This analysis works for full-deficiency states like Alabama. In other words, states in which the bank's foreclosure bid price is credited against the mortgage loan balance, and the borrower will still owe the difference. Let's start with average lenders. The lender will bid its "asset value" at the foreclosure auction. That is not the Fair Market Value (FMV) of the property. The asset value is the cash the lender expects to have left in its hands after it forecloses, pays all the expenses of foreclosing and managing the property (lawyers, advertising, recording, property management fees to check on the property once a month, needed repairs before they can sell it, taxes, insurance, HOA dues, plus sales expenses of closing costs and real estate commissions). They must also assign a time value of money to this, and discount the net proceeds to present. For example, suppose the property is worth $120,000. The lender thinks they will net $100,000 when they finally sell the property in 18 months. They also know that $100,000 in 18 months is worth less than $100,000 today. So, the expectation of receiving $100,000 in 18 months might be worth only $83,000 today. Also, paying $3,000 for repairs today but not getting repaid until 18 months later, might make today's expense the equivalent of $3,540. All that number-massaging has to be gone through. You also have to consider, especially in Alabama, that the FMV of a foreclosure property is less than the FMV of a regular property. A house worth $120,000 in a sale between a regular buyer and seller, might be worth only $100,000 if it's a foreclosure. There are several reasons for that:
- In Alabama, the 12-month right of redemption depresses prices because title is at risk for 12 months. It also limits the pool of potential buyers. Most homeowners will not buy a foreclosure property during the redemption period because they do not want to take the risk of buying, nesting in, and then having to move if there is a redemption. As a result, when you are determining the fair market value, you can't look at the entire market place to see what people pay for a similar property. The bank has to look at the marketplace of foreclosure properties sold to a limited group of buyers.
- Because the owners are gone, buyers are able to obtain only a limited amount of information about the property. They can't ask questions like "Where is the septic tank?" or "Does that stain on the ceiling represent a current roof leak or an old one that has been fixed?" This chills the selling price.
- Because of both of the above reasons, investors are the most likely buyers for foreclosure properties. Investors usually pay less than a residential owner-occupant would pay. Investors are buying properties to flip, or to rent, or both. They can't make money if they pay top dollar.
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