A pre foreclosure home is a distressed, off market property where the home owner has failed to make their mortgage payments on time and are at risk of the home being foreclosed upon.  Pre foreclosure is a pretty lengthy process, and during that time the homeowner could decide to pay off the outstanding balance or sell the home. 

While a home is in pre foreclosure, it is not typically listed on the market and are still occupied by the home owner. Real estate investors may target home owners who are in pre foreclosure in an attempt to purchase a home at a discount since pre foreclosure homes are usually sold below market value. 

Even if you are new to real estate investing, you could get in on buying pre foreclosure homes, you just have to understand how the process works.  Let’s outline some steps to buying pre foreclosure homes:

Understand the Pre Foreclosure Process

Even though the reasons behind the home being in pre foreclosure will not directly affect you as the buyer, you should try to understand what caused it and the upcoming sale and how it will affect the closing process. 

Foreclosure is a long process and pre foreclosure is just the first step in that process.  Each state has different foreclosure proceedings, but they all start when a home owner misses three mortgage payments in a row. The bank will then issue a pre foreclosure notice which indicates that they are getting ready to foreclose on the property. The property owner will have two to three months to bring their account current in order to avoid the foreclosure process.  This could mean paying the outstanding loan balance entirely or renegotiating a new payment agreement.  Banks really do want to work with their borrowers and will try to find a reasonable solution to avoid foreclosure. 

If the seller is unable or unwilling to pay the required amount, they can sell the home at a discount since they are highly motivated.  This is great news for you as an investor and if the numbers work out, you should jump on it!

One common misconception is that that pre foreclosure homes are distressed or located in undesirable neighborhoods when in fact pre foreclosures happen all over the country and in just about every neighborhood you can imagine. You just need to know how to find them. 

How to Find Leads

When it comes to buying pre foreclosure leads, it is extremely important to learn how to find leads. Consulting with a real estate agent is the best way to find pre foreclosure and foreclosure leads.  They have access to their local Multiple Listing Service (MLS) where each of these types of listings is shows.  You can also search through county public records, real estate wholesalers and local attorneys.  Online real estate sites like Zillow also give you the ability to sort through pre foreclosure homes based on the neighborhood you are interested in.  It does take some time and patience to sort through the listings and then you have to put together a plan of how to contact the owner, but it can prove to be lucrative. 

Do Some Research

Before getting in touch with homeowners, do your research on the area and the home itself.  You will need to conduct a comparative market analysis to see how the neighborhood and this house stack up compared to other local properties either for sale or recently sold.  You want to find a neighborhood in an area with the potential for growth and one that is a convenient place to work and live. Here are some things to look for that can easily be researched online:

• Attractions and amenities such as local businesses, restaurants, malls, and parks
• Condition of nearby homes and buildings
• The state of roads, parks, sidewalks and other neighborhood amenities
• School performance
• Average rental income
• Average return on investment

It may be tempting to jump into any investment, but making sure that the property checks all the right boxes will help you maximize your returns.  

Find a Lender to Partner With

Just like buying any other property, you will need to obtain a pre-approval letter before you start seriously looking for a property. This letter will show the seller how much money you are able to spend when purchasing a home and will also help you narrow down your search based on price. The pre-approval letter also shows the seller that you are a serious buyer who has already put in the work and will be able to close on their home. 

Many real estate agents and home sellers, especially in today’s hot seller’s market, will not even consider working with you without a pre-approval letter.  In order to get the process going, you will need to submit the following documents to your lender:

• An identification document like your passport or driver’s license
• Recent paystubs
• Credit report
• Tax returns
• Bank statements

Depending on your financial situation, the lender may ask for more in depth documentation in order to approve your loan. Different loans have different requirements as well, so it is important to speak to your lender about all possible options. 

Make an Offer and Get Financed

Once you have done your property research and obtained a loan pre-approval letter, it is time to make an offer. Once accepted and depending on the loan you utilize and also the seller’s situation, the closing process can take anywhere from 30-60 days from the time the seller accepts your offer. If this is your first time, it is a good idea to have the help of a real estate agent.  Real estate agents are paid by the seller, so there is no extra cash out of your pocket required. The agent will negotiate with the homeowner on your behalf and should also lead you through the escrow process to make sure everything remains in compliance with the legal documents you will sign. They will also submit the purchase agreement to your lender who will begin the underwriting process.   

Your lender will need the following information in order to move forward with your loan approval:

• Complete mortgage application
• Application fee
• Property details
• Property appraisal
• Down payment 
• Purchase contract

There will be a lot of documents to sign and papers to submit during this time and it may begin to feel tedious, but the lender has a reason for everything.  In order to cause any delays which could result in you not obtaining the loan or the seller deciding not to work with you, it is best to submit everything in a timely manner. 

Closing Time

After all of your research, negotiation and patience, you will finally get to close on your pre foreclosure home.  The deed of ownership will be transferred into your name and you will pay all remaining closing costs, insurance and transfer fees. The seller should have already moved their belongings out of the home by this point and you can start preparing it to go on the rental market.  

Now What?

Depending on how the seller’s cooperated, you may not have been able to see the property’s condition prior to closing.  While this is not recommended, sometimes it is unavoidable.  The first thing you should do when you take possession is make sure the previous owner and all of their belongings are gone.  If not, you will have to evict them and all of their belongings.   Welcome to the life of a real estate investor!

Once the home is vacant, you will need to evaluate the home for damage and hire contractors to help make repairs if needed. Walk in with he hopes that everything looks great, but prepared for anything. Best case scenario, you will not have any significant repairs to make and you will only need to do cosmetic repairs to prepare the home for the rental market. Look for durable products that can hold up to a tenant.  I would never suggest installing top of the line appliances, cabinets or flooring.  Go for something that looks nice, not cost too much and is long lasting.  However, If your home has more damage than expected, these repairs will need to be made quickly and hopefully not cost too much. 

Market the Property for Rent

Once the property is in good condition, market it for rent.  You do not have to let potential tenants know that you bought the home while it was in pre foreclosure.  That no longer matters.  Treat the home as you would any other. Compare the home to other rental listings in the area to determine how much rent to charge, find high quality tenants who will pay their rent on time and will take care of the home and collect your checks.  It sounds simple, but it really does require some work.  Real estate investment can be a wild ride, so be prepared for anything. 

Conclusion

Buying a pre foreclosure home takes a lot of research and patience.  There may be some hoops to jump through in getting financing and even more if the seller does not have the funds to cover the amount of money they own on the loan.  Much of this will be out of your control and you will have to look at the pros and cons to determine if it is worth waiting for.

Homes in pre foreclosure are often sold at a lower price than similar homes on the market due to their distressed status. That means the returns you will get once it is time to sell the property will be greater than a non-distressed home. Part of your job as a real estate investor is to make sure that the amount of money you can charge in rent will cover all of your expenses while also giving you cash left over each month.  If you are new to the game, it is wise to consult with an experienced real estate agent in your area. They should be able to help you determine if the home is priced right and if the neighborhood has good potential to be rented out quickly and at what monthly price.