Buying a Home in Pre-Foreclosure: What You Need to Know

Buying a Home in Pre-Foreclosure: What You Need to Know
••• KLH49/iStock/GettyImages

Investing in homes that are in a pre-foreclosure stage can be a lucrative venture. However, it's also a process that is full of risks.

Buying a home in pre-foreclosure is not as simple as making a down payment and getting a mortgage. The pre-foreclosure process is different, so there are numerous issues you must consider before purchasing a pre-foreclosure property.

Let's look at the process of purchasing a home in pre-foreclosure and how to judge the risks.

What Is a Pre-Foreclosure Home?

A home can go into pre-foreclosure when the homeowner falls behind in their mortgage payments and the lender files a notice of default. At this point, the lender has not taken possession of the property, and the owner is probably still living in the house. Legally, the homeowner has been notified that foreclosure is going to begin unless the mortgage payments are brought current.

Lenders usually give homeowners a certain period of time after filing a notice of default to bring the loan up to date with payments of the mortgage and late fees.

Prior to foreclosure being initiated by the lender, the owner can sell the home to pay off the loan, work with the lender to modify the mortgage terms, make a short sale or execute a deed in lieu of foreclosure process. The lender is not involved in any negotiations to sell the house while the property is in the pre-foreclosure stage.

How to Find a Property That’s in Pre-Foreclosure

Homes that are in the pre-foreclosure stage are more difficult to find than properties that have already been foreclosed by lenders. Technically, a home in which the owner is behind on payments is not actually for sale and does not appear in any real estate listings. The homeowner may be negotiating with the lender to modify the terms or trying to work out a payment plan to bring the mortgage current while in the pre-foreclosure phase.

Information about properties that are in pre-foreclosure is publicly available at the county clerk’s office, but in most counties, you have to go in person to look through the records. To make it easier, real estate websites like Zillow and have paid subscriptions with listings for properties in pre-foreclosure.

When buying a pre-foreclosure house, you'll have less competition than if you're trying to buy a foreclosed home at auction. It takes a considerable effort to even find homes that are in pre-foreclosure, thereby reducing the number of prospective buyers.

Evaluating a Prospective Property in Pre-Foreclosure

The goal when buying a house in pre-foreclosure is to purchase the property at a price significantly below its market value, pay the past due loan payments, make any necessary repairs and sell the house for a profit. You should drive by the house and get a feel for the neighborhood and the market value for houses in the area.

At this point, you could check public records to learn the outstanding loan balance and find out if there are any liens on the property. You'll be responsible to pay off the mortgage balance, any liens on the property, the taxes and any unpaid homeowners and mortgage insurance.

In addition to the price that you agreed to pay the seller, you must add the cost of repairs. If the homeowner hasn't kept up with the mortgage payments, they most likely have not kept up with the repairs either. Ideally, all of these costs and past loan payments should add up to a figure that's a lot less than the market value of the home so that you can sell it and make a profit.

Allow for contingencies. You will need a title company to do a title search to make sure there are no problems with the title. In addition, if you're not qualified to do a thorough home inspection yourself, you should hire a professional inspector. You must be absolutely certain that you have discovered everything that needs to be repaired or replaced. Any cost for repairs that you miss will reduce your profits.

How to Negotiate With the Homeowner

Be aware that when you first approach a homeowner whose house is in pre-foreclosure, they may not be eager to see you or talk with you. They may not even be considering the possibility of selling the home that their family has lived in for years. But because the homeowner is financially distressed, they may come to the decision that selling their home is the best option.

These transactions work best if you're paying in cash. If you're not making an all-cash offer, you need to have a pre-qualification letter from a lender showing that you have the financing available to purchase the property. Otherwise, the owner will not take your offer seriously. You have to make it easy for the homeowner to accept your offer. Remember, the homeowner has a short period of time between the filing of the notice of default and the initiation of foreclosure proceedings to solve the problem.

The benefit to the homeowner is that you may be able to save them some of their equity and prevent serious damage to their credit score. The lender will likely notify the credit agencies about the homeowner's late payments, but at least the homeowner will not have a foreclosure on their credit report.

What Is a Short Sale?

Not all pre-foreclosure listings will make financial sense. In some cases, the mortgage balance is higher than the value of the property which means the property is “underwater.” In this case, a lender may agree to a short sale, which means they'll be selling the property for an amount that is less than the balance due, and they'll take a loss on this mortgage.

Lenders will not be happy about making a short sale. They may prefer to go ahead and foreclose on the property and try to sell it at auction for at least enough to pay off the balance of the loan rather than writing it off as a short sale.

Should You Use a Real Estate Agent?

Homeowners who are behind on their mortgage payments and have been served with a notice of default can be emotionally stressed. They might become resentful and uncooperative when first approached with an offer to buy their property.

Unless you're an experienced investor and used to dealing with these kinds of emotional situations, it might make sense to hire a real estate agent to handle the negotiations for you. An agent would have more experience in handling these types of situations.

Buying pre-foreclosed properties is an endeavor best left to seasoned investors, not first-time homebuyers. It's a complex process, and the laws are different in every state. You have to be willing and able to negotiate carefully in sometimes emotionally charged situations. However, if you're willing to do the hard work and investigation, buying homes that are in pre-foreclosure can be a profitable real estate investing venture.