A pre foreclosure happens when a borrower defaults on their mortgage but before the bank fully forecloses on it and sells it at auction. During this time, the seller can either sell the property or make good on the outstanding balance owed. An investor can typically buy a pre foreclosure at a discount.
If you’re ready to finance a rent ready pre foreclosure, working with a reliable lender is key. Visio Lending is a national lender that can fund projects quickly and offer investors 30 year mortgages with rates starting at 4.7%. Get prequalified today.
Here we will discuss how to buy a pre foreclosure home in 8 steps:
1. Understand the Pre Foreclosure Process
Pre foreclosure is the name of the first step in the foreclosure process. The process varies greatly by state and even varies among lenders, but generally if the seller misses three consecutive mortgage payments, the bank will issue a notice of default and the pre foreclosure stage will begin.
This simply means that the bank is preparing to foreclose on the house. Once the notice of default is issued, the seller will generally have 2-3 months to “reinstate” the loan and stop the foreclosure process. Reinstating the loan includes making an acceptable payment arrangement with the bank or catching up entirely on the loan plus late fees.
If the seller can’t afford to do either of these, they can sell the property themselves (typically for a discount) or risk losing it to foreclosure, which means the bank takes back the property and sells it at auction to recoup its losses. This means that if you find a house in pre foreclosure, you can most likely negotiate a deal, but that the seller might be able to reinstate the loan and take the property off the market.
It’s a misconception that pre foreclosure homes are all in distressed condition and located in undesirable neighborhoods. Financial setbacks can happen anywhere and investors often find pre foreclosures in nice neighborhoods that they may otherwise not be able to afford. However, keep in mind that if the seller can’t afford to keep up with the mortgage payments, it’s likely they couldn’t afford to keep up with repairs, so you may have a few things to fix.
Who Pre Foreclosures are Right for
Pre foreclosures can be a good deal for investors since the seller is usually going through a financial hardship and would rather sell the property at a discount than lose it and have a foreclosure on their credit report. Both long-term and short-term investors purchase pre foreclosure properties at a reduced price so they can increase their profit.
However, a pre foreclosure isn’t usually good for first time homeowners since you may need to make repairs and the seller often doesn’t have the money to fix anything before selling the property.
Fix-and-flippers generally purchase pre foreclosures that need substantial repairs by using a hard money loan and then flipping the pre foreclosure for a profit and paying off the loan. Conversely, long-term-investors buy pre foreclosures, do any necessary repairs and season the rehabbed property (often with a hard money loan), and then refinance to a long term loan.
2. Find Pre Foreclosure Leads
The available pre foreclosure leads will dictate neighborhoods to look in since there are fewer pre foreclosures than normal listings. This means that traditionally, you choose an area/neighborhood you like and then look for homes within that area. The opposite is true with pre foreclosures, since there aren’t as many of them – you have to check the available leads first, which will dictate the neighborhoods you look within.
For example, In Miami Dade County, Florida there are currently 682 homes that are listed in pre foreclosure or foreclosure, in contrast to 5,300 non foreclosure homes for sale. As you can see, the foreclosures account for only 12.9% of the total homes on the market.
However, while pre foreclosure leads may be scarce, you should still try to find a property that is one hour or less away from your current resident, so it’s convenient for you to make site visits, meet contractors, etc. That is, unless you want something like a turnkey property that is managed by a professional management company. If that’s the case, you can expand your search to other areas, such as other states.
Regardless, there are 2 ways to find pre foreclosure leads:
Find Pre Foreclosure Leads off the Market
Pre foreclosure leads that are off the market mean that they are not listed for sale yet. These generally take more legwork to find, but can easily be done once you know where to look. If you buy a pre foreclosure before it hits the market, you may be able to get a better deal since the realtor’s commission isn’t already accounted for and there will typically be less competition.
