What is Pre-Foreclosure?
Pre-foreclosure refers to the state of a property that is in the early stages of being repossessed due to the property owner's inability to pay an outstanding mortgage obligation. Reaching pre-foreclosure status begins when the lender files a default notice on the property, which informs the property owner that the lender will proceed with pursuing legal action if the debt is not paid. At this point, the property owner has the opportunity to pay off the outstanding debt or sell the property before it goes into foreclosure.
Breaking Down Pre-Foreclosure
When a homebuyer takes out a loan to purchase a property, they sign a financial agreement with the lending institution to repay the loan in monthly installments. The monthly installments cover a portion of the principal and interest payments on the mortgage taken. If the homeowner fails to make payments for at least three months, they are said to be in default. A mortgagor who is in default on loan payments would receive a notice of default which will also be made a public record by the bank. This action commences the pre-foreclosure process.
Homeowner's Options During Pre-Foreclosure
A home that is in pre-foreclosure is one that is behind on its payments and risks being foreclosed by the bank. The pre-foreclosure period lasts for three to 10 months during which a public auction or trustee sale is arranged. During this period, the homeowner can reverse the default status by making the late payments so the home is no longer in pre-foreclosure. The homeowner also has the option of selling the home during the pre-foreclosure period or risk the home being seized by the bank, which will then proceed to foreclose it.
A pre-foreclosure home that goes up for sale is referred to as a short sale. Note, however, that not all short sales are pre-foreclosures. Because the homeowner wants to avoid foreclosure, an interested party may be willing to purchase the pre-foreclosed property for a higher value than the homeowner would receive if the home was sold in a foreclosed state. The sale can be a private transaction between the homeowner and the buyer whose offer must be approved by the bank before the sale can be finalized. A pre-foreclosed home can be inspected by the buyer before the buyer makes an offer on the home. The buyer could be an investor who prefers to purchase the home for much less than it’s worth, renovate and repair the home if needed, and then sell it at a higher price for a profit.
If the homeowner lists the property for sale through a real estate agent, prospective buyers will have to contact the listing agent. The bank must approve any short sale for a listed pre-foreclosure home and will hire one or more real estate brokers to prepare a Broker Price Opinion (BPO). The broker price opinion is an estimated market value which the broker presents to the bank after conducting an analysis on a number of similar homes that have recently been sold in the market. The estimated market value helps the bank to decide whether the proposed sale value is acceptable.
Benefits and Drawbacks
A home that is sold during the pre-foreclosure phase may be a win-win-win for all three major parties involved. The homeowner is able to sell the property which they can no longer afford to keep while avoiding the damage that a foreclosure would have on their credit history. The buyer may be able to snag the property for below market value price after inspecting the property. The lending institution that approves the buyer’s offer is able to transfer the mortgage to the buyer and avoid the cost of going through a foreclosure.
Buyers of pre-foreclosed homes have to be aware of any property liens or unpaid taxes on the home, as this will become their responsibility after the home is purchased. Also, the buyer has to ensure that they factor in the cost of repairs and renovation on the home, especially if the pre-foreclosed home is in a poor state. Without taking the cost of repairs into consideration, the buyer may end up with expenditures that surpass their budget.
The property will be sold by the trustee at an auction to the highest bidder if the homeowner did not cover the due payments and did not sell the home during the pre-foreclosure period. After a property is foreclosed upon, the bank owns the property and is more likely to try to sell the property at a lower price.
A first time home buyer would be better suited purchasing a foreclosed home or a regular home, as the buyer will be dealing with the bank directly. Purchasing a pre-foreclosed home would have to be negotiated directly with the homeowner or listing agent, who may not be upfront about the home’s worth or additional costs for which the buyer may be liable.