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I've read from several reliable-looking sources that if a foreclosed house goes up for auction, the bidding usually starts at the outstanding amount of the loan (plus fees, etc.): Example Money Talks, Consumer Affairs, Biggerpockets.

My question is: Why? Under what logical set of assumptions should the starting bid have anything to do with the outstanding amount of the loan?

I know a lot about math and econ theory and nothing about mortgages. So I feel like I'm just missing a key assumption here. But without that key assumption, the idea of starting the bidding at the outstanding loan amount makes no sense.

Suppose someone bought a house for $300,000. After time, the fair market value of the house dips to $250,000, and the buyer owes $100,000 on the mortgage. They stop making payments, so the house goes up for a foreclosure auction.

In that situation, why on earth would the bank start the bidding at $100K? It has nothing to do with the expected market value of the house. A bidder might get really lucky and walk away with the house for $101K even though it's worth $250K. More likely, if the marketplace is efficient, the bidders will end up bidding the value to about $250K anyway. But why bother starting the bidding at $100K? The only number that seems to make sense for the bank to start the bidding at, is the estimated free market value of the house (or maybe a little less, just so the bank can be sure someone bids). Anything else seems completely arbitrary.

I feel like maybe these articles are leaving out some key fact, like: "If you bid the outstanding loan amount, you win the right to live in the house, but you don't own the whole house; the previous owner still retains the equity that they had before they got evicted." Now in that completely hypothetical scenario that I just made up, it actually would make sense for the free market bid to be $100K -- however, I'm pretty sure that's not what happens in a foreclosure auction.

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    Think about why houses get auctioned off after being foreclosed.
    – Kevin
    Jun 7, 2018 at 18:23
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    As Patrick87's answer points out, the key fact that I was missing is that any money that the bank collects over the amount of the outstanding loan, has to be given to the previous owner who defaulted, so the bank has no incentive to start the bidding any higher than that. (Even though the bidding often does drive the price higher.)
    – Bennett
    Jun 7, 2018 at 19:10
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    In many jurisdictions an auction is legally required. I would speculate that it comes from cases where the mortgage was quite small compared to the value of the property. The bank then could sell it to a captive developer and avoid paying the borrower the excess value, so the the government demanded an auction. In theory, this protects the borrower by recovering the excess of the value of the house over the mortgage. Whether it works in practice is left as an exercise. Bidding the outstanding loan does not guarantee you will win.
    – Ross Millikan
    Jun 8, 2018 at 4:34
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    This differs by legislation. E.g. in Germany, the initial price (or rather, the acceptable price on an initial auction) is bound to the valuation: sucdessful bid cannot be lower than 50% or 70% of what the valuation says (this is dropped in consecutive auctions if the initial auction is not successful). Also, it is possible to sell the mortgage together with the house just like movable property can be included in the sale (bank needs to agree, though).
    – cbeleites unhappy with SX
    Jun 8, 2018 at 13:05
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    The only number that seems to make sense for the bank to start the bidding at, is the estimated free market value of the house (or maybe a little less, just so the bank can be sure someone bids). Anything else seems completely arbitrary. In a perfect market, the auction process would always arrive at exactly the fair market value. Therefore bidding could start at $0. The purpose of an auction is to determine the fair market value of something. If the fair market value is already known, then you just publicly offer to sell it at that price, and it sells (instantly, in an ideal market).
    – user13722
    Jun 9, 2018 at 14:58

9 Answers 9

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The bank only cares about getting paid the owed amount as quickly as possible. Anything more than that the bank has to give to the owners whose property they're auctioning.

Also, a house that could sell for $250k on the open market if the sellers wanted to sell and move out might be worth a lot less if the sellers don't want to move, might refuse to leave and might even be expected to strip the copper from the air conditioners on the way out.