These pre foreclosure leads are generally found in the following places:
- Public records at your local county clerk’s office, usually called the recorder’s office
- Local newspapers
- Through attorneys
- Referrals from real estate wholesalers
“One way to find pre foreclosure leads is to look for properties that have a notice of default. This is a public notice that states the borrower has not made their mortgage payments by the deadline and has a certain amount of time to pay the past due amount and late fees, sell the property or the lender will repossess the property. Many investors look at these notices and contact owners directly to purchase their properties.” — Ross Hamilton, CEO, Real estate Investor, Connected Investors
Pre Foreclosure Leads on the Market
These are the easiest leads to find since they’re “on the market,” which means they’re listed on the Multiple Listing Service (MLS). You can find these leads by working with a local realtor. All licensed realtors have MLS access and unless the property is a short sale, any realtor should be able to help you.
When you work with a realtor to find pre foreclosure leads, you usually don’t pay the realtor anything up front. This does vary by state, but generally the realtor is paid at closing from the seller’s proceeds. This is important to know, so you can use their expertise and guidance without worrying about any additional costs. Further, this means that you should be looking for off market leads at the same time you’re using a realtor to help with leads on the market.
In addition to working with a realtor, you can proactively find pre foreclosure leads yourself online at sites like the RedX, Zillow and Foreclosure.com. Sites like Zillow will offer data on how many homes are in varying stages of foreclosures in a certain area and will provide a map with the locations pinned. Just search homes for sale on the menu and then click on foreclosures.
For more detailed information on finding both on market and off market pre foreclosure leads, read our article on how to find pre foreclosure leads.
3. Research the Pre Foreclosure Neighborhoods
You know what to expect during the pre foreclosure process and you have seen where the pre foreclosure leads are, so now you need to research the neighborhood with the best leads. It’s important to know the neighborhood you’re buying in since you can fix up the house but you can’t change the neighborhood.
The neighborhood should be convenient to where you live and/or work (unless you expect to have a property management company). It should also be easily accessible by highway or public transportation so contractors and tenants or future buyers can get to your property without difficulty. Keep in mind that it doesn’t need to be a neighborhood that you would necessarily live in, but you want it to be well-kept and safe.
What to Look for in a Neighborhood
Regardless of if you’re planning on renting or flipping the pre foreclosure home, someone is going to be living in the property and they generally want to see certain things in a neighborhood. Some things to consider are the overall market conditions, affordability and availability of public transportation or parking, and the strength of the school system.
Specific things to look for in a neighborhood:
- Amenities and attractions including parks, shopping, restaurants and local businesses
- Walkability score, which means what you can get to without the use of motorized transportation
- Highly rated schools
- Condition of sidewalks, street lamps and roads
- Condition of buildings and nearby homes
- Days on market: how long properties generally sit on the market before being sold
Keep in mind, however, that the things you want to look for in a neighborhood is different if you expect to fix and flip a property or rent one out as either a vacation rental or long term rental. For example, a quiet street might be more desirable for a long term renter but an Airbnb guest might want a busy street that’s closer to the action.
4. Find a Lender & Get a Preapproval Letter
Now you have put some feelers out there, found some pre foreclosure leads, and researched the neighborhood, you want to know how much property you can afford. A pre approval letter will give you your max borrowing amount, and from there you can decide on your budget.
Of course, you don’t have to buy a house for the full amount of the pre approval letter. It’s meant to represent your max borrowing amount and you can use it to set your own house budget. A pre approval letter not only sets your max borrowing amount, but it lets the seller know that you’re a serious, qualified buyer, and most realtors and agents won’t even work with you without a preapproval letter.
You can find a loan through the following:
- A permanent loan through a bank or credit union where you already have a relationship
- A short term rehab loan through a hard money lender, using this nationwide hard money lender directory
- A referral from your realtor, attorney or accountant
The type of lender you work with will depend on the condition and type of the property. For example, a hard money lender will finance a pre foreclosure in poor condition, while a conforming lender will finance a property in good condition. If the preforeclosure is an apartment building then you will need an apartment building loan issued by a lender familiar with commercial loans.
