When you go to a trustee sale, you will hear terms like “no warranties or guarantees,” “subject to existing liens and encumbrances” and “address purported to be.” There isn’t even a guarantee that the address is correct, because the sale is based on the legal description, not the street address. If you place the wining bid, you take possession of the property with no guarantee of the condition, the title history, or presence of senior liens against the property.
The title is the auction investor’s iceberg. It is the biggest source of potential problems, either because of irregularities or mistakes in the history, or because of a lack of understanding of the subtleties of title research. Title insurance is typically the safeguard for these issues, but it is not available for properties going to foreclosure auction. You can go a long way toward minimizing the greatest risk factor in auction investing by learning to do your own title research.
When you buy a property at a trustee sale, you are really buying a loan position based on the deed of trust held by the trustee that initiated the foreclosure process. This sounds complicated, but it’s actually fairly simple.
Lenders don’t foreclose on a property, they foreclose on a loan. The property is involved because of a mortgage. Some people use the word mortgage as a synonym for loan, but a mortgage is actually a legal instrument whereby the borrower (mortgagor) offers real property as security against a loan provided by a lender (the mortgagee).
A loan of this type is referred to as a mortgage loan, a term that is often shortened to the word mortgage. It is important to keep the two ideas distinct, because it is the mortgage the borrower offered to the lender that involves the property in the process of foreclosure. It places a lien, a legal claim, on the property specified in the mortgage. There can be more than one lien against a property.
The lender requires the borrower to convey a deed of trust to a trustee, a disinterested third party who holds the title to the property, until either 1) the borrower pays the loan, at which time the title returns to the borrower, or 2) the borrower defaults on the loan, at which time the lender instructs the trustee to initiate foreclosure proceedings. This process starts with the notice of default, followed by a notice of trustee sale, and culminates in a trustee sale, the auction where investors gather.
Senior liens. Keep in mind that a winning bid at a trustee sale means you own the property subject to the existing senior liens. Property taxes are always senior to any other liens, including mortgage loans. This is known as a super-senior position.
Besides taxes, there may be other government liens, such as for abatements or uncollected fees. In California, the Government Code section 38773.5 gives a city the authority to pass an ordinance that allows the cost to abate a nuisance to be applied as a special assessment against the property on the tax bill, thus arguably giving it senior status. But that should only apply if there is a local municipal code providing for the special assessment and if the assessment was actually levied against the property.
In addition to government liens, the first loan on a property, usually a purchase money loan or a refinance, is the senior loan.
Junior liens. Any secondary loans or home-equity line of credit (HELOC) loans are subordinate to the first loan. If the foreclosing trustee represents the senior loan, all subordinate loans are wiped out. But, if the foreclosing trustee represents a junior loan, the buyer is responsible for the first loan.
Tales from the Trenches: Buy a Second, Owe on the First
At one auction, I saw a couple place a winning bid of $175K on a second loan for a property valued at $250K, thinking they had just bought a house with $75K of equity. They didn’t realize they were buying a loan position, not a property. The first loan had $350K outstanding (the house was seriously underwater in financing) and the couple lost their savings in the time it took to bid at auction. There were no competing bids because the other investors had done the title research and realized that this was one of those deals where winning is worse than losing. Much worse.
Determining outstanding obligations. You can get an idea of the title history through several methods.
Preliminary title report. A title company can provide a preliminary title report that indicates who currently holds the title and documents exceptions, such as easements, liens and encumbrances. This is not the same as title insurance and does not provide any guarantee.
Property profile. A Realtor or a title company can provide a property profile, which includes public record information about the property, its features, open loans and sales comps. However, it may be incomplete and like a preliminary title report, comes with no guarantee.
Abstractors. An abstract of title is a condensed history of title. It includes the original grant and all subsequent conveyances and encumbrances affecting the property with a certification by the abstractor that the history is complete and accurate. Like the other documents, an abstract does not provide a guarantee.
Real estate professionals. Some real estate agents provide this kind of service. You could become one of them, but until then, you could use an agent to do the research.
Or you can do it yourself.
Do it yourself
You can do your own research making use of various sources, including property profiles available from a service provider, and records from the county tax assessor and the county recorder.
Foreclosure information sources. ForeclosureRadar goes beyond a simple list of notices or properties to track the transaction history of recorded documents and automatically estimate loan positions. This saves a trip to the courthouse and hours of digging through the indexes to compile a list of all the documents connected with a property.
In the event that there are loans that appear to have been refinanced, especially those that appear earlier in the title chain than the loan under foreclosure, it’s important that you verify that the earlier loans were actually reconveyed and are no longer outstanding against the property. For many counties you can click a link within the ForeclosureRadar Transaction History to buy the source documents for your research.
In addition to assuring prior loans were reconveyed, it’s also important to do a name search of the owners of the property to make sure there are no IRS liens, mechanics liens or other loans, liens and encumbrances that the buyer may be responsible for after a trustee sale and which ForeclosureRadar does not show by default.
County recorder. Legal documents are recorded in the county where the property resides. Access to the to the grantor/grantee index, which records the document number, recording date and names of the parties, is free. In some cases, the index is online and you can do a basic search, typically by name, document number and document type. The actual documents, which contain more information, are available for a small fee and are sometimes available for purchase online as well.
