Foreclosure Investing - Understand 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 even
the largest project 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. One is that you need to know when you buy a property at auction
whether or not the owner can get the property back if he somehow comes up with sufficient
funds (typically the outstanding balance, accrued interest, late fees and costs).
The second is that you may be able to buy the redemption rights whether or not you
actually buy the property.
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 where 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 at some point before
the sale or 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 up to a year or more after
the auction to redeem the property, you have 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. Also, because most of the secondary liens are wiped out with
the foreclosure, it’s possible that the owner could put himself in a better financial
position by waiting until after the foreclosure to redeem the property rather than
trying to pay those debts and stop the foreclosure.
The solution is, when possible, to buy the redemption rights from the owner, either
shortly before or shortly after you purchase the property at auction, 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 rights he never expects to use.
Acquire property through redemption rights
Another strategy to consider is to use redemption rights as a way to purchase property
after foreclosure. The potential effectiveness of this technique will depend on
state law—the redemption period needs to extend beyond the foreclosure sale—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 preforeclosure
debt on the property. Let’s say 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 would likely 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 have any title issues resolved before exercising the redemption right.
To get more information on the laws regarding the right of redemption in your state,
start by calling your county courthouse and talking to someone who handles foreclosures.
Jacquelyn Lynn is a business writer based in Orlando, Florida, and the author of
Entrepreneur’s Almanac, Make Big Profits on eBay (with Charlene Davis) and
Online Shopper’s Survival Guide.