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    And if the "adjusted" fair-market value (allowing for damage and obstinacy of existing occupiers) were still considerably higher than the outstanding debt (say, $200k against $100k owed) then in most/many cases, the auction process itself will drive the opening bid up to close to the (adjusted) fair-market value: it's great if you could get a $200k house for $100k, but still worth it if you have to go to $180k before the other bidders drop out of the auction.
    – TripeHound
    Jun 7, 2018 at 7:02
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    "The bank is running the auction, and doesn't really benefit from higher bids" is the key part here.
    – Yakk
    Jun 7, 2018 at 14:07
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    If you bought a $200K house for $180K, it's a $180K house, not a $200K house. A house is worth only what people will pay for it.
    – shoover
    Jun 7, 2018 at 18:59
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    Houses are not entirely liquid. It's entirely possible to have a house appraised at $250K which the owners are trying to sell for $220K and the process takes so long that the bank steps in and sells it for "best offer over $100K."
    – arp
    Jun 7, 2018 at 23:16
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    @vsz This will only happen if the debtor is not able to service his debt. So if he has allowed the situation to get this far, corruption should be the least of his worries. He could have sold the house in the open market way before a foreclosure.
    – ssn
    Jun 8, 2018 at 6:34
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As Patrick87 cogently points out (+1), anything more than the outstanding debt on the property being foreclosed on (plus various fees for filing the foreclosure paperwork etc) belongs to the original owner (the person(s) being foreclosed upon), and not the bank. Remember also that the bidding starts at the price the bank sets, and the bank can choose to accept the highest (or best) bid if it wants to, which could be higher than the starting price for bidding that has been set by the bank. If the property is worth $250K and the starting price is $100K, it might be that some prospective buyer will bid more than $100K to get the property instead of buyers who bid the minimum. Hey, getting a $250K house for $110K is still a great deal, though not as good as getting it for $100K, and some buyers might choose to bid more than the minimum to improve their chances of having their bids accepted.

There are also other matters to be considered such as the property is typically not available for inspection prior to purchase because the original owner is still in possession of the property, and might not cooperate. So the prospective buyers have no way of verifying that the property is indeed worth that $250K, other than by looking at the tax rolls and taking a wild guess. Nor, as Patrick points out, is there any guarantee that the property will be worth $250K when the original owner vacates the premises; the built-in appliances (which ordinary real-estate contracts spell out are included in the purchase) might have been ripped out, the interior painted black out of spite, etc. In fact, in many cases, evicting the original owner is something that the bank (forecloser) leaves to the new owner to handle; the bank just issues a new warranty deed transferring title to the buyer once the full amount of the accepted bid has been paid to the bank, and then it is the buyer's responsibility to evict the previous owner and take possession of the new acquired bargain. Possession is indeed nine points of the law, and the buyer may well need to go to court to get an eviction order which the sheriff can then execute (for a fee, of course) and so there is more expense yet to come, etc.

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    Painting walls would be too much work. I've personally seen appliances (washer, dryer, oven) ripped out and sold, and even heard about case where cement was poured by previous owner down the toilet to ruin it piping. Much more expensive to fix. Bank even pays "cash for keys" moving out expenses to prevent such destruction.
    – Peter M. - stands for Monica
    Jun 7, 2018 at 16:13
  • @PeterMasiar A few years ago, I saw the buyer of a foreclosed property pay first last and deposit for an apartment for the evicted owner to move into just to get them out without drama.
    – barbecue
    Jun 8, 2018 at 13:30
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    @PeterMasiar Painting the walls properly is a lot of work. Buying a can of paint, popping the lid, and flinging it on the walls and carpet (or similar types of abuse with a rattlecan) is no more work than buying and flushing a bag of cement.
    – Dan Is Fiddling By Firelight
    Jun 8, 2018 at 14:12
  • I'm curious... the wording you used in part of your answer leads me to believe these auction bids are "sealed". Is that true, are the auctions usually/always "sealed bids"?
    – Kevin Fegan
    Jun 13, 2018 at 16:39
  • @KevinFegan All the foreclosure deals I have seen have been sealed bids rather than open auctions, but then, my experience has been limited to one county in one state. (I have lived in different states but didn't pay much attention to real-estate foreclosures in them...)
    – Dilip Sarwate
    Jun 14, 2018 at 3:57
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Why? Under what logical set of assumptions should the starting bid have anything to do with the outstanding amount of the loan?

The lender is primarily interested in getting the property sold, getting his money back and recover from the situation.

It thus makes sense for the lender to ensure that the house gets sold. If the starting price of the house is lower; chances of it getting sold are higher. How low is low ... this is where the lender says as long as I get my money back; thats the low. If I get more, I have to give the excess to the original owner.

Thus starting point is generally set to outstanding amount. If the property goes for the said amount; then lender takes the money. If the property gets more; the original owner get the money.

Under no circumstances the lender will make more money that the outstanding loan amount.

The only number that seems to make sense for the bank to start the bidding at, is the estimated free market value of the house (or maybe a little less, just so the bank can be sure someone bids).

