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Buying at a Foreclosure Auction
Risk Versus Reward
A recent business page headline in The Boston
Globe proclaimed "Mass. foreclosure deeds rose 148 percent in 2007". The current
real estate market (where it seems everyday brings new reports of increases in
the record number of foreclosures) may cause a prospective buyer to consider the
possibility of trying to find a "bargain" at a foreclosure auction. The
difficulty with what can be perceived as a foreclosure "bargain" is the very
real risk a bidder exposes him or herself to in the process. A prospective buyer
must seriously weigh the risk versus the potential reward before considering
whether to bid for a property at a foreclosure auction.
Massachusetts foreclosures are governed by
Massachusetts General Laws Chapter 244. When circumstances cause a borrower to
be unable to make his/her monthly mortgage payment it results in a default of
his/her obligations under the Promissory Note (the promise to pay back the
amount of the loan to the bank signed contemporaneously with the mortgage). Once
a borrower is in default the lien holder (the bank) is authorized by law to sell
the property by foreclosure auction (pursuant to the power of sale contained in
the mortgage) in order to satisfy the defaulted Promissory Note.
The prospective buyer will ordinarily become
aware of the foreclosure auction as a result of a published notice (in the legal
notices section of a local newspaper) required by the court where the
foreclosure action is filed. The publication contains a description of the
property, a foreclosure sale (or auction) date, the recording reference of the
foreclosing mortgage and the terms of the sale (required deposit - often
$5,000.00 - $10,000.00; and days within which to pay the balance - ordinarily 30
days). If the statutory provisions governing foreclosure sales are strictly
complied with (by the foreclosing attorney's office) then the foreclosure
auction can result in the transfer of the property to the successful bidder.
Without sufficient research and preparation a
prospective buyer could attend a foreclosure proceeding very much handicapped.
The foreclosing bank will require at the auction that a "Memorandum of Sale" be
signed by the successful bidder. The usual Memorandum of Sale will place all
title risk on the buyer. The foreclosing bank makes absolutely no warranties
about the property but rather represents that they (the foreclosing bank) will
only convey the interest that they have - subject to any liens, obligations or
other rights senior to the foreclosing mortgage. In short this puts a
prospective buyer on notice that there may be any number of hidden risks in the
purchase of the property. Although, assuming notice provisions are complied
with, second mortgages and some other liens will not survive a first mortgage
foreclosure auction some liens are superior in the eyes of the law and will
survive becoming the obligation(s) of the successful bidder.
For instance if there are federal or state tax
liens (for a failure to pay income or other taxes) which have been recorded with
the Registry of Deeds such liens would remain against the property despite the
foreclosure sale. In other words the successful bidder would be responsible for
any federal and/or state tax liens above and beyond the successful bid price.
Depending on the amount of a tax lien this circumstance can greatly change the
equation of a property being a "bargain". Real estate taxes, municipal liens and
Town Tax takings (for failure to pay real estate taxes) can also become the
responsibility of the successful bidder. The risk that several years of real
estate taxes are outstanding could amount to a substantial sum owed. Some towns
have municipal water, sewer, electric and/or gas which could result in
additional sums owed on the property. The prudent auction bidder should
investigate these items on each property in which they are interested.
Another item that must be considered is the
septic system at the property. If the property is not serviced by town sewer
then its septic system is subject to the requirements of Title V of the
Massachusetts Code of Regulations. The usual Memorandum of Sale specifies that
the successful bidder assumes all responsibility for compliance with Title V
(septic system requirement) of the state environmental code. If a property has a
defective (non-compliant) septic system the requirements of the repair or
reconstruction will also fall upon the successful bidder. That cost could be a
real variable. A newly constructed system could be as expensive as Thirty to
Forty Thousand Dollars. This type of a "surprise" after foreclosure would
certainly dramatically alter what a successful bidder had thought was a
"bargain". The Memorandum of Sale is also going to place on the successful
bidder the danger of any lead paint risk as well as the requirement to install
smoke and carbon monoxide detectors. If the property is a condominium there is a
possibility of unpaid condominium fees and/or assessments which could also be
the responsibility of the successful bidder. In short at the foreclosure auction
the foreclosing bank is selling to you what it has, "as is" - with all defects.
Another obvious risk of buying at auction is
that the people being foreclosed upon remain in the property. If this is the
case the only legal way to remove the tenants from the property is an eviction
action. Obviously the expense of an eviction and the danger of a disgruntled
tenant causing physical damage to the property must be considered by the prudent
prospective purchaser before bidding at auction. The usual Memorandum of Sale
also transfers to the successful bidder the insurance risk of the property.
Accordingly once a bid is accepted the successful bidder must place property
insurance on the property. If there is a fire at the property prior to the
successful bidder placing insurance on the property the terms of the Memorandum
of Sale still require that the successful bidder purchase the damaged structure
at the full bid price. The usual Memorandum of Sale also mandates that all
recording fees (including the State Excise Tax required on the transfer on real
property - which is ordinarily paid by the seller) to be paid by the successful
bidder. The State Excise Tax is currently Four Dollars and 56/100 cents ($4.56)
per thousand. For example if a successful bidder paid Four Hundred Thousand
Dollars ($400,000.00) for the auctioned property he or she would be responsible
for an additional One Thousand Eight Hundred Twenty Four Dollars ($1,824.00) tax
stamp.
The potential problems mentioned in this article
are common items but do not represent an exhaustive list. Other hidden dangers
could also surface. At a minimum, to prudently bid at a foreclosure auction for
real property a prospective buyer should have a title search (by a title
attorney) performed on the property. It also is essential to investigate the
current status of the property's real estate tax and municipal services billing
(including water and sewer as well as any other municipal costs) and to find out
what information is available regarding the septic system (if applicable). These
"legal items" don't even factor into the consideration the market value of the
property (an imperfect science at best). There are significant and numerous
risks inherent in purchasing a property at a foreclosure auction. It is not a
simple process and anybody considering bidding at a foreclosure auction should,
at the very least, consult with a licensed real estate attorney.
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