For many real estate investors, foreclosure auctions are an important part of their investment strategy. But what happens to excess proceeds from foreclosure sales? Read on to learn what happens to any surplus proceeds and how the distribution process should affect your investment plans.
What happens in a foreclosure sale?
Depending on where the home is located, a foreclosure sale can either be judicial or nonjudicial. In a judicial foreclosure, an officer of the court, usually a sheriff, will conduct the foreclosure sale. In a nonjudicial foreclosure, a trustee will be appointed to conduct a trustee's sale. In either case, the property is typically sold at foreclosure auction to the highest bidder.
In the past, a public auction would usually take place on the courthouse steps. These days, the foreclosure auction is more likely to happen online. Regardless of the method used, at the end of the auction, the winner must provide sufficient funds to match their bid to become the new property owner.
How funds from a foreclosed property are distributed
Once the officer of the court or the trustee has the funds in hand, it's their responsibility to distribute them properly. In the mortgage foreclosure process, funds have to be distributed in a very specific manner, as follows:
- First, the mortgagor is paid any debt owed, plus the cost of foreclosure. They're given first priority for the proceeds since they're the primary lienholder and usually the one foreclosing on the home.
- If there are any surplus funds after the debt is settled with the mortgage lender, any subordinate lienholders are paid next. In a mortgage foreclosure case, a subordinate lienholder might be the lender from a second mortgage or a home equity line of credit. However, if the former homeowner had any sort of judgment against them, they would also be paid at this step in the process.
- Finally, in a mortgage foreclosure, if there are any excess funds left over after the subordinate lien holders have been paid, the former homeowner (or the foreclosed party) is entitled to the surplus money.
Example of the distribution of excess proceeds from foreclosure sale
Let's say Jim's home was sold at a sheriff's sale for $250,000, which was well more than the minimum bid. At the time of foreclosure, Jim only owed $192,000 on his mortgage, which meant that there was a foreclosure overage of $55,000 left over after the mortgagor was paid what they were owed plus the cost of the foreclosure process.
However, Jim also had a home equity line of credit on the property with a balance of $15,000 and an additional lien from another creditor worth $5,000. As junior lienholders, those lenders were next in line to be paid with the surplus funds.
After both those debts were settled, there was a total of $35,000 left over in foreclosure overage. As the mortgagee and former property owner, Jim is entitled to those profits.
What real estate investors need to know about the surplus money from a foreclosure auction
As a real estate investor, it's important to realize that a mortgage foreclosure is an entirely different entity then a tax sale.
In a tax foreclosure sale, rather than excess funds going to the former homeowner after the tax collector is paid, parties of interest may submit claims to the surplus funds. In some cases, the current property owner may be considered a party of interest, which makes tax sales a potentially lucrative, yet risky, investment strategy.
That said, since tax laws are determined on a state and local basis, each county often deals with unclaimed funds from a tax foreclosure sale differently. If you're thinking of going this route, check in with a tax professional before investing any money in tax foreclosures.
In a mortgage foreclosure, even if you currently hold the deed to the property, there's no way for you to become a claimant for the surplus funds. So from an investing standpoint, your best bet is to bid low at the auction as a way of padding your profit margins when you eventually sell the property.
The bottom line
In the end, the process for the distribution of surplus proceeds from a foreclosure sale ultimately depends on what type of foreclosure you're faced with. It's absolutely crucial to do your research on the investment process from both perspectives. Once you've decided which real estate investment strategy works better for you, you can take part in your first auction.