What Is Preforeclosure?

After a mortgage lender files for foreclosure — but before the foreclosure auction date — houses enter the preforeclosure period. 

These off-market properties offer an opportunity for real estate investors. Investors can buy these distressed properties at a deep discount. 

Preforeclosure properties come with their own quirks and challenges however. Before attempting to buy properties pre-foreclosure, make sure you fully understand the pros, cons, and challenges. 

What Is Preforeclosure?

As the name suggests, pre-foreclosure properties have not yet gone to auction, but are headed in that direction. 

Banks and other lenders must go through an extensive legal process to foreclose on a homeowner in default. A window of time opens between when the foreclosure proceedings become public knowledge and when the property actually goes to auction. 

Investors often try to buy distressed in that window, before the lender takes ownership of the property and lists it for sale on the MLS. 

While the timeline varies by state, it generally takes at least two to three months from the time foreclosure proceedings are filed with the court until the actual foreclosure auction takes place. That’s the window that investors try to work within. 

For homeowners, it’s a terrifying time. Some go into denial and ignore the wave of letters and phone calls from investors, bankruptcy attorneys, and other solicitors offering to work with them. Others frantically call a dozen different solicitors, looking for any way out of their bind. 

As an investor, you must approach these distressed owners with empathy and understanding if you want them to consider working with you. They are living through their worst nightmare, and you are in a position to offer them options. 

Preforeclosure vs. Foreclosure: What’s the Difference?

The difference between pre-foreclosure and foreclosure lies in the phase of the legal process. 

Foreclosure refers to the entire process of forcing the sale of a property to collect on a defaulted loan. That process includes many phases, each with its own timeframe. 

Pre-foreclosure is only one phase of the larger process. The entire foreclosure process looks like this. 

Phase 1: Default Through the Demand Letter

When a homeowner defaults on their mortgage, lenders start with informal letters and phone calls to try to work with the borrower and get them caught up. 

After 90 days of default, they then typically send a demand letter informing the owner that they have another 30 days before the lender initiates foreclosure proceedings. 

Phase 2: Formal Notice of Foreclosure

After that federally-mandated 120-day waiting period, lenders may file in the local courthouse to start the legal foreclosure process. The homeowner receives an official notice of the pending foreclosure. 

Phase 3: Pre-Foreclosure

Once the lender files for foreclosure, it becomes public record. Anyone can view information about the filing, and several tools such as Propstream and Foreclosure.com make it easy for real estate investors to view preforeclosures. 

The court sets a date for the foreclosure auction, and advertises it to the public in some states. 

Phase 4: Foreclosure Auction

Once the auction (also known as a trustee’s sale) starts, homeowners can no longer bring their loan current.

Lenders typically start the bidding at the total balance owed, including late fees and legal fees. Because buyers can’t see the interior of the property, they rarely bid at foreclosure auctions. The lender takes ownership in nearly all foreclosure auctions. 

Phase 5: Change in Ownership

It usually takes a couple months for the lender to navigate the red tape of taking legal ownership of the property. 

Phase 6: REO & Disposition

Once the lender does take legal ownership of the deed, the property goes to their “real estate owned” or REO department. The lender evicts the former homeowner if they haven’t already moved out. 

At that point, they list the property for sale with a local real estate agent. 

How Preforeclosure Works

As outlined above, homeowners have a narrow window of time to stop the foreclosure process, once started. 

By that point, lenders usually will not consider a loan modification. The time for that passed once the lender hired a law firm to file for foreclosure. 

Property owners do have a few other options however. They can of course sell the property outright, whether publicly on the MLS or to an investor able to close quickly. 

Most homeowners want to stay in their home at all costs however. They can do so by declaring a Chapter 13 bankruptcy, which restructures their debt. 

Or they can do so by selling to an investor willing to sign a seller leaseback with them. In this case, the former homeowner stays in the property as a renter, usually with the option to buy it back for a certain price within a certain time period. 

That can create a win-win for real estate investors. They buy a distressed property at a deep discount and start collecting rent on it. If the renter buys it back over the next few years, the investor earns an easy profit with little property management effort. 

If the renter defaults again, the investor files for eviction, updates the property, and sells it at full market value for an even larger profit. 

Advantages and Disadvantages of Pre-foreclosure Sales

Like every other real estate investing strategy, pre-foreclosures come with their share of pros and cons.

On the plus side, investors can score a bargain price from a motivated seller. They can lease the property back to the seller, or flip it outright. 

The downsides of preforeclosures are more nuanced. 

First, investors face steep competition for preforeclosures in most markets. What investor wouldn’t want to buy off-market distressed properties at a great price? So, homeowners in preforeclosure often receive hundreds of direct mail postcards and letters, and sometimes get texts, phone calls, and even in-person visits at their front door. 

Second, most distressed homeowners don’t want to sell. Many only consider a sale-leaseback as a last resort. 

Third, owners in pre-foreclosure sometimes wait until the eleventh hour to contact solicitors. They call a week or a few days before the auction in a total panic. That leaves little time for investors to arrange financing, conduct due diligence, do a title search, and close on the property before the auction. 

I used to buy preforeclosure properties myself, and once bought one within three days from start to finish. We held the settlement a few hours before the auction. It took a mad scramble to close that quickly. 

Conclusion

What is preforeclosure, and why should investors buy properties at that stage of the foreclosure process?

Real estate investors can buy distressed preforeclosure properties at a deep discount, before the owner loses their home to auction. But pre-foreclosure sellers are notoriously difficult to work with, and investors face stiff competition from other investors. 

It often takes hundreds of direct mail letters to close a single pre-foreclosure. Only try this strategy if you’re willing to commit to it for several months at least, as you refine your approach.

Preforeclosure FAQs

What are the consequences of preforeclosure?

Preforeclosure homes are scheduled to sell at a foreclosure auction. Investors can buy these homes before they hit the auction block. 

Can investors purchase properties in preforeclosure?

Yes, by approaching and negotiating directly with the distressed homeowner. 

Does pre-foreclosure hurt your credit?

Mortgage loans appear on borrowers’ credit reports, and late payments do hurt their credit scores. If a mortgage loan goes to auction, it does even more damage, appearing as a public record.

Why do investors target pre-foreclosure listings?

Investors market to homeowners in preforeclosure because they can potentially buy the property for far less than its value. These homes are not listed on the MLS, and homeowners are motivated to sell before the pending foreclosure auction. 

How long is the pre-foreclosure process?

It varies by state. Under federal law, lenders must wait at least 120 days before filing in court to begin the formal foreclosure process. At that point it enters preforeclosure, which can last anywhere from one to four months.