put your name on the auctioneer’s list, and show him that you have certified funds (cashier’s checks) up to a certain amount. He will count your cashiers checks and mark down that you are qualified up to whatever amount you have brought with you.
The Bidding Process
Once the auctioneer names the opening bid, he opens up bids to those who have qualified for the auction. You can bid in any increment over the minimum, and the auctioneer will mark down the bids on his clip board as things progress. Sometimes you might be the only bidder, but other times, you may be bidding against a few other people. Frequently the bidders are brokers who are working on behalf of their buyers. Those buyers may be standing behind them at the auction, or they may be in touch via cell phone. The actual auction is actually somewhat fun to watch, in a low-key, yet intense sort of way. There are a lot of poker faces at the table, almost like those Texas Hold ‘Em tournaments you see on TV, and sometimes they will trade little jokes back and forth with the other bidders. The auction proceeds until no one raises the bid any further. It is clear that each of the bidders has set a maximum bid amount prior to the auction, based on their assessment of the market value of the home and risks they are taking.
Paying for a Winning Bid
If you win a bid at a trustee auction, you must immediately pay for the property with certified funds, which are cashiers checks. Bidders bring cashiers checks in varying increments to the auction, and then sign them over when the auction is complete. Buying at an auction does require all cash, and traditional mortgages are not available. However, there are hard-money lenders out there who will make high-interest/high-fee short-term loans to auction bidders. If you are using a short-term loan, you will have applied prior to the auction and the lender will have the funds available for you there. These loans are quite expensive, with high upfront fees and usually do not last for more than a few months, so you need to immediately work on replacing them with a traditional mortgage once you own the property. This is one of the riskiest parts of buying at the foreclosure auction, and you need to make sure that your loan plans are lined up and pre-approved prior to making your purchase. Also, these short-term loans often require a down payment of 20%+ from your own funds, though lower down payments may be available for higher fees.
The Risks of Buying at a Trustee Sale
There are attractive prices available at a trustee sale, though sometimes only for a handful of properties. If you are looking to participate, do not underestimate some of the risks that you are taking. We already talked about the difficulty of financing such a transaction, but there are some key things you need to evaluate before plunking down your hard-earned money.
- “As-Is” – You are buying the property in as-is condition. On something like 30-40% of the properties, you may have had a chance to go inside because they were previously listed for sale. For most properties, you don’t get to go inside and you don’t get to hire an inspector to evaluate the property. Any defects become your problem. At a minimum, you need to look at the outside of the property and get a feel for its condition. This risk is why foreclosure investors insist on getting a steep discount at auction, as you never know exactly what problems a home may have. A home priced at $50k under fair market value at the auction is not a deal if it requires $50k of repairs to bring it to sellable condition!
- Get a title report – Work with a local title company to evaluate all liens and encumbrances against a property. You don’t get a title insurance policy at a trustee auction, so you need to understand any major issues recorded against the home prior to your purchase. Some of these issues may be extinguished by the trustee sale, but some may become your problem to clear up. This is particularly important if you are looking to resell in the near term.
- Set your price limits – Don’t get wound up by the excitement of the auction. Set a conservative bid limit prior to the auction and stick to it. Overpaying for a home is never a great idea, but it gets worse if you overpay at a trustee auction for a home that has a bunch of unseen issues.
Successfully navigating a foreclosure auction purchase is not a part-time job. Evaluating which properties will actually be auctioned, tracking the minimum bids, and evaluating the condition of the potential properties require a lot of time. Not to mention, if you are serious about buying at the auction, you need to spend hours there waiting for your properties to come up for bid. If you can’t dedicate the time or are new to the process, hire a real estate broker to help you who does this for a living. Their fees are nominal compared to the time requirements involved in being a successful buyer at the foreclosure auction. Do NOT hire a real estate agent who is unfamiliar with the process.