Something that all lenders usually look at is your DTI ratio and that will help dictate your max borrowing amount, or the amount listed on your pre approval letter. The lender will also want to see a specific amount of cash reserves.
Keep in mind that depending on your strategy, you may have to factor in other expenses such as a renovation budget as well as any holding costs. These are important components to consider when buying a pre foreclosure home to ensure you’re borrowing enough.
Documents Needed for a Pre approval Letter
A pre approval letter is important for two reasons. It tells you how much money you can borrow and what the general terms are such as when the letter expires (usually 60-90 days), interest rate and down payment required. It also shows the buyer and their realtor that you’re qualified to purchase the property.
You will generally need the following in order to receive a pre approval letter:
- Identification such as your driver’s license
- Credit report (check your score free here)
- 2 most recent pay stubs that show year to date earnings
- 2 years of tax returns
- 2-3 months of bank statements
Of course, the specific documentation needed will depend on the type of loan you’re getting and the lender you’re working with. If you’re a fix and flip investor, it’s probably a good idea to check out our article on the best hard money lenders. If you’re a long term investor and you don’t need to renovate your pre foreclosure, it’s best to look for a more traditional loan with an established lender.
5. Narrow Down Search to One Property
After you know what properties are out there and have a pre approval letter, you can narrow down your search to one property. You should start looking at your pre foreclosure leads online to save time and money, and then visit the ones that you’re interested in.
It’s also a good idea to search for the properties yourself online in conjunction to working with a realtor. That way, you will vet more properties in less time, thus being able to narrow down your search to the one property you want to make an offer on. You should compile a list of what you want in a pre foreclosure property and then break that list up into two sections: what you must have and what you want to have in a pre foreclosure property.
Examples of must haves in a pre foreclosure property:
- Repairs that fit in your budget
- Good bones, i.e. the structure and size of the house should be what you want since they’re expensive and difficult to alter
- Amenities that are popular in the neighborhood like a garage or backyard
Examples of things that are nice to have in a pre foreclosure:
- Open floor plan
- Light filled rooms
Once you decide what you need to have in a pre foreclosure property, that will automatically help narrow down your search. For example, you may only be looking at properties with a garage and three or more bedrooms, so you will take any two bedroom homes without garages off your list.
A realtor that’s familiar with the area can help you zero in on a property too. They should be able to tell you what common home features in the area are, like a finished basement or an eat in kitchen. They will also be able to tell you what prospective buyers look for. For example, if all of the two bedroom homes are sitting on the market longer than three bedroom homes, that generally tells you that you want to purchase a three bedroom home.
6. Make an Offer on the Pre Foreclosure Property
You already have a pre approval from your lender, so now you can comfortably make an offer on your desired pre foreclosure property. Your offer will most likely be contingent on financing, which means that if your financing falls through you won’t lose your deposit.
However, remember that the seller’s financial situation may change and they may be able to catch up on the mortgage and decide not to sell the property. This rarely happens, but in the case that it does, just be prepared. If everything moves forward as planned, after you make an offer, it usually takes 30-60 days to close on a property, which is basically the same as buying a non pre foreclosure.
If you’re paying cash or using a hard money lender, the timeline is much shorter and can be as short as 10 days.
It’s a good idea to work with a realtor when making an offer since they’re familiar with your state’s paperwork and deadlines for an inspection etc. Your realtor will either negotiate with the seller directly or with their realtor. In the case that the property is a short sale, you or your realtor will be dealing with the bank in an entirely different process.
Once an offer is accepted by the seller, you or your realtor (if you’re working with one) will send the purchase contract to the lender and they will begin underwriting the loan. This just means that the lender will review all of your documents before issuing a financing commitment.
7. Get a Financing Commitment
Ideally, you have a strong pre approval letter from a reputable lender before making an offer on a property because your offer is usually contingent on getting financing. A financing commitment is different than a preapproval letter and the lender usually needs more information and documentation than during the pre approval phase.
