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Is it bad to buy a pre-foreclosure home?

Buying a pre-foreclosure home gives homebuyers the opportunity to pay lower than market value prices for houses.

Ever wonder why Zillow pre-foreclosures never show pictures inside the home?

The Zillow pre-foreclosure feature is popular among hopeful home buyers. Other home search apps like Trulia, Redfin, and Realtor also offer pre-foreclosure searches. But buying a pre-foreclosure is not as simple as it looks.

Pre-foreclosures aren’t always for sale, meaning they haven’t been registered on the Multiple Listing Service (MLS). If a house doesn’t have an MLS number, you can’t make an offer traditionally. That doesn’t make a pre-foreclosure impossible to buy, but it does make things more difficult.

Follow this 10-step approach to invest in a pre-foreclosure.

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Buying a Pre-Foreclosure

Pre-foreclosures can be an investor’s dream or a money pit. This 10-step approach covers the process of buying one from beginning to end. Spoiler alert: buying a pre-foreclosure doesn’t end with closing day. Your buying plan should include all of the following.  A pre-foreclosure occurs when a bank sends the homeowner a notice of default. Typically this happens when a homeowner has missed two or three consecutive mortgage payments, but every lender is different. Suffering from foreclosure can greatly damage a property owner’s credit score. After a notice of default, public records will list foreclosed properties in local newspapers and offer them in public auctions and special foreclosure auctions. Whether you’re dabbling in real estate investing or are looking for a great deal on your next home, buying a pre-foreclosure home could be your best move.

Step One: Research, Research, Research

If you’re willing to put hundreds or thousands of dollars into an investment, you’ve got to be ready to research first. You’re here, and that’s a great start. You’ll need those research skills throughout the process. You may find it helpful to do some note-keeping as well.

Your first step is to understand the pre-foreclosure process.

How Do Pre-Foreclosures Work?

Pre-foreclosure is the beginning of the foreclosure process, meaning the current homeowners have not made a payment in at least 60 days. The home is still in the current homeowners’ possession, and this has significant consequences for the buyer. Mainly that the homeowner may or may not have decided if selling the home is right for them.

Some pre-foreclosures are listed for sale, meaning they have an MLS number. However, the majority of pre-foreclosure listings you’ll see on Zillow and other sites are not on the MLS listing. Simply put: a house is not for sale until it goes on the MLS listing.

The home may never make it to the market. The current homeowner has a few weeks or a few months to make the mortgage current. If this happens, the house comes out of pre-foreclosure and never gets listed for sale.

Lastly, you should know that every state treats foreclosure proceedings differently. Be sure to check out your state’s rule regarding foreclosures. You don’t have to be a real estate investor to successfully flip a pre-forclousre, now could be your time. If an actual foreclosure is occurring, a public notice will inform interested parties of the home’s availability.

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Step Two: Pre-Approval

Once you understand the pre-foreclosure process, you’ll need pre-approval for your new mortgage. It’s essential to get your pre-approval before you start looking. Not only will a real estate agent want to see your pre-approval, but you’ll want to see it, too. Pre-approval lets you know exactly how much you can spend on your purchase.

If a problem arises during the pre-approval process, you can figure out the solution right away. Better to take care of a roadblock early and not in the middle of negotiations. Keep in mind that pre-approval isn’t the same as getting a loan. It means that you have been determined to be creditworthy enough to borrow. The lender does not have to give you a mortgage just because you’ve been pre-approved. As the borrower, it’s your job to make sure you’re ready to make those mortgage payments before getting your heart set on a new property.

What Type of Lender Do I Need?

If you’re buying a pre-foreclosure that’s in good condition, a regular lender is all you need. Homes needing serious repairs may make it difficult to find a traditional lender. In this case, consider using a hard money lender.

There are some significant drawbacks to using a hard money lender, and it’s not appropriate to use one if you are new to home investing. Interest rates on loans with hard money lenders are much higher. It’s a lot easier to get into financial trouble this way. Not only can those repairs become more expensive than initially expected, but the interest rates make it difficult to pay down the debt.

Lastly, houses don’t fix themselves. All major and minor repairs must be done by you and the people you hire. Be sure you have money and time in your schedule to take on project management.

How Long Does a Pre-Approval Last?

Pre-approvals usually last three months. If you don’t find the right pre-foreclosure property by the end of the pre-approval, you can always reapply.

Step Three: Find a Real Estate Agent

We recommend using a real estate agent who specializes in pre-foreclosures and foreclosures. If you’re new to this process, we think it’s a must. Your agent will have deep, insider knowledge about the process, and he or she will have a better understanding of which houses are a better fit for your investment.

Step Four: Look at Listings

Your real estate agent will have the best access and insight into pre-foreclosed homes. However, you can also scout opportunities by using Zillow, Trulia, and other sites to browse the market.

When you look at listings, keep a few things in mind:

  • Consider the neighborhood the pre-foreclosure home is in, the business of the streets, the walkability, nearby parks, and other amenities like shopping areas.

  • Consider the shape of the home, is there any apparent damage?

