Please explain why lenders do not bid more than they are owed, and why the foreclosing lender is often the only bidder at foreclosure sales.
A. Why Foreclosing Lenders Almost Never Bid More Than They Are Owed.
Lenders are required to bid at foreclosure sales. When bidding, lenders receive a credit for the debt they are owed. As long as a lender bids less than, or equal to, the amount it is owed, lenders need not bring funds to a foreclosure sale. If lenders bid more than they are owed, they need to bring funds to the sale for the difference.
Institutional lenders who foreclose do not want to own the property on which they are foreclosing; they prefer to have their loan paid off. It is even this author’s experience that most “hard money lenders” (lenders who make loans based on the value of the collateral, less mindful of the borrower’s ability to generate income to repay the debt) do not want to end up owning the foreclosed upon property. While the occasional hard money lender does “make the loan to own,” and while the occasional commercial lender is enthusiastic about scooping up the equity in the foreclosed upon property, these situations are exceedingly rare. Lenders hope that a higher bid at the foreclosure sale, or a post sale redemption pays off their loan. Even in situations where there is value in the property which exceeds the sum of the debt senior to the foreclosed loan and the foreclosed loan, it is exceedingly rare for foreclosing lenders to bid more than they are owed.
If the property is worth more than the lender’s debt, the lender is typically tickled to be out bid.
B. Why Foreclosure Investors Generally Do Not Bid at Foreclosure Sales (and why this might change in 2008).
Foreclosure investor purchases are quintessentially “as is” purchases, typically without an opportunity to inspect the property. The owners and borrowers often have nothing to lose, and securing possession of the property can be problematic. Finding suitable foreclosure investing opportunities is similar to looking for a needle in the haystack. For these reasons, and others, foreclosure investors require high profit margins.
If a property is a good target for one investor, it is likely to be a good target for another investor. Prior to 2008, Colorado foreclosure law essentially permitted owners and investors to create redemption rights for investors after the foreclosure sale. If an investor was the successful bidder at the foreclosure sale, the investor’s money might be tied up for as short as 75 days, and for as long as six months while the investor waited out the owner’s redemption period and potential redemptions from junior liens.
When a purchaser at a foreclosure sale is redeemed out, he receives a return on his investment – the interest rate under the note which is applicable when the loan is in default. Yet this rate of return, over the 75 day or six month redemption period, was not a sufficient return to entice many foreclosure investors to purchase at the foreclosure sales.
Under the foreclosure law that became effective for Colorado foreclosures commenced after January 1, 2008, owners no longer have redemption rights (see Foreclosure Revolution (Part I) article) and junior lien holders do not have redemption rights unless the lien created by those junior liens was recorded prior to the commencement of the foreclosure (see Foreclosure Evolution (Part II) article).
Therefore, two changes in the law should increase competitive bidding at foreclosure sales: (1) The inability to manufacture redemption rights after the foreclosure sale; and (2) the removal of the need to wait out the owner’s redemption period. Since redeeming junior lien holders, in some circumstances, ultimately control the disposition of foreclosed upon property in Colorado, foreclosure investors will still pursue junior liens that existed prior to the commencement of the foreclosure.
A version of this article appeared in the Colorado REALTOR® News, the monthly publication of the Colorado Association of REALTORS®.