This is because the lender is pledging that they will lend you money on a particular home based on the information you provided them. The financing commitment is issued once the lender is comfortable that you and the property meet their underwriting requirements. You can only get a financing commitment once you’ve identified a pre foreclosure and agreed with the seller in principal on a deal.
Keep in mind that the commitment (and therefore the sale) is not set in stone and will depend on all of your financial information being accurate. However, it’s still stronger than a pre approval letter since the lender has had time to review all of your financial documents as well as documents pertaining to the property.
The lender will need the following before issuing a financing commitment:
- Complete mortgage application
- Application fee if applicable
- Documentation showing where down payment is coming from
- Property details
- List of current assets and liabilities
- Property appraisal
- Purchase contract
Keep in mind that all lenders have their own requirements and a conforming lender will have the most stringent qualifications, as compared to a private money lender.
8. Close on the Property
The last of the eight steps on how to buy a pre foreclosure home is closing on the property. This is where the deed is transferred into the new owner’s name at what is called a settlement or closing. Usually this happens at a title company of the buyer’s choice and takes about 60-90 minutes.
At the settlement you will pay closing costs which can include property taxes, transfer taxes, title insurance, lender fees etc., and total 2-5% of the purchase price. The title company usually handles the disbursement of the funds between you, your lender and the seller and then you receive the keys and the property is yours.
What to Expect After Closing
Congratulations, you just purchased a pre foreclosure property. Now you need to know what to do next. Keep all of your paperwork in an organized file since you will need to access it for tax purposes, turning on or switching over utilities etc.
After closing on the property, remember to:
- Hire a locksmith to change all of the locks
- Transfer utilities to your name or call utility companies to get them turned on
- Start fixing up the property right away if it needs repairs since the shorter your timeline the lower your carrying costs
- Once the property is in move in ready condition, advertise it for rent or sale
Pros and Cons of Buying a Pre Foreclosure
Buying a pre foreclosure is different than buying a home the traditional way. There are advantages to buying a pre foreclosure such as less competition since the property may not be listed on the market yet. However, there are disadvantages too, including dealing with uncooperative sellers and a lengthy timeline to get to closing.
Pros of Buying a Pre Foreclosure
- Less competition since some of the properties aren’t listed yet
- Purchase a property for less than market value
- You can often finance the property
- Buy a property in a neighborhood you couldn’t otherwise afford
Cons of Buying a Pre Foreclosure
- Neglected home repairs
- You need to look for pre foreclosure leads if the property isn’t listed
- Dealing with emotional sellers
- A lengthy timeline if you negotiate with the seller’s mortgage company
Frequently Asked Questions (FAQs)
Can a Pre Foreclosure be Stopped?
Generally, the answer is yes you can usually stop a pre foreclosure all the way up until the sale date if the owner either pays the outstanding balance and any late fees and/or attorney fees or sells the property. However, it does vary from state to state.
Where to Find Pre Foreclosure Leads?
Pre foreclosure leads can be found online on sites like the Redx. They can also be found with the help of local Realtors, attorneys and wholesaler, as well as in newspapers.
What’s the Difference Between a Foreclosure and a Pre Foreclosure?
Foreclosure is the process a property goes through from the time the owner defaults on the mortgage until it is sold at auction or listed as an REO. The actual foreclosure is when the lender has taken back ownership of the property. A pre foreclosure happens when the borrower defaults on the mortgage by falling behind on payments. It’s the first step in the foreclosure process.
You can learn how to buy a pre foreclosure home by following the eight steps we outlined in this guide. Keep in mind that a pre foreclosure may not be listed for sale so you will need to know where to find the pre foreclosure leads. A pre foreclosure can be a good deal but it may be a long process until you close on the property.
Remember that one of the most important aspects when learning how to buy a pre foreclosure home is working with the right lender. Luckily, Visio Lending is a national lender that can fund projects quickly and offer investors 30-year mortgages with rates starting at 4.7%. You can get prequalified today.