Preforeclosure houses typically occur when a homeowner falls behind on mortgage payments, which results in loan default. During preforeclosure, the homeowner can either sell the property or pay the outstanding balance on the loan. This gives an investor the opportunity to buy a preforeclosure property below market value. To learn how to buy a preforeclosure home, follow our step-by-step guide—from deciding if it’s the right investment strategy for you to finding listings to closing on the property.
The process of finding and buying a preforeclosure property is a bit more complicated than a traditional real estate purchase because listings are not always readily available to the public. Here are the steps that you need to follow:
1. Understand the Preforeclosure Process & Decide if It’s Right for You
Preforeclosure is the first phase of the foreclosure process, which enables a mortgage lender to reclaim ownership of the mortgaged property to recuperate the debt associated with the defaulted mortgage. During preforeclosure, the lender sends a Notice of Default to the borrower, informing them that legal action is being taken toward foreclosure. However, the owner still has a chance to ward off a foreclosure by getting enough money to pay the bank or sell the property to pay off the loan.
Identifying a foreclosed home depends on where it is in the foreclosure process. The original owner, a bank, or the government may still hold title to a property in the early phase of the foreclosure process or properties offered in a short sale. In the United States, there are two types of foreclosure: judicial and non-judicial foreclosure.
Judicial foreclosure, also known as “foreclosure by judicial sale,” refers to foreclosure proceedings that occur in a court of law. This happens when a mortgage note lacks the power of sale clause, which would legally allow the mortgage lender to sell the property in the event of a default. The borrower can avoid foreclosure by repaying the amount owed up to the point of sale. If no legal objections are raised to the foreclosure, the process can take four to eight months to complete.
Here are the two types of judicial foreclosures:
- Foreclosure by sale: Necessitates auctioning the home to the highest bidder, with the lender placing the first or opening bid. Sheriff sales are the common name for these auctions.
- Strict foreclosure: The court sets a deadline for the owner to pay the mortgage, and if the owner fails to do so, the court grants the lender ownership of the home without holding an auction.
Non-judicial foreclosure is when the court does not intervene or is not required to intervene. The borrower must have agreed to the non-judicial foreclosure process when they took out the loan. If the borrower fails to make payments, a power of sale clause is added to the mortgage or deed of trust, giving a third-party trustee the right to sell the property. Because of this provision, non-judicial foreclosures are sometimes referred to as a power of sale.
Lenders typically file a Notice of Default (NOD) with the county clerk in the state where the property is located in non-judicial foreclosure states. This document serves as notice of an impending foreclosure and gives the borrower a period of time to object to the lender’s claim or pay what he owes. Following the expiration of a set period of time, which varies by state, the trustee files a Notice of Trustee’s Sale (NTS) with the county clerk. The date, time, and location of the foreclosure auction are specified in this notice.
Who Preforeclosure Properties Are Right For
Preforeclosure homeowners frequently face financial difficulties, and some would prefer to sell the home rather than have a foreclosure appear on their credit report. Preforeclosure homes are commonly available at a reduced rate to market value for investors.
Preforeclosure property investments are right for the following investors:
- Fix-and-flippers: They use a hard money loan to buy preforeclosures that need extensive repairs, then flip the property for a profit to pay off the loan.
- Long-term investors: They purchase homes that are about to go into foreclosure, make the necessary repairs, stabilize the property, and then finish the renovations to make the property eligible for a long-term loan.
Pros & Cons of Buying a Preforeclosure Property
The traditional home purchase process is different from buying a preforeclosure. Buying a preforeclosure has advantages, such as less competition since the home might not even be on the market. However, as you learn how to buy a preforeclosure home, you’ll see there are also some drawbacks, like working with uncooperative homeowners and a longer closing period. Here are the main advantages and disadvantages:
|Less buyer competition since some preforeclosure homes are often not on the market yet||Preforeclosure homes sometimes require deferred maintenance or significant repairs|
|You can buy preforeclosure houses below market value||Preforeclosure properties are difficult to find or search|
|It has lower settlement costs, and you can often finance the property||Homeowners are sometimes emotional, which makes the dealing process challenging|
|You can buy a preforeclosure home in higher-cost areas for less||Slow process, and it has a lot of paperwork for the buyers|
2. Research Neighborhoods
After learning what preforeclosures are, the second step is to ensure you’re looking for preforeclosure homes in the right neighborhoods. Investing in the right community allows you to capitalize on the appreciation and maximize your investment profits. It can make the difference between achieving expected returns and achieving exceptional returns.
