9 Tips for Buying a Preforeclosure (Especially If It’s Your First)

So you’re thinking about buying a house, and you start looking around online “just to see what’s out there.” As you’re getting familiar with the lay of the land —  eyeballing homes that seem to meet your criteria and fit your budget, daring to let yourself feel excited about the possibilities — maybe you stumble upon a listing marked as a “preforeclosure.”

The photos show a home that looks like it’s in good shape, and the price is neither suspiciously low nor alarmingly high. So what’s the deal? What does preforeclosure even mean?

Before you rush into (or out of) anything, let’s slow down and take a look at what you need to know about buying a home in preforeclosure. With the help of top agent and San Francisco Bay Area real estate expert Rick Fuller, we’ll cover nine important tips for shopping for and purchasing a preforeclosed home.

1. Understand what preforeclosure means

As the term implies, the home in question is approaching foreclosure. The homeowner is behind on mortgage payments, and while they do still have an opportunity to catch up before the bank seizes the property, an official notice of default has been issued.

Because notices of default are public documents recorded with the county, this information is now public. “It doesn’t tell you by how many payments; it just means that there’s an official notice that this homeowner, this borrower, is in default,” says Fuller.

2. Know the difference between preforeclosure and short sale

At first glance, there may seem to be parallels between a home in preforeclosure and a short sale property, but the two are very different.

“The nature of a short sale is that the homeowner owes more than what the home is worth. We might also say that they’re ‘underwater,’” explains Fuller.

“If they were to sell the property, they would have no proceeds and would in fact owe the lender or the lienholder money at the time of closing.”

To avoid this deficit, short sale homes involve negotiating with the mortgage company to sell the property for less than what is owed. The seller can then typically walk away from the closing table without owing anything further.

Meanwhile, homes in preforeclosure generally have enough value to cover the outstanding mortgage.

“A preforeclosure doesn’t mean that the seller doesn’t have any equity; it simply means they are heading toward a foreclosure,” notes Fuller.

3. Know that the homeowner has options

While selling the property before it goes into foreclosure is a common solution for those in preforeclosure, it is still possible for a homeowner to remedy their situation and keep their house.

Borrowers in default can explore options for a loan modification or a forbearance plan, which they’ll need to discuss with their loan servicer. As a potential purchaser, it’s worth being aware that sometimes homes will appear across different online portals as soon as the notice of default is on record, and this doesn’t necessarily mean the homeowner is looking to sell.

In short? Avoid getting starry-eyed over a preforeclosure home until you know the owner is willing to talk. Be mindful, too, of the human aspects of financial hardship. A little compassion goes a long way when someone is facing the potential loss of their home.

4. Understand what kind of discount you could get

Since preforeclosure homes do have enough equity (usually) to cover the balance of what is owed, the discounts may not be as deep as you might anticipate. Just like any other real estate transaction, the price will ultimately depend on local market conditions in regards to the size, condition, and features of the house.

What can help you save some cash on the purchase of a preforeclosure, however, is working within other negotiable variables.

“We’ve got a very competitive market today, but in years past, buyers who purchased properties in preforeclosure did get a really good purchase price on the home; usually significantly less than market value,” says Fuller. “Generally speaking, it’s because they’re buying [the home] in its current, as-is condition — without any repairs and without the seller having to put any money into the property.”

Alleviating the back-and-forth strain that comes with negotiating repair contingencies can help expedite the sales process. Fuller also notes that it can be helpful to offer a unique advantage to the seller, such as the ability to remain in the house for a period of time — perhaps 14 or 30 days — after closing to help facilitate a smooth transition to their next home.

5. Know how to find preforeclosures

Now that you have an understanding of what a preforeclosure is and what your negotiations may entail, if you’re interested in buying, you’ll need to know where to find these homes.

Perhaps unsurprisingly, working with a knowledgeable agent is a great starting point. Real estate agents who are experienced in preforeclosure properties will know how to help you locate properties of interest and pursue them appropriately.

You can also browse various real estate platforms at your leisure. Some specialize in preforeclosure and foreclosure properties (these often require paid access), but most will have filters you can apply during the search process. A few places to start include:

• RealtyTrac
• Foreclosure.com
• HomePath
• HomeSteps

6. Get yourself pre-approved

Whether you’re shopping for a preforeclosure or not, one of the best things you can do to give yourself a leg up in a competitive market is to have preapproval from a bank.

Preapproval means that you’ve taken the time to vet your financials with a lender, which indicates not only that you’re serious about buying, but also that you have the capacity to do so in the first place.

When you’ll need a mortgage to purchase a home, your purchase agreement is contingent on your ability to secure a loan. Whenever possible, sellers like to see a preapproval letter because it lends credibility to your offer.

7. Sweeten the deal with earnest money

Earnest money is a deposit offered alongside your offer to purchase as a way to prove, well, your earnestness. Sometimes referred to as a “good faith deposit,” earnest money shows a seller that you’re so serious about buying their home that you’re willing to put up a little cash to prove it.

Between 1% and 3% of the purchase price is common for earnest money, but in some cases, the amount can be as low as $500. Your agent can advise you on this one, but especially if a homeowner is on the fence about selling, or if there’s a multiple-offer situation, earnest money can sometimes help tip the scales in your favor.

Since the seller is eligible to keep your earnest money if you back out of the deal for reasons that aren’t clearly outlined in the contract, be sure there are inspection and appraisal contingency clauses that will allow you to get your money back if something doesn’t add up.

8. Do your due diligence

Speaking of contingencies, even if you’re willing to entertain the notion of buying a preforeclosure as-is, it’s in your best interest to get a proper home inspection. Having a full report on the condition of the property can help you determine if you’ll be biting off more than you can chew.

Fuller also highlights the importance of a thorough title search to uncover potential liens against the property. “We want to know what lienholders exist and whether or not the homeowner is going to be able to sell the property, or whether they have to negotiate — or have a RealtorⓇ negotiate on their behalf — the transaction so that they’re able to close escrow and not owe a lienholder.”

Tax and mortgage liens are potential hurdles, but liens can also come from disputes with homeowner’s associations, contractors, repair services, and more.

9. Make your bid

When you and your agent have ensured that everything checks out and the homeowner is indeed willing to sell, it’s time to write your offer. Ideally, the offer will strike a sweet spot between being a good deal for you and a good deal for the seller — especially as a path to avoiding foreclosure.

Your agent can help you suss out the amount owed on the seller’s mortgage so that you can make your best offer, but do be aware of possible appraisal snags that could arise depending on the condition of the home.

There’s likely to be less wiggle room on the price since the seller is already in hot water with their mortgage, so if there’s any doubt on the property’s ability to appraise, make certain to have an appraisal contingency written into the contract.

Be sure to also request a final walkthrough, especially if you’re buying as-is. This is standard practice with most purchase contracts so it shouldn’t be a big ask, but you’ll want to verify that the house is in the same condition at closing as it was at the time of your offer.

Good luck!

Buying a preforeclosure isn’t wildly different from a traditional purchase, but there are nuances that can make the process tricky to navigate without an expert.

Do take the time to find an agent who has experience with these types of properties and move forward with someone who can help ensure a smooth, fair, and equitable transaction for both parties.

Header Image Source: (Erik Mclean / Unsplash)