Everything you need to know: Buying a pre-foreclosure house

Pre-foreclosures are often great deals for real estate investors and home buyers as they often sell below the market. It is an excellent opportunity to obtain a home below market value. Investing in the pre-foreclosure market tends to eliminate some competition because pre-foreclosures aren’t advertised, but you must become skilled in discovering the opportunities or you could wind up with some bad deals.

You will want to learn how the process works, discover great places to find leads and then close the deal quickly or you may lose out on it entirely. In this article, we share some tips to help you understand and master the pre-foreclosure buying process.

How Foreclosure Works

The first step in the foreclosure process is issuing a Notice of Default (NOD). This is the official notice to the homeowner which gives them three to five months to either take care of the defaulted payments and catch up or sell the house to someone else and use the money to pay the loan. This is the pre-foreclosure period. If the homeowner does not do either of these things, the lender can proceed to take the home back through foreclosure.

The pre-foreclosed home will be occupied by the owners who are making the tough decision to catch up with their payment or sell quickly. You will target them right after they have received a default notice, but before their home is up for sale. It is important to be sensitive to the owner’s situation when you contact them.

Once the pre-foreclosure is for sale, it will be listed on real estate websites. Pre-foreclosures that are listed for sale are short sales. The homeowner selling short is trying to make a quick sale to prevent the bank from foreclosing on their home.

Pre-foreclosure short sales can occur if:

  • A homeowner is more than two months delinquent on their mortgage
  • The house appraises for at least 70 percent of the remaining principal amount of the loan
  • The sale price is at least 95 percent of its appraised value.

Since there is a requirement that the home must appraise for at least 70 percent of the principal owed, not all homeowners will be eligible to offer their home for a short sale. In some places, property values have fallen to such a degree that the house is worth less than the loan amount.

Finding Leads for Pre-Foreclosures

To find the pre-foreclosures that are listed as short sales, you will check the real estate software listings.

If you are searching for homes that haven’t gone on sale just yet, check the public-record notices of default. Contact the homeowners to ask if they are interested in selling their home.

Networking can lead to many pre-foreclosure leads. Real estate wholesalers may have insight into pre-foreclosures in your area. You can find real estate networking groups in your area on meetup.com.

Leads for pre-foreclosures can be found through:

  • Public records at your local county clerk’s office, usually called the recorder’s office
  • Local newspapers
  • Attorneys
  • Networking
  • Real estate wholesaler referrals

Analyzing the Neighborhood

Investing in a good neighborhood can make or break your real estate deal. If a home is in a bad neighborhood, it may never rent or sell. Neighborhood analysis can help you weed out the bad neighborhoods and make a great investment.

Whether you plan on living in the pre-foreclosure or renting it out, there are some specific things that a great neighborhood will have. They will be zoned for good public schools, have well-kept sidewalks and roads, and include nearby restaurants and businesses.

Specific things to look for in a neighborhood:

  • Parks and attractions
  • Shopping, restaurants, and businesses
  • Great walkability score
  • 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

When evaluating the property, checking out how long the neighbor’s properties have been on the market can indicate whether other people find the neighborhood attractive. If the homes are sitting on the market too long, it may be difficult to unload the property or find renters for the property.

Neighborhood analysis also includes determining whether there will be a return on investment for real estate investors. They will want to examine the cap rate and the cash on cash return of properties.

The cap rate is used as an indicator of the cash flow that a rental property will have as a percentage of the property’s current market value. To find the cap rate, divide the net operating income by the property price. A good cap rate should be around 10%.

The cash on cash return is used to indicate to rental property’s cash flow as a percentage of the total amount of cash invested in it. The formula to calculate the cash on cash return is the net operating income divided by the total cash investment. Investors tend to aim for a range of 8-12% cash on cash return.

Getting a Loan

Your financing options for pre-foreclosures will be the same as if you are buying a traditional property. Due to the competitive nature of pre-foreclosed home sales, you will want to start the pre-approval process early. Other buyers will be interested in purchasing the property and may have cash on hand. A pre-approval will allow you the opportunity to make a bid promptly.

Pre-approval is the lender’s stamp of approval that you meet their criteria for financing and will get the loan. Pre-approval is not the same as pre-qualification, which simply means that you meet the bank’s pre-determined requirement to get a loan, but have yet to go through the approval process. Pre-approval signals that you are ready to buy. Homeowners can take your bid seriously with pre-approval.

It is important to note that foreclosure and pre-foreclosures are often in a terrible condition which can make getting a loan quite difficult if the home doesn’t pass inspection. Banks do not want to make loans when there are plumbing or electrical issues. Homeowner’s insurance will be quite costly for a home that is in bad shape.

Making an Offer

Once you have been pre-approved for a loan, you can make an offer on the pre-foreclosure. This will start the negotiation process. It is best to work with a real estate agent through this process. They will be familiar with your state’s paperwork requirements and skilled at negotiations.

When making an offer, it is important to know how much the home is valued for and how much is still owed on the home and how much you may need to make in repairs. You will want to make an offer that is more than what is still owed to the bank.

When the property is in a short sale, the real estate agent will be dealing with the bank. This may require a slightly different process, but the real estate agent will know how to handle it.

Once the offer is accepted by the seller, you will send the purchase contract to the lender. They will begin underwriting the loan. At this point, lenders review all of your documents prior to issuing the loan.

Closing on a Pre-Foreclosure

The final step in the home purchase will be closing. This is where the title will be transferred from the previous homeowner to you. Closing typically occurs at a title company of the buyer’s choice and lasts 60-90 minutes.

During settlement, you will pay the closing costs including the transfer taxes, title insurance, lender fees, and property taxes. The title company will handle the disbursement of funds between you, your lender and the seller. Once the fees are paid and the paperwork signed, you will receive the keys and the property is yours.

Purchasing a pre-foreclosure may enable you to purchase a home at a great discount. You may be able to buy in neighborhoods that you otherwise wouldn’t be able to afford. There will be extra effort to find these deals. You will want to research the homes well to ensure that they meet your needs and your budget in case there are repairs to be done. Software like ProspectNow can help you quickly research pre-foreclosures.