The highs and lows of parenting and real estate.

Trustee's Sale – In Layman's Terms

How many of you have heard the words ‘trustee’s sale’ and nodded, knowingly, to whomever is speaking, while really thinking to yourself, “I don’t want her to think I had moron-flakes for breakfast, so I’m going to pretend I know what she’s talking about, but really, she could be speaking dolphin and I would understand her just as well.”? There’s a certain blank look my clients get when I’m discussing something they don’t understand. I can always tell when they are saying ‘sure’ and really mean ‘nope’. It’s sort of a combination of not wanting to look stupid and also not knowing if they really want to hear a long complicated explanation after we’ve seen 7 houses and they mostly just want lunch. Apathy – that’s what it is. If I nod my head yes, she’ll stop talking and we’ll get through this more quickly.

But you do want to understand this term, I know you do. Maybe after you’ve had a snack and a nap, but eventually, you want to know where these trustee’s sales are and who is allowed to buy at them because you have a sneaking suspicion there are deals there. People buy houses cheap at these things, but there’s like a special handshake you have to know to find out which houses are going there and how to buy them, right? – is what you’re thinking.

This is how it works: Arizona is a Trustee state. When you buy a property using a loan, the ‘note’ that says you own the house (think ‘pink slips’ with cars) is not held by the buyer and not held by the mortgage company, but by a neutral third party, called the Trustee. Let’s say John buys a house. Bank of America loans him the money, and we’ll call BofA ‘Bob’ for this analogy. Well ‘Sally’ is the neutral third party who holds the note to make sure everyone is following the agreement put together at the time of purchase. Sally just basically hangs out with the note until one of two things happens: 1. John pays off the entire mortgage to Bob, in which case, the note then goes to John or 2. John stops paying what he owes to Bob and Bob becomes sufficiently pissed off that he decides to go Sally and do something about it. Case 2 is what can eventually lead to a trustee’s sale.

Now, in real life, before Bob even goes to Sally there’s a whole process of things that happen. Bob first calls John and reminds him that he hasn’t sent his check this month. Then Bob sends a few letters to John saying, ‘Dude, no really. You totally have to pay what you owe me. I’m completely going to call Sally and she is going to kick your butt. I mean it. Have you seen Sally when she gets mad? It’s not pretty. Just pay me.’ Eventually Bob plays hardball and notifies the credit bureaus and they put big black marks on John’s credit report. After a long enough time of non-payment that Bob is pretty sure John is a total deadbeat and they just aren’t ever going to be friends again, Bob calls up Sally and complains. Sally then gives John three months to get his shiz together and make-up with Bob. At this point, Bob is pretty sure John isn’t going to catch his payments up, but Bob’s still open to the idea. If John sends in what he owes and his late fees, everyone is still good. The trustee’s sale date is the last day of this three month period. Bob can choose to push that date out if he wants to (if John seems to be trying to negotiate a short sale to this other guy, Jake, then it might be in Bob’s best interest to wait on the trustee’s sale).
In this case, however, John is just sitting on his duff, living in the house for free and Bob has had enough. On the date of the trustee’s sale, Sally shows up at the courthouse with the note and announces to the public, “John owes Bob $250,000. If John, or anyone else who has that cash lying around, wants to give it to Bob, I will give you this note and you can have John’s house. If not, then I’m giving the note to Bob, and John, you totally gotta get out.” Generally speaking, when this happens, no one steps forward (John doesn’t have any cash and the house is no longer worth $250K, so why would anyone else pay that for it?) and the note goes back to Bob. Then we’ve moved from a trustee’s sale, to a foreclosure. Bob will put the house back up on the market for $175K or whatever it’s worth and try to recoup some of his loss.
I know what you’re thinking here: ‘OK, but that one house we saw, you said was a ‘fix n flip’ and the owner bought it at a trustee’s sale. So how can people buy houses and make any money from them at trustee’s sales?’ Well that works in a slightly different scenario.

Starting over: John bought a house in 1995 for $150K. Bob loaned him the money. Sally holds the note. In 2005, John didn’t want to buy a new house, but he saw his inflated equity and decided he wanted that out of his house so that he could remodel it and buy a boat and not work for a year. So John took out a second mortgage against his house for $100K. This time George loaned him the money. So Sally still holds the note, but now John, Bob AND George all have a stake in it. Bob is the loan in ‘primary position’ because he was first. George is in secondary position. Now the market has tanked and the house is only worth $175K and John owes $125K to Bob (he’s been paying off for 15 years) and $100K to George and is broke and can’t find work because he’s been boating around and picking lint out of his belly button for several years. John again stops paying. Again, Bob gets pissed (George is EVEN MORE pissed, you’ll understand why soon) and calls up Sally and tells her to do a trustee’s sale. This time, at the trustee’s sale, Jane comes into the picture. Jane is a savvy investor with cash. She watches the tax records and saw that John’s house is going to trustee’s sale and knows that it could sell for $175K and that he only owes $125K to the first position lien. Jane comes to Sally’s sale and brings her $125K and purchases the property. She now owns the note, and because George was in second position, he gets nothing (which is why it really sucks to be George. Poor, dumb, George shouldn’t have loaned John that cash in the first place).

I know it sounds like Jane got a screaming deal, but keep in mind even this scenario has its drawbacks. Taxes are like a perma-first position lien. The government gets theirs first. If John hasn’t been paying his mortgage, it’s unlikely he’s been paying his taxes, so just remember; Jane will be paying those after the fact. Also, John didn’t have his house on the open market (unless he was attempting a short sale that failed), so Jane probably hasn’t seen the inside of the house. She definitely didn’t have an inspection done. She’s buying the house in the hopes that her profit margin is big enough to cover any unforeseen repairs. And of course, all of this has to be done in cash. You can’t get a loan to buy at a trustee’s sale, unless you’re leveraging some other asset and manage to come up with the cash before you attend the sale.

There’s definitely money to be made at trustee’s sales, but it takes research, cash and ultimately, a gamble. Plus, the people who do this regularly really know what they’re doing. Any property that is a viable fix n flip is going to have competition to get it. You have to go into the sale knowing your profit margin well enough to know how high you can bid without busting the whole thing. That said, if I had the cash, I’d be in the game. Sounds like a fun time.

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