A Moral Dilemma: Should You Lose Sleep Over Investing In a Foreclosed Property?

Here are 5 ways to make money while keeping a clean conscience.

A for sale sign is seen in front of a foreclosed home October15, 2007 in Antioch, California.

When a home goes into foreclosure, the owner is often suffering from what Bill Mazur, a 21-year veteran of foreclose investing, calls "the three D's: death, divorce, or disease." Other reasons can include job loss, unexpected medical bills, taking on more house than you can afford in the long term, and ballooning payments on adjustable-rate mortgages. And just when a person struck by tragedy needs all the comforts of home, a failure to make mortgage payments can lead to endless phone calls and letters from bill collectors, a public auction of the house on the courthouse steps to the highest bidder, and an eviction. A total of 215,749 foreclosure filings were reported in December 2007, according to real-estate tracking website RealtyTrac, up 97 percent from December 2006. And economists predict that those numbers will increase as unemployment grows and more adjustable-rate mortgages reset to higher rates. "I think that next year we will see foreclosures rise 40 to 50 percent on a national basis," says Ken Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California-Berkeley. But the misery, fear, anxiety, and anger experienced by someone about to lose a home is an opportunity for foreclosure investors, who are prepared and eager to swoop in and snap up the property at below-market rates, often with cash or a cashier's check in hand and sometimes well before the property is due for the courthouse steps.

Here's how successful foreclosure investors flip these precariously acquired houses and can still sleep at night.

Acknowledge the situation. People often have an emotional connection to their homes. "Sometimes the emotion will be upset, sometimes denial, sometimes relief because it's been a burden for a long time, especially if they have been over and above their means for a long time," says Alexis McGee, author of The Foreclosures.com Guide to Making Huge Profits Investing in Pre-Foreclosures Without Selling Your Soul and an 18-year foreclosure investor. "Dealing with emotion is what it's all about." McGee likes to begin a conversation with homeowners at the preforeclosure stage, when they've defaulted on several mortgage payments but the bank has not yet reclaimed the property. "You start by saying, 'I know you are having a tough time with your home, and I was wondering how I could help,' " she says.Peter Conti, a coauthor of Making Big Money Investing in Foreclosures Without Cash or Credit and a 17-year foreclosure investor, likes to sit down at the kitchen table with preforeclosure homeowners, find out what's going on in their lives, and come up with a way to help them as well. "The person in the house often has this expectation that the white knight in shining armor is going to show up and that they are going to be able to get a loan to make up their back payments," he says. "When someone is at an emotional low point, they really need to be handled with kid gloves and treated fairly."

Ease the transition. Many foreclosure investors see themselves as helping people who can no longer afford their house to transition into a situation that better fits their family's budget, such as an apartment, a smaller house, or a more affordable neighborhood. "If you handle it correctly, you are able to buy a property slightly below market and helping that person to be able to sell their home," says Mazur, a coauthor of Finding Foreclosures: An Insider's Guide to Cashing in on This Hidden Market, about buying homes in preforeclosure. Conti likes to get the homeowner to be part of his team. "The goal of the process is to get the seller to work with you to come up with how to sell the house rather than just telling them how we're going to buy it," he says. "If you go in listening to them with a caring heart, I think you have a much better chance of putting a deal together because you have time to connect with the person and put together something that works for you as an investor and works for them. If you go in to buy the house with dollar signs in your eyes, you're not going to be successful."Other investors prefer a short-sale approach to foreclosure buying. When property values have declined so that a homeowner owes more than a property is worth, a short sale can prevent foreclosure. This usually involves a real-estate agent's finding a buyer for the house before it is foreclosed upon and then negotiating with the bank to either take a loss on the remaining balance above the buyer's offer or working out an arrangement where the homeowner and bank share the loss. "I've got over 75 of these kinds of listings right now, and a year and a half ago, I had maybe five," says Randy Kutz, a co-owner of Phoenix Heritage Real Estate Group. "Because this is preforeclosure, the buyer gets a mortgage and the seller can contribute some of the closing costs." But sellers who have no equity in their home, which is often the case with subprime mortgages, leave the deal with nothing. "They get out from underneath the debt of the house, but they can't walk away with anything," says Kutz.