Today I will be posting a short guide about creating a residual income through real estate. Part 1 will be covering different types of discounted properties.

Produce Income by Buying Mortgages

You can invest in mortgages, just like Wall Street’s Mortgage Securities but on a smaller scale. Make money in the same method by buying discounted mortgages. What is it? Here is a scenario that explains how it works:

Mr. & Mrs. Smith find a house that they want to purchase. They both have excellent credit and earn decent incomes, but the Smiths are $5,000 short of their required deposit. Interest rates are at 7.5%, and they ask the sellers of the property to if they would be willing to take out an interest-only, 8 year mortgage.

What is an interest-only mortgage? It’s when only the interest is paid during the life of the loan and the full amount of the actual loan is paid when the loan matures.

In our scenario, if the home’s purchase price is $100,000, and they need an interest-only mortgage for the $5,000 down payment, then the Smiths would pay $500 each year for 8 years, and in the 8th year, also pay off the full $5,000. In the meantime, they would have two mortgages on their new home.

Whenever property is sold, information regarding the sale of the home is recorded at the country courthouse of the Town or City Hall. The information becomes public record. The information in these records includes:
• Purchase price
• Liens on the property
• Taxes
• Buyer’s and Seller’s names
• Mortgage amount
• Lender Name(s)
Given this information, how do you use it to generate income? First, go to the place where the public documents are recorded and look for properties that have a 1st and 2nd mortgage on them. The first mortgage is typically a financial institution, and the second is sometimes an individual.

Gather 15-20 of the second mortgage holder’s names, and research to find their phone numbers. Call them, introduce yourself, and offer to buy the mortgage, at a discount.

Here is a sample script of a conversation:
You: “Hello, Ms. Jones? My name is John Doe. I invest in real estate, and the town public records here in Anytown indicate that you hold a mortgage for $5,000 on the home at 1 Main St. Am I speaking to the right person?
Ms. Jones: “Who are you again, and how do you know about this mortgage?”
You: “I’m a real estate investor, Ms. Jones, and I wanted to buy your mortgage for cash. I purchase this kind of mortgage often, and I just wanted to see if you are interested in selling for cash?”
Ms. Jones: “What do you mean? How does this work?”
You: “I would pay you cash to purchase your mortgage at a discount. I could give you $3,000 for it. Does that interest you?”
Ms. Jones: “Umm, yes. I think I’d consider it.”
You: “Okay, I can draw up a proposal, and we can meet at your lawyer’s office to go over it.”

Important points to consider in this conversation are:

• The amount of your offer should ideally be 60-75% of the loan value to ensure that you make a profit.
• There are two reasons that Ms. Jones would consider selling the mortgage at a discount.
• Managing the payments and collection process for the loan payments has become more of a headache than it’s worth to Ms. Jones.
• A large lump sum of cash is attractive to Ms. Jones.

A 30% possible profit on this situation can be factored as:
Mortgage Amount - $5,000
Your Purchase Price - $3,000
Remained of Term - 5 years
Interest Rate (original) - 10%
Monthly Profit + $41.67
Annual Return =$500/$3,000 = 16.7%
Total Interest You’ll Get - $2,500
Discount - $2,000
Total Profit - $4,500
Average Return Annually ($4,500/$3,000) / 5 years = 30%!

Using Foreclosures to your Advantage

Another way to make money investing in real estate is through foreclosures. Foreclosure is the result of past due payments on a mortgage. If you lapse in mortgage payments to your lender, the lender will take the necessary steps to get their money – by selling the house.

Educate yourself before attempting to buy a foreclosure property. There are many classes, seminars, books, and websites that have valuable information. Research the local tenant/landlord laws regarding defaulting on payment and eviction processes. Find out if there are rent controls in your area.

Foreclosure law is created and managed at the state level. It is in your best interest to learn about your state’s laws regarding foreclosures. Some states have deeds of trust, others have mortgages.
There are three phases of foreclosure:

1. The pre-foreclosure phase
2. The auction of a foreclosure
3. The post-foreclosure phase
   In the post foreclosure phase, the lender is paid – one way or another. Remember that the primary interest of the lender is for money, not property.