Here the Bank needs to then appoint a 3rd party for valuation and since one maybe subjective, they may need to get opinion from few. This is additional cost and delay. If the valuation is incorrect or the market doesn't agree; the house goes unsold. The Bank has to again get a re-valuation done. All this costs time and money for the Bank and this will increase the outstanding amount. Thus it is easier for the Bank to skip it.

It is also to be noted that the original owner before the foreclosure procedure begins, can sell the house for what he believes is right value; pay back the lender. So there is a choice that the original owner has not exercised and hence lender has forced a closure to get his due.

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    Something I don't understand; If I get more, I have to give the excess to the original owner. - why is that? If a property is foreclosed, that means the original owners have essentially abandoned it (Or at least abandoned paying for it), and it is being taken away from them. Could I buy a (let's say) 100k valued house, and do some changes to the property / find something that makes it worth more, say 200k (somehow, I know this is a long-shot), and then immediately stop paying for it to where the bank auctions it, and the bid goes up to 180k, will the bank pay me 80k for abandoning payment?
    – GrumpyCrouton
    Jun 7, 2018 at 17:47
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    @GrumpyCrouton: You'd be stupid to do that and risk the bank selling it for $100k and all your improvements being a waste, when you could instead have just sold it yourself for $180k despite it being worth $200k to make a quick sale.
    – R.. GitHub STOP HELPING ICE
    Jun 7, 2018 at 18:03
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    If the homeowner fails to pay, the bank's lien gives it the right to force the sale of the property to satisfy the debt. That's not the same as gaining ownership of the property. If the property sells for more than what is owed (which will be more than just the principal amount due to late fees, accrued interest, and so on), then the ex-homeowner is indeed entitled to the residual. Note, however, that a house that can easily sell for more than the amount owed will rarely make it as far as foreclosure. The homeowner would be better off selling themselves and paying the loan without default.
    – Nobody
    Jun 7, 2018 at 18:04
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    @GrumpyCrouton. That isn't really a trick though. If your house becomes more valuable than it was then that is your money. All the bank was ever entitled to was their money.
    – Mark Perryman
    Jun 8, 2018 at 17:14
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    @JeopardyTempest Yes. It is same in every case. The lender gets his outstanding amount. Any thing excess goes to original owner
    – Dheer
    Jun 10, 2018 at 4:47
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There are already several answers which talk about various considerations based on the house, and the lender's desire to get their money back. One consideration I haven't seen discussed yet is the cost/availability of funds to purchase a foreclosure.

The way most people purchase homes is via an underwritten mortgage process. This generally isn't an option for foreclosure auctions. Typically people purchasing a foreclosed property need to have the cash, a large line of credit, and/or access to a private lender. Since the private lenders and lines of credit are more expensive than a standard mortgage which affects the price people can pay. More importantly the difficulty funding the purchase means that only a small subsection of the population can make these purchases. In practice this subsection is generally doing this in order to make money, so there needs to be space for them to make a profit. If there is no space to make a profit then virtually all the buyers disappear and the lender is stuck with a house they don't want. By selling the foreclosed homes for less than "market rates" it helps everyone. The lenders win because they can recover their money quickly so they can lend it again to earn money. The buyers win because they can make a profit on the homes. The new lenders win because they can lend money at a higher rate for a shorter term. The previous owners win because they potentially get a small windfall and they can find a new place they can actually afford.

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    This is a really good point. There is not one, single market value; different groups of buyers will have different views of the value
    – Christian Palmer
    Jun 8, 2018 at 8:12
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    Not sure the previous owners win: The "small windfall" might be much smaller than what they already put into the mortgage, and it might also not be enough to get a new place, possibly leaving them without a place to live (since they were unable to keep up the mortgage payment, they are probably unable to pay rent).
    – mastov
    Jun 8, 2018 at 9:33
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    @mastov they're probably not going to be able to pay the rent for a similar place to the one they just lost, but I don't think it is right to say they're automatically living on the street. The money they put into the mortgage is a sunk cost, and that isn't entirely lost anyway because they'd have to live somewhere during that time anyway which would have a cost associated.
    – Erik
    Jun 8, 2018 at 14:07
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    @Erik - But, they already paid for that when they paid for the property tax, repairs, maintenance, improvements, insurance, etc. This is almost never a small fraction of, and may exceed the comparable rent. Plus, unlike the bank, the owners are almost always loosing out on any/all return on their investment, and they also loose most or all (or at least a large portion) of their investment like their down payment and principal payments. It's hard to imagine a better overall solution, but I don't think you can say, in any sense, that the previous owners come out "winners".
    – Kevin Fegan
    Jun 9, 2018 at 17:07
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    The payments might be a "sunk cost", but that doesn't make them nonexistent. They were investments that are now gone (due to selling the property below market value, not before!), but that otherwise would have had a correspondence in the house value. So you do take something away from them, and often it's not insignificant at all. So I wouldn't dare to call the owners of a foreclosed house "winners". Would you call the owners of a stolen car winners, if their insurance pays for half the current value? After all, they received money and the price they paid for the car is a "sunk cost".
    – mastov
    Jun 11, 2018 at 9:38
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Typically there is more than the main home loan lein on a house that’s in foreclosure. The only way to guarantee clean title to a buyer is to foreclose eliminating most additional leins. IRS Leins for example don’t go away automatically but need to be paid. Even if you see someone buying a house for 100k it often has a lot more debt that a buyer takes on.