  • Are the schools in the area well rated? Is the local government efficient?

  • What do the other houses on the block look like? Buying the ugly house on a nice block means you’re getting a discount. Buying a house in an area that needs improvements means you’ll need your neighbors to step up to increase the value of the area. This will take more time.

  • Are other houses in the neighborhood for sale? Are houses selling quickly in the area?

Your real estate agent will have a ton of insights about the above questions. Still, nothing replaces good research on your part. Once you’ve secured a foreclosure lead, move swiftly as competition can be tight.

Step Five: Make an Offer

There are two scenarios you may encounter in making an offer. In the first, the homeowner in pre-foreclosure has decided to sell and listed the house for sale. In this case, things work like they do in other real estate sales. You work with your agent to make an offer and then wait to see if it’s been accepted.

But what if the homeowner has not decided to sell yet? In this case, you need to proceed carefully. The homeowners may not want outsiders to approach them. They may see you as someone who wants to profit from their misfortune. Keep in mind that you may not be the only person interested in the property. The homeowner may have already been solicited for their property.

Your agent will have some good advice for you, but be prepared to be rejected. These kinds of sales are notoriously difficult. It may take more than a few contacts to find a homeowner willing to sell. Before slapping that down payment towards your short sale home, new owners should ensure that everything – and everyone – is straight away, including

Step Six: Home Inspection

Be sure to work the home inspection into the stipulations of your offer. Pre-foreclosed homes can be in bad shape. The current homeowners are stressed financially, and you can expect some home maintenance to have been left undone. For a couple hundred dollars, your home inspection protects you from investing in a money pit.

A money pit, by the way, is a term used for a home (or other investment) that costs more in repairs than it can return by being repaired. For example, if you buy a home for $125,000 and put in $75,000 of work, you need to sell that home for more than $200,000 to have an even return on the investment.

Long story short, get the home inspected and don’t buy something you can afford to repair.

Step Seven: Find a Home Insurance Policy

Between the offer and closing, you should also research your home insurance options. You’ll need to have the home insured at the end of your closing, i.e., the moment the house comes into your possession. It’s a good idea to have done the research ahead of time.

Be sure to understand that homes in need of many repairs may need to be insured with specialty or non-traditional insurance products. For regular homes, look at several quotes from great home insurance companies. Comparison shopping is the best way to find great deals and know that you’re not overspending.

Luckily, Insurify makes comparison shopping a whole lot easier. Fill out one confidential form with Insurify and access real quotes from top insurance companies. Find the best price for the best coverage without sharing your information everywhere. Try it today!

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Step Eight: Closing

Before you can close, you’ll need approval from your lender. You will likely need to present more information about your income and other financial information. Many lenders have fees for processing mortgage applications, so be sure to keep that in mind when you budget.

Once you have approval, you’ll get a letter of commitment from your lender. Then a closing date is set. At the closing, the property will officially become your property.

You’re not done yet. There are few housekeeping tasks you should put at the top of your list after closing on your home. First, change the locks. You don’t know who has keys to your home, so it’s best to get new locks put in.

You should also make appointments with specialists for home maintenance. Your inspection may have uncovered some issues with the home. It’s best to deal with these issues early before they become bigger problems.

And don’t forget to switch the utilities to your name and have them turned on. You may also want to hire a cleaning crew to tidy up.

Frequently Asked Questions About Buying Pre-Foreclosures

  • What is the difference between pre-foreclosure and foreclosure?

    Pre-foreclosure occurs when the bank sends the homeowner a notice of default. Typically this happens when a homeowner has missed two or three consecutive mortgage payments, but every lender is different.  Foreclosure refers to the process of repossessing the home from the homeowner and to the bank.

  • What are the best ways to find pre-foreclosures sales?

    Many people start looking for pre-foreclosures on sites like Zillow. However, we want to caution you. The information found on these sites may not be accurate. Most do their best to pull from public records reliably. However, as mentioned before, pre-foreclosures do not necessarily mean the house has been listed for sale.  That’s why we highly recommend working with a real estate agent who specializes in pre-foreclosed and foreclosed properties. You can also find listings in the legal section of your local newspaper.

Buying a Pre-Forclosure Home: The Bottom Line

Home buying, whether you’re looking for a pre-foreclosure or not, is a tricky process. There are many details to keep in mind and a whole lot of information to sort through. But time spent researching and planning is well spent. Your home is one of the biggest investments you’ll make. Be sure to choose one responsibly. The process of purchasing a pre-foreclosure home requires many hands and moving parts – the title company, mortgage lender, county recorder, real estate agent… the list goes on. Clinching a home under market price is a pretty great deal, but are you ready for the process?

Well, when it comes to home insurance, don’t forget to use Insurify. Your quotes are waiting for you. Give it a try today!

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JJ Starr
JJ StarrInsurance Writer

J.J. Starr is a health and finance writer with a background in banking, lending, and financial advising. She holds a Series 6, FINRA, and life insurance licensure and a master's degree from New York University. Through her writing, she strives to use her decade of experience to help consumers make sound financial choices. Connect with J.J. on LinkedIn.