Foreclosure Investing Detail: Understanding the Right of Redemption
By Jacquelyn Lynn
The rate of foreclosures and the potential profits they offer to investors mean that they are likely to remain a popular real estate strategy for the foreseeable future. But there’s an old saying, “the devil is in the details,” meaning that the fate of even the largest projects depends on the success of its smallest components, a fact that is certainly true when it comes to foreclosure investing. One of those details you need to understand and keep in mind is the right of redemption.
The right of redemption is the right of a property owner to redeem his or her real estate from foreclosure by paying the lender the outstanding principal and interest due, plus the lender’s costs in foreclosure, or to redeem foreclosed real property from whoever purchased it at the foreclosure sale. The specifics, such as how long the owner has after the property goes to auction, exactly what has to be paid, and even what the process is called, will vary by state.
There are two key reasons why a foreclosure investor needs to be familiar with the right of redemption. For one, when you buy a property at auction, you need to know whether or not the owner is could regain ownership of the property is he is somehow able to come up with sufficient funds to pay the outstanding balance, accrues interest, late fees, and all other costs. It is necessary to incorporate this information into your plan for the investment. The second reason is to understand that you can buy the redemption rights to a property, whether or not you actually buy the property. You can then use those rights as part of your investing strategy.
Protecting Your Investment
In states that provide the right of redemption after the foreclosure auction, you want to be sure you’re not going to be faced with a situation in which you buy the property, spend time and money fixing it up and putting it on the market, then have the owner (or another investor who has purchased the redemption rights) take the property and your potential profits away from you.
The redemption period is set by state law, and typically ends anywhere from some point before the sale to up to a year after the sale. If the redemption period in your state ends before or at the sale and you buy the property at auction, this shouldn’t be an issue. But if the owner has weeks, months, or even a year after the auction to redeem the property, you will be subject to a level of uncertainty that most investors would find unacceptable.
Most people who lose a house in foreclosure aren’t likely to have the means to redeem it later, but circumstances can change and financial windfalls do happen. The solution is to buy the redemption rights from the owner if at all possible. You should do this either shortly before or shortly after you purchase the property at auction, and at a price you are free to negotiate. Typically, redemption rights are sold for amounts ranging from a few hundred to a few thousand dollars. In most cases, an owner facing foreclosure who sees no realistic way to either avoid the foreclosure or recover the property afterward will be happy to sell redemption rights he never expects to use.
As an alternative to buying the redemption rights, you can try using them as a bargaining tool when negotiating the price on a foreclosed property. For example, if your state has a long right of redemption period, tell the lender that has foreclosed that you’re offering less money because you are accepting the risk that the owner could possibly take the property back. The lender might not accept your logic, or your offer, but it won’t hurt to try.
Acquiring Property Through Redemption Rights
Another strategy to consider is the use of redemption rights as a way to purchase property after foreclosure. Because the redemption period needs to extend beyond the foreclosure sale, the potential effectiveness of this technique will depend on state law, but this is how it might work: The redemption price is determined by a statutory formula and may be less than the property’s fair market value or the total pre-foreclosure debt on the property. Assume the fair market value of the property is $300,000. The property has a first mortgage of $200,000, a second mortgage of $90,000, and a mechanic’s lien for $25,000. The lender in the first mortgage position is foreclosing. At foreclosure, the second mortgage and mechanic’s lien may be wiped out. The person holding the right of redemption could exercise that right after the foreclosure sale and pay the redemption price, which if all the junior liens were erased, would be $200,000 plus interest, late fees, and costs. Even if the interest, fees, and costs totaled $25,000 to $30,000, the purchaser is getting the property for far less than fair market value.
If you’re going to use this strategy, it’s a good idea to have your financing in place and any title issues resolved before exercising the redemption right. To get more information regarding the right of redemption in your state, start by calling your county courthouse and talking to someone who handles foreclosures. You may also want to consult with an attorney who practices real estate law.
Jacquelyn Lynn (www.jacquelynlynn.com) is a business writer and speaker, and the author of The Entrepreneur’s Almanac.
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Posted by: Thomas | February 21, 2010 08:22 AM