County tax assessor. You also need to determine whether property taxes are current on a property or if back taxes are outstanding. The winning bidder is responsible for payment of all back taxes.
Types of Notices
Deed of Trust. As mentioned earlier, a deed of trust indicates that the title is not free and clear, that a trustee holds it until such time as the loan is paid off. A deed of trust is a voluntary lien that the owner signed as a condition to get the loan.
Reconveyance. When a loan is paid off, a reconveyance deed releases the borrower from the mortgage and clears the way for the title to return to the owner. In the case of a refinance, the original loan would be paid off and reconveyed. A new deed of trust would be recorded for the new loan. The lien position is determined by the recording date. First in time is first in line. However, mistakes are sometimes made and the reconveyance is neglected, leaving what was originally a smaller second loan in first position, the larger refinanced loan now in second position. See Beware of Position below.
Lien. A lien indicates a party has legal claim to sell the property to satisfy a debt. Only a deed of trust and an HOA lien have the power of sale (if granted in the terms of the CC&Rs and bylaws). The lien holder can be a homeowner’s association, a contractor, the county tax assessor, the IRS, a family support judgment or a judgment from a lawsuit. These are all involuntary liens attached to the property when recorded and owed by the owner of the real property, which will be you if you buy this property.
Transfer. A transfer confers title from one party to another. It can be noted as a grant deed, deed of trust, trustees deed, gift deed, warranty deed, tax deed, or quitclaim deed. Transfers indicate the chain of title.
Abstract of Judgment (ABJ). If the title of the property was awarded to a party by a court of law, it is recorded as an ABJ.
Chain of Title
When researching the title, you want to determine two things:
All the parties who have a claim (lien) against the property.
The true position of each lien.
The rule of thumb is “First in time, first in line.” However, as always there are exceptions. And those exceptions can signal a stealth deal that gets you in under the radar for a nice profit, or a turkey that can put you out of business. Understanding title research gives you a competitive advantage by allowing you to identify the good, the bad, and the bragging rights deals.
Senior liens. Tax liens are always super senior. They stay at the front of the line regardless of whatever loans may be present. Typically, the first loan after taxes and CC&R (See HOA liens below) is the senior loan, indicated by a deed of trust.
Junior liens. Loans that come after the first loan are in a subordinate position. This includes a second mortgage loan or a HELOC. Make sure a HELOC is reconveyed because otherwise the former owner could continue to draw against it but the new owner is responsible.
IRS/Tax liens. The IRS has a 120-day right of rescission, meaning that for the four months after the auction the IRS can exercise the right to pay you what you paid for the property and take it to pay off back taxes. They haven’t aggressively exercised this right in recent years, but it is prudent to hold off on improvements until the period is past. This has implications for your time-to-revenue and for any financing you may get for the deal. Include this variable in your financial analysis.
HOA liens. A homeowner’s association has legally enforceable rules, called covenants, conditions and restrictions (CC&R). Violation of the rules (including non-payment of HOA dues) can result in a lien being placed against the property. HOA laws vary from state to state.
Mechanic’s liens. Relevant to remodeling and code enforcement. A contractor can place a lien against the property for non-payment for work. The date work began establishes priority.
Beware of Position. Thorough research pays in profits gained or losses avoided.
A missed reconveyance can create a stealth deal for an investor. See Tales from the Trenches: When the First is really a Second in the Analyzing Opportunities section for an example of when sloppy title work made everyone, lenders and investors included, think a second was really a first. In that situation, because of a mistake a $150K SBA loan was the senior loan and $600K of mortgage loans were wiped out at the auction of a property valued at $550K.
However, a mistake the other direction could be disastrous. An investor could bid on a property thinking the second would be wiped out, only to discover that it was really a first and was now due.
Subordination agreements also affect position. They are common when refinancing a senior loan where junior loans are present. The refinancing lender would agree to give the loan on the condition that the junior lien holders sign a subordination agreement that would place their interest subordinate to the new (refinancing) lender.
Beware of validity.Some people use fraudulent reconveyences to delay foreclosure or as a scam to steal money. If there is a reconveyence in a title history, verify that a title company recorded it. Do the documents look like other reconveyences from the same bank/timeframe? Also, it pays to be aware of stories of fraud in the news.
For example, in Modesto, CA several years ago a loan officer worked with a title officer to run a scam. The lender created new loans, but instead of paying off the old loans, he moved the cash into an offshore account and had the title officer issue fraudulent reconveyences. The original first and second loans were still outstanding and now the owner had four loans on the property. Because of title policies the lender was covered. But an investor buying the property at auction would not be.
If something is too good to be true, it could be the sign of a great deal or the worst deal in history. It’s your job to figure out which. Check for fraudulent reconveyences and subordination agreements. See Tales from the Trenches: When the First is really a Second in the Auction Investing section for an example of how title issues can create an unexpected deal.
Tales from the Trenches: Pulling a fast one with subordination
On one deal, I did all the research and was able to buy a house at auction for $100K. The $85K second loan was wiped out, leaving me with a good bit of equity. Or so I thought.
After the auction, the private lender who held both loans approached me and said I was responsible for the $85K, which according to him, was the first, not the second.
This is where building a good team pays off. My attorney contacted the lender and convinced them to rescind the sale and return my cash.