Distressed properties are attractive targets for real estate investors who are always looking for discounted opportunities. A popular target is the auction property. Unfortunately, conventional financing does not work for obtaining auction properties. But hard money does.
Auctions Are Designed for Quick Sale
Auctions are designed to dispose of distressed properties quickly. Typically, an auction will be advertised for 30-90 days, depending on the nature of the sale and who is conducting it. But on auction day, bidders must be prepared to pay. Auction sales typically require either full payment or a sizable deposit within 24-48 hours of winning.
There is no way an investor could arrange a conventional loan that quickly. As for arranging financing ahead of time, banks typically will not approve financing on an unknown project. So conventional loans are out.
Hard money is a much better option for auction properties because lenders can arrange loans more quickly. How much more? Actium Lending, based in Salt Lake City, Utah, has been known to close loans in a single business day. While not the norm, 24-hour closing is possible when circumstances warrant.
The Proof of Funds Letter
Although hard money can be leveraged to purchase auction properties, there are strings attached. First and foremost, an investor needs a proof of funds (POF) letter from a lender before he can even think about bidding. A POF letter verifies the lender’s commitment to funding a potential purchase.
Many online auction platforms require a POF letter just to register. Local auctioneers will usually want to see a letter before issuing a bidder number.
The letter will state how much the lender is willing to offer. This sets a hard limit on what the investor can bid. He cannot exceed the total amount of cash he has to work with, including the loan amount and whatever cash he brings to the table.
Also, it is vitally important that the investor confirms how his lender handles auction payments. Some hard money lenders wire the funds directly to the property’s trustee or the auctioneer. Others require that investors pay for properties upfront before being reimbursed via the loan.
The Preliminary Lien Search
Lien position is the most dangerous aspect of auction buying. If a property being auctioned still has liens attached to it, each of those liens has a position of order. Here is what this means practically: buying a house at auction is more than just buying a property. It is also buying a position.
With that being the case, a preliminary lien search is non-negotiable for nearly every hard money lender. Ideally, a lender wants the investor to be purchasing in the first position. If it is a second position or lower, a lender will find it more difficult to approve.
A practical example would be a house up for auction after the primary mortgage lender foreclosed. That primary mortgage lender is in the first position even though the property is also subject to second and third liens related to home equity loans.
Buying that first position is doable. But what if the house was foreclosed on by the home equity lender in the second position? Purchasing the house would mean purchasing the second position – something hard money lenders are traditionally unwilling to do.
The Bottom Line
Auction properties are attractive targets for property investors looking for discounted deals. They cannot be obtained with conventional mortgages. So if an investor does not have the cash, hard money is the only financing option. The good news is that hard money works well, provided all the investor’s ducks are in a row.