A couple of weeks ago, Dataquick real estate news reported "The typical monthly mortgage payment that Bay Area buyers committed themselves to paying was $3,183 in June. That was up from $3,091 in May, and up from $2,651 for June a year ago. Adjusted for inflation, mortgage payments are 25 percent higher than they were at the peak of the prior cycle sixteen years ago."
$3,000+ per month is a pretty big monthly obligation. That’s over $36k annually, not including property taxes and insurance. Factor in the consideration that many of these loans may be 2 year adjustable loans, and it becomes clear that many borrowers are not going to be able to keep making their loan payments.
Is it any wonder that there are reports nationwide of surging loan defaults headed to foreclosure? This is not to spell out a message of doom as those same reports will usually also tell you that only a small fraction of houses are ultimately sold at foreclosure sale.
However, it is a call to arms for many real estate self-help gurus and seminar speakers to rally would-be investors to start "saving" homes and getting rich in the process.
What is Equity Purchasing? Say for example that you live in San Jose, California. Zillow.com and comps put most of the single family residential properties in your neighborhood in the $750k range. Imagine you are out trimming your hedges or cleaning your gutters when you spy your neighbor Joe packing and moving. You exchange friendly greetings and inquire if he’s moving for work. Joe tells you rather quietly that he was laid off several months back and can no longer keep up with the payments for the house. You are sympathetic and invite him for coffee and a chat. During your conversation you learn that Joe has a loan for $525k with Chase bank and he is delinquent about $25k to Chase and his monthly payments are $3000. He is in foreclosure and his house is going to be sold in two weeks at foreclosure sale. He admits that he ignored the problem for too long and will not be able to properly list the property with a broker.
It occurs to you that there is probably close to $200k in equity left in Joe’s property. You discuss the situation with your spouse and the two of speculate that you could offer to buy the property from Joe, subject to his loan with Chase. You offer Joe $50k for his interest in the property. He agrees and gives you a grant deed to his house. You reinstate Joe’s loan with Chase and pay the $25k delinquency. Joe takes the $50k, decides to move to Oregon and uses it as a downpayment on a much lower cost home.
You now own a property worth $750k that you paid $75k for, right? You got a great deal, right?
Not exactly. But most newspaper articles on foreclosure buying tend to exaggerate the value of the house and slant it to show the equity purchaser as having defrauded the former homeowner and maximizing the delta between the market value and the equity paid.
Those articles often neglect to mention that the equity purchaser takes the property subject to the loan. In the scenario above, you now owe $525k to the property and you are $75k out of pocket. That means that you are $600k into the property and at foreclosure, it’s unclear what the distressed value of the property would have been. Chase bank would have stopped credit bidding after it reached the amount of its loan, $525k. If no other bidders had attended the sale, Joe would have received no money above the amount of Chase’s loan. In effect, he would have had zero equity. Therefore, his acceptance of your $50k for his equity puts him ahead of the game.
However, there may have been other bidders attending the sale and they could have bid up to $625k, in which case, Joe would have been entitled to $100k of surplus sale proceeds. Either way, the sale of the distressed property would be below the full market value of $750k.
So it is difficult to assess the value of the distressed home and whether the equity purchase was a "good deal" for the homeowner.
As for the equity purchaser, a host of other issues have now arisen. First of all, as the purchaser, you have stepped into the shoes of Joe. Has Joe been paying his property taxes on time? Does he owe $ to the IRS? What about the fact that he borrowed $25k from his sister and she has a note and deed of trust recorded behind Chase? What if Chase learns that Joe is gone and that you have attempted to assume the loan?