It’s what people always think of when foreclosures are mentioned. The auctioneer, the gavel, the bidders, and the frenzy of pushing up the price. It’s usually not as dramatic as that, but there’s no question that auctions are the glamour area of foreclosures. It’s here that properties go to the highest bidder. It’s also here that some of the best buys can be obtained.

You can see a condo worth $225,000 go for $117,000 and a house worth $335,000 go for $200,000. There’s no question that the bargains are here.

However, right at the outset, it must be understood that this is also one of the riskiest areas of foreclosure to deal with. Many times it involves bidding blindly and hoping that you’re doing the right thing. If you don’t like taking risks, you don’t belong at foreclosure sales.

It also usually involves either having a lot of cash, establishing a strong line of credit from a bank (which is equivalent to having cash), or setting up financing in advance. If you don’t have money or strong financing, you don’t belong at foreclosure auctions either.

Having thus glimpsed at the problems, let’s see how to find the benefits.

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Bidding an auction is inherently risky. Further, that risk is amplified if you are new to the process. Therefore you should check for pitfalls and problems with a good attorney and/or real estate agent who participates in auctions on a regular basis. If at all possible, preview several auctions before actually bidding. Doing your homework here can save you a bundle later.

How a Foreclosure Auction Works

There are three stages to the foreclosure process. In the first stage, the borrower-owner is in default. If we buy then, we buy directly from this person.

In the last stage, the lender has taken the property back after a foreclosure auction—we’re buying an REO property.

At the auction—stage 2—we’re in the middle. This is where the borrower-owner loses the property and the lender acquires it. Here we can step in and snatch that properly up at the sale.

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The foreclosure process differs from state to state. However, in all cases, at some point there is a public auction, whether it be held by a trustee, a judge, a magistrate, or a referee. The property is auctioned off to the highest bidder.

In Trust Deed States

Using California as an example (a good many states are modeled after California), the foreclosure process uses a trust deed (sometimes called a power of sale) and normally takes place outside a court (although court foreclosure is allowed as a lender’s option).

In California the first step is for the lender, called the beneficiary, to file a “notice of default”. Once this notice of default is filed, the owner-borrower has 90 days in which to make up any delinquent mortgage payments, interest, and penalties. If these are made up, the mortgage is reinstated, and the parties involved go their separate ways.

Once the 90-day reinstatement period has passed, however, the situation changes. Now there is a period of 21 days during which the trustee advertises the property in a newspaper, announcing the coming sale. (This is usually in a legal paper, which often turns out to be a tiny one that few people read.)

During the 21-day period, the owner-borrower may redeem the property by paying up all the delinquent payments and penalties and paying back the entire amount of the mortgage. Notice that paying only the back.

After this the trustee, to whom the borrower or beneficiary- originally gave a power of sale, sells the house to the highest bidder “on the courthouse steps,” which can be any public place (such as a courtroom). The place and time of the sale, however, must be publicly announced in the advertisement.

Auctioning by use of the power of sale given the trustee is at the lender’s option. The lender may decide not to go through a trustee’s foreclosure but instead to go through judicial foreclosure. Why would a lender opt for the longer and more costly judicial process? The reason would be that the lender felt the property, could not bring enough money at sale to pay off the mortgage balance. By going through a judicial foreclosure, the lender can now go after the borrower personally. After a judicial foreclosure, if the property does not bring enough money at auction to cover the mortgage and costs, the lender may sue the borrower for any deficiency. If the lender prevails, a deficiency judgment can be issued by the court, which will hold the borrower personally responsible for the remaining debt. (Some states have “purchase money laws” in which a deficiency judgment may not be obtained when the mortgage was used as part of the original purchase price.)

In Judicial Foreclosure States

At one time all states used judicial foreclosure. Now, however, only a handful do. (The trustee sale process grew out of a common need for a swifter, less costly procedure.)

Although the process differs from state to state, generally speaking there are five steps:

1. The lender gives the borrower notice that he or she is in arrears and must make up the back payments.

2. The lender initiates foreclosure by filing a complaint in the county or township where the property is located and the deed is recorded. The borrower must be served with a notice of the complaint. Typically, the sheriff does this. The lender’s attorney also will typically record a foreclosure pending notice, which alerts everyone, including bargain hunters, that a property is in foreclosure.

3. Eventually, a court date will be set, and the lender and the borrower can come and present their cases. The lender’s case almost always is that the borrower failed to perform by making the mortgage payments. The borrower usually doesn’t show up, and in that case the judge issues a judgment which sets an amount that usually includes the unpaid balance of the mortgage along with interest due and costs. Now the borrower can no longer reinstate the mortgage by making up back payments. He or she can only save the property by paying off this total amount. The judgment also usually sets a date for a court sale of the property.

Sometimes, however, the borrower-owner does show up and pleads extenuating circumstances such as loss of a job, illness, divorce, or whatever. The lender will claim that the property is a wasting asset and no time must be lost, but sometimes judges will give the person time (days, weeks, sometimes months) to get back on their feet and reinstate the mortgage.

4. Advertisement in a legal paper lets the public know that the property is going to be sold. The time allowed before the sale differs markedly from state to state.

5. Finally, the property is auctioned on the courthouse steps to the highest bidder. Some states have a redemption period, noted earlier, during which the former borrower-owner can sometimes live in the property and can redeem it by paying back the bidder’s price plus interest.

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Depending on the state, the successful bidder may not get completely clear title. For example, many states that have judicial foreclosure also offer the original borrower-owner a right of redemption that can extend for many months. That person can, during this period, come back and redeem the property by paying the auction price plus interest at a hefty rate on that money. In trust deed states, on the other hand, there is normally no right of redemption after the auction sale. Be sure you check with an attorney for exactly how the procedure is handled in your state.