Foreclosed for less than what was owed

[Rob K.]

I have a question about foreclosures. I know that in most states, when a property is foreclosed and goes to the courthouse auction and you are the high bidder, you own the house that day. In Michigan, if someone doesn't pay his or her mortgage, after a few months the house will be at the courthouse auction. After the auction day, the people can live in the house for free for another six months. We have one of the longest redemption periods in the country.

For this reason, most of the houses are sold back to the bank at auction as a private investor will not want to tie up their money for six months or longer. Also, if the foreclosed person is able to come up with the money owed during that six months, they can redeem the house and the investor would just get their money back along with the same interest rate that the people were paying to the bank. The people are also able to sell the property and pay the bank or investor the amount owed out of the proceeds.

What I have noticed is that a lot of banks are buying the houses back at auction for less than what is owed. They can then go after the people for the deficiency. I also understand that the people can then redeem or sell the property at the lower amount. What I'm wondering as an investor is if I can go directly to the foreclosed person during the redemption period and buy the house for less than what they owed before the tax sale. If anyone can answer the two scenarios below, please do so.

Scenario #1. Someone has a first mortgage fore $100,000 and gets foreclosed on. The bank bids $60,000 on the house and plans to go after the borrowers for the other $40,000. Could I offer to pay off the borrowers debt ($60,000 plus interest and fees) and pay them another $2,000, thus purchasing the house for under $65,000? I realize that they would still owe the bank the $40,000 deficiency, but that's not my concern.

Scenario #2. Someone has a first mortgage for $100,000 and a second mortgage of $40,000. The bank for the first mortgage bids $60,000 at the auction and goes after the borrower for the remaining $40,000 on that first mortgage. The second mortgage is now void. Could I buy the house for $65,000 as in scenario #1?

If anyone has any insight on this, I would really appreciate it. Thanks in advance.

[Dion DePaoli]

There is some mixing of concepts here that seems to be leading to confusion. Let's walk through some of the concepts:

1. Redemption periods are different from state to state. Some are before the foreclosure sale and some are afterwards. The times vary as well.
2. When foreclosure initiates, either through Summary Judgement or Trustee Agreement, the action of foreclosure is for consideration of the unpaid principal balance of the loan along with interest arrears and all advances (sometimes with interest).
3. To redeem, is to pay off the the amount owed. To who it is owed is determined by when the redemption period occurs. Usually prior to the foreclosure sale, the lender is still owed, thus to redeem is to pay all principal, fees and interest. When the redemption is after the sale, the redemption is a function of the county trustee or sale trustee. In some of those cases the amount of the "winning" bid is used instead of the note balance. Fees and interest along with outstanding taxes are on top of that number.
4. Any junior lien holder, such as a second position mortgage, which has language in its contract to allow for the advancement of funds in order to secure their interest in the collateral can do so and have the borrower obligated to said advancement. So for a second mortgage, yes, they could redeem the first position during the redemption period. Since at that time the redemption causes the foreclosure to be vacated or the mortgage/deed of trust to be satisfied, the second lien then becomes the first lien. The borrower would owe the amount due for the second lien plus the "advance" made to secure their interest.
5. Many loans have language which allows the advances to become a part of the principal balance and accrue interest at the note rate. Additionally, there is language to call for the advance to be paid or the loan can be accelerated. Moral of the story, if this is done, there are a couple ways a lender can play their cards. BTW, a first position could redeem a second position if the action would harm the first's position. Albeit, most of the time, the first will just file a foreclosure of their own. That gets a little sticky and is a topic of another thread.
6. Foreclosure bid (by mortgagee) is the minimum amount of money the mortgagee is willing to take to extinguish their lien. The mortgagee has to receive at least the minimum, which they send in as a "bid" and can receive up to the total amount owed including all principal, interest and advances. The amount owed is usually calculated by the court or a trustee depending on foreclosure process. The minimum foreclosure bid from a mortgagee varies county to county in every state. Some have no minimums and some have large percentages of what was owed. A bank does NOT "pay" when it wins the a foreclosure bid, the property reverts to the ownership of the mortgagee. In a sense, the "payment" was the capital used to make the note in the first place. The bank can pick any number they want as a bid number to send in. If there is no minimum requirement by the county, they could send the asset to sale for $1.00. This has no relation to the fact they are owed the entire amount due, which they receive all overages from the initial bid until the total due is paid in full. Then the next lien holder is paid or the borrower, etc.
6. Deficiency is state specific. Not all states allow deficiency recourse. For those that do, deficiency is the difference between the proceeds collected and the total principal outstanding. This only includes the shortfall of the unpaid principal balance and the received funds not interest and advances.
7. A Deficiency Judgement, which I think most folks refer to when they say "deficiency", is a court action. This is where the deficiency is monetized and judgement is rendered allowing the holder of the judgement to collect from the defendant (borrower). This is separate and distinct process. And that is important to understand. In this court process, the mortgagee must assert the collected proceeds or value of the property as a function of the court calculating the judgement. So if the bank took the property back at FCL sale, then it brings a value report such as appraisal or BPO, etc. If the home sold, then the net sale price is used as the assertion of value. A winning bidder at foreclosure sale or in the open market is a sale and that is the "value" used in calculating the judgement. This action also allows the mortgagee (plaintiff) to assert the costs of the entire process including foreclosure costs and legal costs for deficiency along with the accrued interest.
8. A Deficiency Judgement process is a separate court action for the borrower, which the borrower can defend themselves. If a judgement is rendered, then the judgement is public record of who is owed the money, who is due the money and how much. Deficiency judgements have a secondary market where they trade as they are of value. Once a judgement is granted a defendants wages can be garnished and other harsh collection tactics can take place. All that said, just because there is a deficiency does not mean there is a deficiency judgement nor does it guarantee a favorable court judgement in favor of granting said judgment. A plaintiff (mortgagee) can loose at court. (not a chance most take though)
9. As stated, some redemption rights can be transferred and some can not. State specific and really only applies to those redemption periods after foreclosure sale. Since prior to foreclosure sale, you are really buying the actual note and mortgage/DOT.