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    I agree that this can happen sometimes and that even in some cases, the new buyer (bidder) may not be aware of all those debts, but I wouldn't say it happens often. I quickly tried to find statistics with no luck, but from personal experience, I would say the vast majority of homes have only the one "main" mortgage. Of course the percentage for people under foreclosure could be higher, but at the same time, it would be unlikely that a person in that position would qualify for a second mortgage.
    – Kevin Fegan
    Jun 9, 2018 at 18:44
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Why not start at $1?

This would maximize the chance of the house selling, but it could hurt the bank's balance sheet. While the bank owns the house, it can fudge the estimated value to some extent. When the bank auctions the house, the (assumed) value of the loan principal is replaced with (actual) cash from the buyer. If the bank were to sell the house for less than the outstanding principal, then the bank would immediately realize a loss in equity. This is one reason why banks in precarious financial situations would rather let the house sit vacant than lower the opening bid.

Why not start at the estimated value of the house?

As others have written, the bank wants to recoup the principal now and doesn't have an incentive to maximize the sale price, because extra money goes back to the foreclosed owner.

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  • This could all be true (I have no idea) but it still wouldn't explain why the bank would start the auction at $100K in the case where the house is worth $250K, everybody knows it's worth $250K and the bidding is extremely likely to go that high. As others have pointed out, the real reason is that if the auction collects any money above the amount of the outstanding loan, the bank has to give that excess money to the previous owner, so the bank has no incentive to start the bidding any higher than that (even if in practice it does usually go higher).
    – Bennett
    Jun 11, 2018 at 21:06
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I feel like maybe these articles are leaving out some key fact

Right of Redemption often isn't mentioned (neither equitable nor statutory).

Under what logical set of assumptions should the starting bid have anything to do with the outstanding amount of the loan?

This post should not be considered financial advice.
I'm not qualified to give anything but my personal opinion.

The seller (let's say "bank") is interested in recouping its debt.
Where debt = unpaid loan amount, +taxes paid, +amount paid in fees (paperwork, lawyers, etc.)

if the marketplace is efficient, the bidders will end up bidding the value to about $250K

Markets are (reasonably) efficient at the moment, but as you said, "about 250".
If the market value is $250k, I would expect to see less than that as the sale price. Current occupancy, the time and money it takes to restore or upgrade the property (including permits), and Right of Redemption will generally put downward pressure on the $250k theoretical value.

I am not a lawyer (IANAL), but I understand Right of Redemption to mean that the person who lost their property/home to forclosure has the right to buy it back at bid price + allowed fees. Right of Redemption after Forclosure doesn't exist in some places, but for example can be up to two years in Tennessee.

See State Laws Regarding the Right of Redemption for what I assume is an accurate list.

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  • It turned out the key fact (according to multiple people who answered) is that any money collected in the auction, above the amount of the outstanding loan, has to be paid to the previous owner who was foreclosed on. So the bank has no incentive to start the bidding any higher than that. (I hadn't heard of Right of Redemption, so that's interesting. Although, that would only explain why the price would be driven down; it wouldn't explain why the bidding starts at exactly the amount of the loan. The preceding fact is what explains that.)
    – Bennett
    Jun 9, 2018 at 0:06
  • That's interesting that a "Right of Redemption" might apply to a bank (lender) foreclosure. I had only heard about "Right of Redemption" regarding a "tax sale (auction)" for unpaid property tax.
    – Kevin Fegan
    Jun 9, 2018 at 17:13
  • @Kevin Both (legally) seize property. And you don't always have that right, it depends on the property location as I mentioned and linked. Even having the right generally makes no difference because if you had the money you (normally) wouldn't be in forclosure in the first place.
    – J. Chris Compton
    Jun 11, 2018 at 12:39
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If the opening bid was the free market value of the house, there is the risk that the auction will fail because either no-one would want to buy the house from the auction when they can buy the a house of equal value for the same amount of money on the free market instead of in an auction. Or even if one bids, a second bid would be waste by definition because it exceeds the free market value. Actually, the end price in an auction is by definition, so to speak, the free market value of the house because it is exactly the price at which supply (one house) and demand (only one buyer left) meet.

