Bridge loans are often used to purchase distress properties, but this does not mean that buying distressed properties is automatically a good deal for a hard money borrower. There are four main categories of distressed property that a borrower may be interested in and each of these categories has its own unique benefits and risks that the borrower should weigh before proceeding.

Short Sales

A short sale is when a property is sold for less than what is still owed to the lien-holder. The benefits of these sales are that buyers have a chance to inspect the property prior to purchase, the title is usually clear of all liens, and any outstanding taxes are the seller’s responsibility. The main risk associated with this type of purchase is that the lender must give their consent to the sale, which they are not required to do. Because of this required consent, it can be a very drawn-out process, taking from three to 12 months to complete. Patience is required – but it can pay off if you are successful.

Foreclosure Auctions

A foreclosure auction is where properties are auctioned off at a public sale by the Public Trustee (in Colorado) and sold to the highest bidder.  The lender who is foreclosing automatically can bid the amount of their loan (or in certain cases they can bid less than the full amount of their loan and try to obtain a “deficiency judgment” against their borrower if the borrower had personally guaranteed the loan.   The main benefit of foreclosure properties at auction is the possibility of winning the auction and thus obtaining a below market price for the successful bidder. The downside to these auctions is that buyers cannot inspect the properties beforehand, there is a possibility of legal issues with the title, and the buyer is responsible for paying property taxes and any other fees that are still due. Bidding at a Public Trustee Auction is not for amateurs.  We would advise any investors who are interested in playing this game to use legal counsel for advice.

Real Estate Owned Properties (REOs)

REOs give buyers an opportunity to purchase foreclosed property directly from the lender outside of an auction.  This occurs when the lender (for example a bank) had the highest bid at the sale and now actually owns the real property.  This type of foreclosure purchase differs from the auction because the buyer in most cases will have the opportunity to inspect the property and there is a lower chance of problems with the title transfer. The other advantage of REOs is that the seller/lender pays any outstanding taxes and liens rather than the buyer. The drawbacks to REO purchases are that the lender may require the entire price to be paid upfront in cash, the property could be in need of major repairs, and the high demand for REOs can increase the cost of purchasing them.  In cases like this having a pre-existing relationship with a private money lender (such as Montegra) may facilitate the purchase from the bank.  Banks like to deal with purchasers that can close quickly and for all cash.

Note Purchases

Note purchases involve the buyer purchasing a lender’s promissory note rather than the property itself. This practice is much riskier than the other categories of distressed property purchases. First, remember that the buyer has bought a lien right from a lender and not the right to possess the property; therefore, he cannot have it inspected. Second, the note is only as valuable as the borrower’s ability to repay the loan, so if the borrower defaults, then the buyer will have to go through the lengthy and expensive process of foreclosure in order to obtain the property. The only benefits to this type of purchase are if the buyer can reduce the borrower’s monthly payments because of the low price paid for the note, while still making a profit for himself, or the buyer can convince the borrower to sign over the deed in lieu of foreclosure if the borrower is unable to repay the loan. Again, use of legal counsel for advice on this type of purchase is strongly advised.

Hard money lenders can help borrowers finance purchases of all of the types of distressed property described above. For a savvy investor this type of transaction can be extremely profitable. There are risks and there are benefits.  A pre-existing relationship with a private money lender and use of legal counsel can make the difference between success and failure in this complex game.

This article was written by Bob Amter, President of Montegra Capital Resources, LTD., a Colorado hard money lender.  [google_authorship] has been in the private capital lending business for 41 consecutive years.