Now here are the scenarios:

Scenario #1 -

The bank sends the property to sale with a bid of $60,000. This is not a published number and you would not ever know this number prior to the sale. The property does not sell at the auction. The property reverts back to the bank with a certificate or similar instrument. The property goes into redemption (after the sale).

The amounted owed to redeem is paid to the sale trustee, which most of the time is the county. Usually, the borrower has to file for a redemption certificate with the county for a nominal fee. The county will use the "winning" bid to calculate the redemption amount which will add on interest at the note rate and other fees for the sale and at times outstanding taxes or city/county liens.

Because in this example, the redemption is after sale, the mortgagee has no control over what is paid to redeem. A purchase and sale real estate contract could be used to effect a transaction between the current owner and the investor. The proceeds would just have to be sent to the trustee with the redemption certificate. Likely a task you could get a title company/attorney to handle at the point of sale. I would not walk to the county window and pay for redemption without a contract. In other cases, you can the borrower go get the redemption certificate and then purchase that from them or some other arrangement. The possession of the redemption certificate is what allows you to redeem.

Title insurance will be a little hairy in this, depending on the agent, since title is clouded with the redemption. The title could be insured after the redemption occurs, which might be after the point of sale, if need be I suppose.

Scenario #2
Mortgages are not "void", they are extinguished. (pet peeve of mine, sorry) Provided the foreclosure process extinguishes the second position. Which not all foreclosures do. Then the same set of events occur as above.

In a situation where the second lien survives, then they could foreclose you.

In properties that have equity, usually both liens will file foreclosure, since that is a provision they have available to them. In cases where there is negative equity, many cases the second lien choose not to advances any additional funds to protect their interest or enforce the security instrument.

Note: Any lien holder can usually redeem (can't think of anywhere that is not true off hand), that is the point in having a lien in the first place. This is the case for the state of Michigan. An uninterested third party can not redeem, since they have no interest in the property. In order to redeem you have to get a certificate of redemption. Getting a certificate can be done by proving interest in the property and like I said usually requires a fee first.

The answer to the question everyone was thinking....yes, you can work this sort of loophole, if it is present in your state to obtain the property and possibly avoid other headaches with REO or alike.

(For those "A+" readers, in theory, you could establish an interest in the property with the borrower, file the lien and then go apply for the certificate without the borrow. That is, since you as a lien holder hold the right to redeem to protect your interest. This is not as taboo as you might think.)