At any rate, the risk of no-one being willing to make a starting bit grows with the minimum bid, hence in order to be sure the house is sold, the bank should try as low as possible - so in principle they might start at a single dollar! But in that case, as long as the current bid is below the outstanding mortgage plus fees, it would be advantageous for the bank to bid the current bid +1$ themselves! So if instead they start at that amount as minimum bid, the outcome is the same except that the actual act of the bank buying from itself in case of no high enough bids is replaced by the auction failing.

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  • Yes, that's why I said in the question, "The only number that seems to make sense for the bank to start the bidding at, is the estimated free market value of the house (or maybe a little less, just so the bank can be sure someone bids)." What you're describing is a reason why the bid starts at less than the value of the house, but not why the bid starts at exactly the amount of the loan. As another answer explained, the real reason is that any money collected over the amount of the loan, the bank has to give to the previous owner, so they don't start the bidding any higher than that.
    – Bennett
    Jun 9, 2018 at 2:57
  • There are issues with this answer. 1. The end price of one particular auctioned property is not its market value, it is just the price of that particular sale. Market value has a specific meaning and has a set of assumptions e.g. about openness and competition. E.g. the market value could be $250k but it could be a bad auction day and it sells for $200k. 2. "free market instead of in an auction" - generally these two methods of selling do not achieve the same price e.g. because of this.
    – JBentley
    Jun 10, 2018 at 3:16
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The "opening bid" doesn't actually mean much. In your example, all it means is that bids below $100,000 won't be accepted. If that house is worth $250,000 and in the very unlikely case that nobody is willing to bid even $100,000 then the house would not be sold.

Usually the reason for a limit on the opening bid is to waste time. Imagine the Mona Lisa is on auction, and two hours are spend bidding her up from $1 to $1,000,000. That's just wasted time. Now if it was my property and I was selling it myself, I would want an opening bid close to what I want to get, and possibly have a limit so the property cannot be sold too cheap. Since it's the bank that is selling, and they are only interested in getting their $100,000 back, that's where they can set the opening bid.

Obviously if the house is worth $250,000 and the debt is $350,000, then the bank will not have an opening bid at $350,000 because nobody will buy the house. They know they are not getting all their money back, so they pick an opening bid that maximises their chances. (Something not too cheap, but cheap enough to get the auction started, and hoping that someone gets all excited and bids more than the house is worth).

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  • I think most of this is true, but it doesn't explain why the bank starts the bidding at exactly the outstanding amount of the loan. The reason, as other answers have stated, is that if the auction collects more than the unpaid loan amount, the bank has to give the extra money back to the previous owner who was foreclosed on. So they have no incentive to start the bidding any higher. (It is not technically true that the bank "is only interested in getting their $100K back" -- they are "interested" in whatever they can get -- but the real reason is they can't keep any proceeds beyond that.)
    – Bennett
    Jun 11, 2018 at 21:02
  • What are you trying to say there? Are you saying that if I owed $100,000 with a house worth $350,000 the bank would love to have the $350,000 but they have no right to it? That would some to be so obvious that Mr. Obvious himself would call it obvious.
    – gnasher729
    Jun 11, 2018 at 21:47
  • Well it can't be that obvious, if more than half of the other answers missed it. A lot of the answers say things like "The bank starts the bidding at a low amount because the true value of the house isn't as high as the street estimate, because the previous owner probably stopped maintaining it." That's irrelevant to the real answer, which is that the bank just starts the bidding at the outstanding amount of the loan because they don't get to keep anything above that amount.
    – Bennett
    Jun 13, 2018 at 0:24
  • also I'm not sure what you mean by "They [the bank] know they are not getting all their money back." If the house is worth $350,000, the bank almost certainly is going to sell it for more than $100,000, which means they will get all their money back (the outstanding amount of the loan, plus the loan amounts that have already been paid).
    – Bennett
    Jun 13, 2018 at 0:25

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