Analyze online maps to determine whether the area is urban, suburban, or rural, as well as the accessibility of public transportation and major routes. Search online for available rentals to see market rents if you intend to rent the property. Consider the overall market conditions, affordability, public transportation or parking availability, and the school system when looking for a neighborhood. Furthermore, renters and buyers prefer locations that have the following characteristics:
- Accessibility to major establishments like supermarkets, parks, shopping, restaurants, and businesses
- Highly rated schools
- Sidewalks, street lamps, and roads are in good repair
- Buildings and homes in good condition
- How long properties sit on the market before being sold
After choosing a few properties to examine, conduct your due diligence. You can focus your search on a few potential areas and properties within that area.
3. Find Preforeclosure Listing Leads & Narrow Down Property Options
Knowing how to buy a preforeclosure home becomes more complicated when locating preforeclosure homes for sale, which is often the most difficult part of the purchase process. Unlike typical property listings, preforeclosure listings do not appear in abundance on popular listing websites. In fact, there were only 90,139 U.S. properties with foreclosure filings in the second quarter of 2022 compared to 619,305 active properties listed in June 2022.
There are several methods to find preforeclosure homes with or without the assistance of a real estate agent:
Access preforeclosure listings for free by visiting your county recorder’s office. Look for Notice of Default, Notice of Trustee Sale, and Lis Pendens in the public records section. These are public notices sent to the property owner as a part of the foreclosure process.
Public records contain the following information:
- The property owner’s name
- The property’s address
- The foreclosing bank
- The amount owed on the home
Searching public records to locate accurate preforeclosure listings takes time, and it only gives you a little information. There is no comprehensive property description, home photos, or liens owed on the house. This method may be helpful for any investor or real estate agent with the time, energy, and expertise to communicate with property owners and get more information.
Real Estate Attorneys & Wholesalers
Real estate attorneys represent clients during their real estate transactions, including people whose properties are in preforeclosure. On the other hand, real estate wholesalers are entrepreneurs who acquire properties from homeowners and connect them with a buyer or investor. The wholesaler does not purchase the property. Instead, the owner’s temporary contract gives the wholesaler the authority to sell the property on their behalf, and the wholesaler keeps the difference.
Therefore, you should make valuable connections with specialized professionals who are consistently in contact with preforeclosure leads, like real estate attorneys and wholesalers, to get firsthand information. Attending in-person events or establishing connections through personal and professional friendships are the best ways to connect with real estate attorneys and wholesalers. Additionally, you can easily connect with them online or through social media.
Real Estate Agents With Access to the Local Multiple Listing Service (MLS)
When looking for active foreclosure and preforeclosure listings and comprehensive property information, your local MLS is one of the significant data sources. The Multiple Listing Service (MLS) is a local database of properties for sale that is only accessible to real estate professionals. For security and operating costs, each MLS is used and managed by real estate agents and brokers and is specific to your state.
Investors can work with accredited real estate agents and have access to the MLS. Your real estate agent will look through the MLS for preforeclosure listings. Furthermore, the agent can set up meetings with property owners and negotiate deals on your behalf. They will research and provide comprehensive property photos and information such as annual property taxes, square footage, and the price at which the home was last sold.
Find foreclosure and preforeclosure listings using online directories, which have extensive information on properties in your neighborhood. It filters to sift through potential listings and easily find the most pertinent information.
Online directories are the best option for real estate investors to find preforeclosure listings because you can access them instantly from any device. However, verifying multiple sources is crucial because some directories occasionally contain inaccurate or outdated information.
Here are a few online directories to help you find preforeclosure listings:
Investors who want unlimited access to preforeclosure and foreclosure listings
Investors looking to prospect for non-agent represented listings like preforeclosure leads
Investors seeking a nationwide database by state to see the properties that are available in their area
Investors who want to cultivate high transaction probability deals by combining lead research with built-in CRM software
Monthly Starting Price
$119 per user
After you’ve narrowed down your search to a few preforeclosure properties, conduct a comparative market analysis (CMA) and a rental market analysis (RMA) to examine comparable homes in the area. These reports will give investors an objective look at property data so they can make a definitive decision about which property purchase is right for them.
The CMA is a report, typically created by real estate agents, to compare similar homes and property data in order to estimate a home’s current value. This will let you know the best offer on a potential preforeclosure property purchase. An RMA report will evaluate rental properties in the area to determine the rental potential of a specific property. This is particularly helpful for investors who intend to rent the property to tenants after they’ve purchased it.
If you don’t know how to create these reports, download our free templates and learn how to make a CMA and RMA report by reading these articles:
- Rental Market Analysis: What It Is & How to Complete One
- Comparative Market Analysis (CMA): Definition & How to Create (+ Examples)
4. Get a Loan & Pre-approval Letter
Before making an offer on a preforeclosure property, find a lender and obtain a pre-approval letter. This letter shows you what your maximum borrowing amount is, reassuring the seller that you are serious and would be able to secure financing to buy the property. However, pre-approval does not guarantee you a loan. It means the lender determines how much you can borrow after a preliminary assessment of your creditworthiness for a loan.
