default on their mortgages or their real estate taxes. Many times it involves schemes from mortgage brokers who seek out the uneducated who have equity in their homes. The homeowner ends up refinancing into a mortgage they can't afford. When payments get behind, these unscrupulous lenders get creative. They may refinance again and again every several months taking more closing fees and points until there is no equity left in the property. Others persuade borrowers to sign deeds in lieu of foreclosure, basically giving the lender the property.
Other times it involves people who call themselves investors who see a huge pile of equity in a property that is headed toward foreclosure. They approach the owner and tell them that that by selling their residence to "the investor", it would wipe the slate clean and "the investor" would take over all of the homeowners' property-related debts and obligations. The homeowner complies and loses all their equity in their property.
This sounds like theft already, but before we pass judgment on "the investor" this may be the only possibility for the homeowner to save himself from financial ruin. Let's face it - if the property goes to foreclosure the homeowner will be evicted. He and his family may be split up or end up in a homeless shelter. If the property sells for less than what is owed to the lender, the lender will go to court and receive a judgment against these poor homeless people. The judgment is good for twenty years and may be renewed twice. The lender can garnishee any paycheck the borrower may get in the future including tax refunds and lottery winnings. In order to get out of paying the judgment, the borrower files bankruptcy (if he can afford it). Then, the IRS comes looking for him. The loss that the lender took at the auction, including all legal fees, is considered income gain to the borrower. This gain is a taxable event. IRS won't stop until they get their taxes and penalties from this defaulted borrower. The borrower loses his house and has to pay taxes on the loss. Now the picture may be a little clearer for you.
Does this sound like it might be a fair trade - all the equity in the house for a "new beginning" in finances, credit, and life? Probably. However, the question still remains: When is this procedure fair and when is this procedure robbery (i.e. equity skimming)?There are many factors that must be considered. The largest consideration is the proximity of the foreclosure date. If the foreclosure process is in the beginning stages, there are at least eight options that a homeowner has to alleviate his problem. A conscientious professional investor should use his knowledge to help by calming the homeowner down and explaining in detail all his possible options. Most of the time, a call to an honest real estate broker and the problem is on the way to being solved. Sell the house and use the cash to start over.
If, on the other hand, the investor becomes aware of the property two or three weeks before the auction, it would be almost impossible for a real estate broker to find a qualified buyer ready to close before the auction. In this case, there are no other options available. The homeowner would be lucky to receive any offer, and would be wise to take it. Usually, first, last, and security for a new apartment and access to a moving van would be generous for the investor to offer. If there is considerable equity in the property, a chunk of cash sometime in the future may be appropriate.The main thing to remember here is that as in every encounter you have in life, you should always remember to structure the transaction so that everybody wins. You as an investor may get the equity, but you must handle these delicate people with kid gloves and ensure that they are also gaining from the transaction - and are content with the solution you have proposed.
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