Bank Foreclosure


Buying foreclosure properties is not all that it's cracked up to be.  Buyers are often under the mistaken impression financially distressed Real Estate can be purchased at prices significantly below fair market value. While that may be the case in the US where foreclosure laws are substantially different than in Canada, here you can typically expect to pay no less than 5% below market value, due mainly to the additional protections afforded to property owners under foreclosure laws in Canada.  

The process of foreclosure begins with the lender filing a "petition for foreclosure" asking the courts for a hearing to commence the foreclosure process in order to dispose of the property put up as security.  The owner of the property, or borrower in default, has 21 days to respond to the petition after receiving the notice of the hearing required to be provided to them by the petitioner, after which a hearing will scheduled for the issuance of an "order NISI". This court order typically gives the owner about 6 month to either refinance or sell their property - the redemption period. As of recently, it also often simultaneously provides for an order for conduct of sale to be granted, which gives the bank the right to list the property for sale at a certain price, and at a given rate of commission, if the respondent borrower fails to solve the issue within the redemption period. 

In many cases the respondent (property owner) is not in a position to obtain financing elsewhere during the redemption period due to the credit and insolvency issues that have put them into foreclosure in the first place; often leaving the disposition of their property as their only option. The owner may also not have enough equity in their property to sell it either, with all the accumulated arrears, Real Estate commissions, and legal fees incurred by the bank, which are all the responsibility of the owner, in which case the process move to the next stage, the court ordered sale. 

Under a court ordered sale, or conduct order, the bank selects the Realtor and controls the the marketing process, while the owner is typically permitted to remain in the property providing they do not interfere with the marketing process; otherwise the bank may also petition the courts for an order for possession, forcing the owner to also move out. 

It is at this stage that the property enters the market as a foreclosure or distressed sale. Owners tend to be co-operative here in hopes of minimizing any potential shortfall of capital after the discharge of the mortgage liability, principle, accrued interest, and fees at the time of completion, as they will still be responsible for this deficiency.  In some cases the owner knows the shortfall will be excessive and result in bankruptcy and insolvency.  In these cases the chances of an uncooperative owner will be greater.  

Signs of damage to the home, a deliberate mess left behind, or difficulties in scheduling viewing appointments are typical signs of an uncooperative owner that should be well noted by anyone considering acquiring such a property through a court process because the banks will typically insist an amendment be included (Schedule A) in any contract to acquire foreclosure property that provides, among many other things, that the buyer will take responsibility for the condition of the property on completion. This is done since the lender does not have much control over what the current owner does there while still in possession.  This deviation from the standard practice of holding the seller responsible for the condition of the property on completion often contributes to impacting the value of properties sold under foreclosure to the downside.

A contract to purchase a property under foreclosure is typically submitted to the lender in charge of selling the property.  It can contain conditions in favor of the buyer, will typically contain the aforementioned Schedule A, which should be studied carefully, and will also contain a condition in favor of the seller / lender, that the contract is subject to approval by the courts.  Except in rare instances, all buyer conditions must be removed before the lender will schedule a court hearing for approval of the contract. 

Once a hearing is scheduled the interested parties will be notified of of the court date and will appear before a judge to have the contract approved.   The judge may also invite other interested parties to make a competing offer at the time of the hearing, which is probably the most egregious aspect of the foreclosure process, and the primary reason for the price discount that can often be achieved when purchasing foreclosure properties - typically in the 5% range.  Lately, with the lack of inventory, and generally overheated market condition, this discount has begun to narrow and is in some cases eliminated entirely.  Bidding wars in court have become far more common.  

Once the sale has been approved by the judge issue an order transferring title to the buyer called a "vesting order". One important technicality of vesting orders that is often overlooked is that the property can only be transferred directly to the buyer named in this order at completion.  No assignments or secondary transfers are permissible.  It is therefore important to choose the entity that will eventually take possession of the property at the time of writing the offer.  I have seen foreclosure cases for commercial properties where this has become a serious issue.

Not all foreclosure properties are sold under this process, however.  Banks have the option of applying for "an order absolute", giving the banks complete possession of the property.  The banks are then free to sell the property to third parties without court approval.  An order absolute is typically granted when the value of the property is below the value of the recoverable debt, meaning that no equity will remain for the original owner and secondary or subsequent mortgage holders when the property is sold.  

A secondary mortgage holder may opt to pay out the primary mortgagee at this point to take an order absolute possession of the property themselves, if they believe the property value can be improved. Banks also typically avoid this option if they believe they can sue the borrower for the shortfall as their right to sue the owner for the difference between what is owed and what is achieved at sale, also known as deficiency, is lost under this process.  If the owner is also undergoing bankruptcy proceedings, and the chances of any recovery of the deficiency is small, the bank is more likely to proceed by way of an order absolute. 

Properties acquired by banks in this manner are typically sold at fair market value.  No discount applies because the court process and other associated risk burdens to the buyer are eliminated.  

A further category of foreclosure sale that fall into a category similar to an order absolute sale are sales by government mortgage insurance agencies like CMHC and Genworth and AIG.  These will take possession of the property under foreclosure from the petitioning financial institution when it becomes apparent that a deficiency will be incurred and the originally borrower has a mortgage insurance policy in place.  The government agency will pay the borrowers debt to the financial institution, take possession of the property, and market the property conventionally.  No discount applies in these instances to the buyer.  In fact, Realtors in charge of marketing these properties on behalf of mortgage insurance agencies are prohibited from making any reference to a foreclosure process, or distress sale, or to even mention the name of the mortgage insurer anywhere in the listing data, in order to avoid the impression that the property can be had below market value.  The only exception to this will be a reference in the title document.  

Buying foreclosure properties can be a stressful proposition that may not resolve in a discounted price.  Up front costs for property inspections, financing applications, appraisal fees, and other costs can be lost if a competing buyer steps forward, and the property may not be in the original condition on the possession date.  The pressure, risk, and time involved discourages many from going through this process, especially fist time buyers.