To make money on foreclosures, you need to be involved in the process before they public learns about them. The public usually learns about foreclosure property when it is announced in the newspaper. For the homeowner, missing two or three months of payments will start the foreclosure process moving. After another 4-6 weeks, the case is handled over to the lender’s attorney, who will send additional letters, and set a cure date. The cure date is the last date that the property owner can settle payment before the property goes up for sale at a foreclosure auction.

You will have more leverage the earlier you involve yourself in the process. Leverage is the ability to take a little money and use it to do large scale things. You have the ability to create a win-win situation for the property owner, yourself, and the lender. The property owner will get out of an embarrassing situation and help protect their credit, you will make money, and the lender will get paid.

First, you will need to learn about the different security instruments, determine which is used in your situation, and then determine the method of foreclosure. There are various laws and foreclosure processes depending on the state or country where the property is located. The two types of security instrument used in the United States are mortgages and Deeds of Trust.

A Closer Look at Judicial Foreclosures

Judicial foreclosures are handled within the court system. This type of foreclosure using takes the longest time to process because the court must agree with the final bid to avoid exorbitant discrepancies between the property value and the bid.

**What happens in judicial foreclosure? **

First, a pending action, called lis pendens is filed with the local Clerk’s Office. This is the official notice that the action of foreclosure has been started against the mortgagor. After lis pendens is filed, no other liens can be added. Before involving yourself in any way with a foreclosure, be sure that all parties involved – the owners, renters, lease holders, creditors, etc. – have been given notice properly. If the notice process is not handled correctly, existing tenant leases may still be legally binding after the foreclosure process.

The second step of a foreclosure is the appointment by the court of a referee. The referee posts the property foreclosure auction in the local newspaper, typically under the section called “Legal Notices.” The referee handles the auction. He will announce the terms and conditions of the sale, and open the bidding at an “upset price.” The upset price is the opening bid amount, and is determined by the court. The factors included in determining the upset price include the mortgage balance, back taxes, interest, liens, court fees, legal costs, and any judgments on the property that were in place before lis pendens went into effect.

The winning bidder will get a Certificate of Sale after the auction. On some properties, there is still the chance that they deal can fall through. If the deal included a Statutory Right of Redemption clause that remained in effect past the auction, this could be the case. Without this clause, the property deed (sometimes called the Sheriff’s Deed) goes to the winning bidder.

An In-Depth Look at Non-Judicial Foreclosures / Power-of-Sale

Non-judicial foreclosures are the same as the power-of-sale method of foreclosure. These foreclosures do not involve the court system, and the trustee can sell the property title outside of the courts if payments have not been made on the loan. This will avoid a long, drawn out court proceeding. Non-judicial foreclosures are sometimes called a “Trustee’s Sale.”

How do non-judicial and power-of-sale foreclosures work?

First, the Trustee files a “notice of default”, and officially notifies the Trustor. The sale occurs, and it is final. In trust deed states, there are no rights of redemption or deficiency judgments. As a protection for yourself, have your lawyer include a contingency clause that gives you the right to perform inspections following the sale. Be sure it allows for adequate time to complete the inspections.

A recommended reference for a state-by-state guide to security document and foreclosure methods is Your Fortune in Foreclosure: Today’s Best, Low-Risk, High-profit Real Estate Investment, by Fredy Bush, Carl Hunter and Bruce Erb, pages 199 to 204.

What is a Deed in Lieu of Foreclosure?

We have all heard the saying, “the early bird gets the worm.” This theory stands true when investing in real estate, too. How do you get the inside scoop on real estate investments?

1. Look for newspaper real estate listings that say either “For Sale by Owner” (also called FSBO), or something like, “Must sell, all offers considered.”
2. Find out the owner’s contact information on properties that appear to be abandoned, and call them.
3. Research probate court cases that involve divorces, deaths, and business failures to determine if there is real estate left on the table.
4. Contact relocation companies and title insurance companies to ask for real estate referrals.
5. Act on the foreclosures listed in the newspaper.
6. Watch the lis pendens or Notice of Default filings at the country courthouse or the Clerk’s Office. You can either do this yourself, hire a college student to do it for you, or buy them from a list service. The first two ways give the highest returns usually, because the list service has a large distribution list.
7. Internet real estate services. Try www.therealestatelibrary.com as a starting point.
8. If you want to buy your primary residence, look into HUD and VA. Their websites have links to government-linked sellers of repossessed homes.
9. Find out about investment clubs in your area.
10. Open accounts at area banks. Network with the bankers and lenders because they handle mortgages, loans, and are in contact with property owners in financial distress.
11. Focus on real estate agencies. When home owners know foreclosure is eminent, they usually contact an agent to try and sell the property on their own. Let area agents know you are a real estate investor.
12. Become a licensed real estate agent, and create a niche in foreclosure properties.
13. Contact law offices that specialize in real estate law, because they are the ones that distressed homeowners contact at the beginning of foreclosure proceedings. Although attorneys can’t disclose information because clients are protected by a code of ethics, the attorney can keep your business cards for referrals.
14. Market yourself by posting an ad in the newspaper of the area you want to buy in. Make up flyers and post them on public boards, car windows, and canvas the neighborhood, looking for people considering selling their home.
15. Ask builders and contractors if they have any leads on prospective sellers.