Your choice of lender is influenced by the kind and state of the property. If you can pay for the property and any necessary renovations in cash, you’ll be in a better position for a quick close. But if you aren’t able to pay in all cash, you will need to obtain a hard-money loan because you will most likely not be approved to purchase a preforeclosure with a conventional loan.
However, traditional lenders typically demand that the properties be in good repair or only need minor improvements. Apartment buildings with more than five units usually require a loan from a lender that provides commercial financing.
5. Make an Offer & Negotiate
You can make an offer on a preforeclosure property once you have been pre-approved for a loan—kicking off the negotiation process. When making an offer, it is critical to understand how much the house is worth, how much is still owed, and how much you may need to spend on repairs.
Don’t forget to include contingencies in your offer, allowing you to back out of the deal if terms are not met. A contingency in real estate is a clause in a purchase agreement that specifies an action or requirement that must be fulfilled for the contract to become legally binding. Before the contract becomes legally binding, the buyer and seller must agree on the terms of each contingency and sign it.
Here are some of the common contingencies in real estate:
- Title contingency: This provision gives the buyer the right to obtain a title search and raise any objections to the status of the property’s title, which the seller must clear before the buyer can close on the transfer of title.
- Appraisal contingency: This clause protects the buyer by requiring the property to appraise for at least the indicated sales price, or the contract will be invalidated. This is due to banks’ aversion to lending money to borrowers for a home that costs more than it is worth. It may also state that the seller can lower the price to the appraised value.
- Inspection contingency: This clause specifies when the buyer has to have the property they intend to buy professionally inspected. The home inspection ensures no significant problems, such as a leaking roof, a faulty electrical system, or structural flaws.
- Sale of a prior home contingency: This clause protects homebuyers who need the cash proceeds from selling their existing home to buy a new one. The homebuyer can pull out of the real estate contract if they need to sell their current home by the contract’s deadline but cannot find a buyer.
- Home insurance contingency: This provision requires the buyer to apply for and obtain homeowners insurance on the property. Either party may terminate the contract if they cannot get the necessary insurance. The seller or the mortgage lender frequently requests this.
- Mortgage contingency: This clause specifies a time frame within which the buyer must obtain financing to purchase the home. If the buyer does not secure a loan by that deadline, they can withdraw from the deal without penalty, and the seller can relist their home and choose a different buyer.
When making an offer, working with a real estate professional is advantageous as they are familiar with purchase contracts and contingency deadlines.
6. Execute Paperwork & Close on the Property
This stage is where the previous homeowner’s title will be transferred to you. Once the lender’s underwriting has approved the buyer and property, you will receive a commitment letter. The closing attorney or title company will set a closing date. The time it takes from accepting an offer to closing varies depending on the property but can typically range from 30 to 60 days. If you are paying for the properties with cash, this time frame is usually shorter.
You will be accountable for paying all closing expenses, such as transfer taxes, title insurance, lender fees, and property taxes, at the time of settlement. Closing costs can range from around 3% to 6% of the loan amount. If you take out a $300,000 mortgage, closing costs will vary from approximately $9,000 to $18,000. The title company will handle money transfers between you, your lender, and the seller. You will receive the keys, and the preforeclosure property will be yours once the fees are paid and the paperwork is signed.
However, if you intend to close in the name of your limited liability company (LLC) rather than your own, make sure that the lender allows you to do so before applying for loans. Putting all your investment properties in an LLC adds protection. But if you own properties in multiple states, you should have an LLC in each state because laws and taxes vary per state.
Read our How to Start a Real Estate Holding Company or Real Estate LLC article to know more about how to maximize your LLC company in real estate investing. Also, check out our Real Estate Closing Checklist for Buyers & Sellers article. This will help keep track of every stage of the closing process and reduce unnecessary stress from being unprepared during a transaction.
7. Complete Post-closing Action Steps
Immediately after an investor closes on a property, there are several action steps to take to ensure the property is secure and you have maintained ownership. While a few of these steps may seem like they can wait until later, it is best to get started on them right away.
- Since you can’t be sure who has the keys, you must change the locks
- Transfer or have the utilities turned back on in your name
- If the property requires repairs, begin immediately
- Advertise the property for sale or rent, depending on your investment plan
Property management software, such as Avail, can help if you intend to rent the property. Avail provides robust property management services to independent landlords managing one unit or a portfolio of properties to simplify rent collection and listing rental properties. Syndicated listings, credit and criminal screening, state-specific leases, online rent payments, and maintenance tracking are all included.
Preforeclosure homes are a great investment opportunity for long-term investors and home flippers. While locating preforeclosure properties can be a tedious task, investors can greatly benefit from the lower cost of these investment properties. Follow the seven steps above to easily navigate through the purchase process of a preforeclosure home.