Knowing how to buy a pre-foreclosure home gives you one more potential strategy for buying an affordable home in a crowded market.
It’s important to know how to buy a pre-foreclosure home. Buying a pre-foreclosure home can be a way to get a house at a competitive price and potentially break through the home-buying crowds.
What is a pre-foreclosure home?
A pre-foreclosure home is the first step in the foreclosure process.
When a house goes into foreclosure, the mortgage lender takes over the home and puts it up for sale. During the pre-foreclosure period, the lender has warned the borrower that they are in default and at risk of foreclosure, but the house has not yet been repossessed.
At this point, the borrower can sell the property to avoid an actual foreclosure, which can negatively impact their credit.
“A pre-foreclosure happens when the borrower fails to make three consecutive payments on their mortgage loan. In this case, the lender issues a notice of default, which means that a pre-foreclosure has occurred,” explains Daniela Andreevska, a real estate expert with Mashivor, a U.S.-based real estate data analytics company. “During this time, the borrower can try to work out an agreement with the lender to allow them to keep the property, or the borrower can attempt to sell the property before it heads to actual foreclosure.”
Martin Orefice, CEO of Rent To Own Labs, says a sale at this point is sometimes in the best interests of all parties involved.
“The homeowner can get out of their mortgage without damaging their credit score. The buyer of the pre-foreclosed home can get a good deal on the property. And the bank can get out from a risky borrower,” he says.
What are the advantages of purchasing a pre-foreclosure home?
The biggest plus of buying a pre-foreclosed home is that you will likely be able to pay less for the house than if it were not in pre-foreclosure.
“Since the homeowner is in a hurry to sell their home before the bank reclaims it, they are usually willing to sell at a very discounted price,” Andreevska notes.
They may also be more amenable to negotiating because they want to sell fast and avoid foreclosure.
Other advantages to Pre-foreclosure homes is that they are not listed on the MLS. That means there’s less competition for these homes from rival purchasers. (Pre-foreclosed homes listed on the market are considered short sales, not pre-foreclosure sales.)
Brendan McElhaney, a real estate investor in Chicago, adds that the buyer also can use traditional financing and choose to have the property professionally inspected and its title searched during a standard due diligence period.
“Additionally, by purchasing a pre-foreclosure property, you can help out a person in need,” says Andreevska. “You’ll have the moral satisfaction of knowing that you assisted a homeowner in a very stressful financial situation, allowing them to sell their home, repay the bank, and potentially have some money left rather than losing their home to the bank.”
What are the risks of buying a pre-foreclosure home?
Pre-foreclosure home purchases are not slam dunks. There are drawbacks and have risks involved, too.
If the homeowner is struggling financially, they may not have been able to maintain the property, says McElhaney.
“You may be taking a chance on a distressed, problematic home that needs upkeep and repairs,” he cautions.
Of course, that’s not always the case. The property may be well maintained despite being in pre-foreclosure, particularly if the homeowner has only recently fallen on difficult financial times.
It’s always wise to get the home you plan to buy inspected, regardless of whether it’s a pre-foreclosure home.
“It’s essential to have the home professionally inspected before finalizing the deal and paying for the property so that you know exactly how much you will need to pay for any fixes or repairs required,” Andreevska says.
Another negative is that the seller can back out of the transaction if their financial situation improves, leaving you suddenly without a deal and a potential home, he adds.
“Depending on what stage the property is in with the lender, you could reach the closing stage only to learn that the current borrower is now no longer the owner of the property and not in a position to sign over the title,” says Chris Barnett, a real estate agent with eXp Realty in Birmingham, Alabama.
It’s important to work with your real estate agent and learn as much as you can about the property and where it is in the foreclosure process before you commit to the purchase.
How to find pre-foreclosure homes for sale
Pre-foreclosed homes are not listed on the market. That means you’ll need to do a little extra digging to find these rarer properties for sale.
You can find free pre-foreclosure listings in the public records area at your county recorder’s office or online. You’ll want to hunt for “Notices of Default,” “Lis Pendens,” and “Notices of Sale.”
“You can also buy online pre-foreclosure leads and consult with real estate wholesalers and attorneys, who may have access to information about these types of properties,” suggests McElhaney.
Ask your real estate agent as well. They may know of homes that are coming onto the market and may be able to arrange a showing even if the home is not publicly listed.
How to buy a pre-foreclosure home
When you make an offer on a pre-foreclosure home, you are typically dealing directly with the seller – not their lender (although the lender will need to approve the deal).
One approach is to pay down the balance owed by the owner to their lender and then purchase the home directly from the owner for a significant discount, with or without financing involved.
“It’s always best if you can pay in cash, which can speed up the sale and avoid any problems like not being able to qualify for financing from a lender,” says Andreevska.
If you need financing, you will take out a new mortgage loan for the pre-foreclosure property. The amount you borrow will pay off the seller’s existing mortgage debt.
This transaction can get complicated and legally sticky. Barnett recommends working with a real estate agent and attorney who have experience with pre-foreclosure homes and other off-market properties for sale.
“You want to ensure that everyone involved is legally protected and that the lender is informed of the intent to sell,” says Barnett.
Also, “make sure to include contingencies that will allow you to get out of the sale if there’s a problem with the title or home inspection,” Andreevska suggests.
Keep in mind that the purchase process could take slightly longer than a typical sales cycle, “and you may have to deal with the actual closing date moving around a bit just because there are so many moving parts involved,” Barnett continues. “A buyer who is not in a position to be flexible with the possible closing date might be in for a lot of frustration and end up without a home to live in if the closing date gets pushed back far enough.”
The bottom line on how to buy a pre-foreclosure home
A pre-foreclosure home can represent a great deal for a smart buyer or investor who is willing to take the time to carefully research these opportunities and partner with trusted experts like an experienced real estate agent, attorney and title professional.
If you choose to pursue a pre-foreclosure home, make sure you are in regular contact with all parties and that you fully understand the circumstances and the extent of any repairs that may need to be made to the property.
“Communication is crucial between the buyer, seller, and lenders involved so that everything can be completed correctly and in a timely fashion,” says Barnett.
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