Foreclosure Process & Property Selection Tools

To make the decision process easier, use these tools as a template to develop your own system. The subsequent forms will be used to help sort out the many factors that go into determining the best investment opportunity.
Step 1: Find a property that is within the first 3-4 months of the foreclosure process. Go look at the property and talk to the owner. Figure out the market value by researching comparables in the neighborhood. Find the most up-to-date appraisal at the Clerk’s Office. Keep a detailed folder on each of your potential properties.
Step 2: Call the trustee, or whomever is responsible for the property, and go visit the property to examine it inside and out.
Step 3: Find out the financial status of the property. Contact the lender to get the amount of the balance on the loan. Also ask about any additional charges and legal documents that will be required to sign. Inquire about any liens, mortgages or second mortgages on the property.
Step 4: Do a comprehensive title search on the property, looking for any liens or judgments. If there is a shadow of a doubt of problems with the title, don’t do it. There could be problems with the sales process involving the conveyance of the title that would cause delays and cost you money. Have an attorney review all documents and get title insurance as protection.
Step 5: Have your lawyer draw up a deed and get the owner sign it in the presence of your lawyer. Have it notarized. The owner of the property must sign the deed because you cannot buy property without the owner’s signature. Be sure to have full coverage insurance on your new property (fire, theft, vandalism, etc.)
Step 6: Have all papers and a cashier’s check brought to the trustee. This will cure the situation. Lastly, record the deed with the appropriate city or town offices.

Tips for Buying Foreclosure Property at Auction

If you decide to buy foreclosure property by going to an auction, consider these tips:
• Attend a few auctions to just watch the process before you actually plan to bid.
• Do your homework about what you should bid before you go to auction. The lender will start the bidding with the amount that includes the foreclosed mortgage balance, taxes, liens, fees, etc. You bid needs to be at least this much, but less than the market value so you can make a profit.
• Know the rights that you, and the original property owners, have under your state’s laws.
• Find in out in advance if bidding is through sealed written offers, or if it is verbal.
• Find out how much money is needed up front and what the schedule of payments will be for the remainder.
• Inquire whether it is a regular deed or a Torrens title. A deed is required to sell a piece of property, and if it’s lost, a regular deed is easy to replace, but a Torrens title is not.
• Your bidding strategy should be to bid based on the mortgage balance. Don’t fall into the trap of bidding based on market value or you might over bid.

The World of REOs

REOs, otherwise known as Real Estate Owned property, are real estate that goes back to the lender or government after the foreclosure auction takes place. There are two main reasons why this happens: either the property was bid on by the bank and they won it back, or it did not sell at auction.

To get the insider information on REOs available in your target market you will need to network with bankers, lenders and real estate agents in your area. When REOs fall back into the hands of the lender, they sell them in a variety of ways. They are sometimes sold directly from the lender themselves, or through auctioneers, real estate brokers, private mailing lists, or on the internet.

The follow chart details the pros and cons of investing in REOs:

Pros
• You might get a better interest rate
• It might be offered at a discounted price
• You’re able to inspect the inside of property
• They’ve handled any necessary eviction process
• You have more time to set up financing
• They can be more flexible with terms and financing options
Cons
• The sale price will be closer to market value than if sold at auction
• A real estate broker or agent can prevent the deal from going through
• The lender may not give you financing
• There might not be flexibility with the lender’s terms
• There may be many repairs necessary

To be continued in Part 2: Tax Liens and Rental Property