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Understanding the preforeclosure process, timelines, and investment opportunities.
What is preforeclosure?
Preforeclosure is not a formal legal term, but rather the first phase of a process when a homeowner is at risk of losing their home.
This process starts the moment you miss your first payment and extends until formal foreclosure proceedings have been initiated, or there is some sort of other resolution (like a sale or the homeowners catching up on past payments).
You can think of preforeclosure as a window in which the homeowner has stopped paying, is at great risk for falling further behind, and the property will soon tumble towards foreclosure.
But within that finite window also lies some golden opportunities for potential buyers and real estate investors.
But to do so, you really need to understand the preforeclosure process, its timelines, the possible homeowner options, and ramifications, You also need to know how you can step in to both help them and create a financial opportunity.
So, what exactly is a preforeclosure?
Usually, people consider a home to be in preforeclosure when the lender has already filed a Notice of Default for nonpayment, but that hasn't progressed to the foreclosure sale quite yet. However, others look at preforeclosure as a broader process, possibly spanning from the moment a homeowner misses their first payment until right up to a foreclosure sale.
In almost every case, that risk of losing the home to the bank comes because a homeowner is unable (or unwilling!) to make their monthly mortgage payments. So, when you hear the term 'preforeclosure,' it's reasonable to assume that a homeowner or property owner has missed several mortgage payments at the very least.
The preforeclosure stage is also a slippery slope towards entering the actual foreclosure process, for several reasons. If a homeowner wasn't able to make their monthly payments for several months, one by one, it's very unlikely they'll be able to make up a huge sum with past payments and get back on track with their current – and all future – monthly mortgage payments. Therefore, in the vast majority of cases, homeowners cannot "back out of" the preforeclosure process, and it leads to some other terminal resolution, like foreclosure or a sale.
Homeowner options when in preforeclosure:
But that doesn't mean missing payments and entering the preforeclosure always needs to end with the homeowner losing their house to foreclosure. There are several other options along the way, including:
- Pay your mortgage current
Catch up on past payments by making a lump sum or other large payments to the bank, paying off the mortgage and late fees in arrears, and getting back on track with current payments.
- Payment plan
Or, work out some sort of payment plan or arrangement with the bank that allows them to pay back their mortgage amounts in arrears in stages according to an agreed-upon schedule. While not common, if the bank or mortgage servicer allows the homeowner to do this, it's usually a win-win and keeps them out of foreclosure.
- Work out a mortgage modification
Mortgage modifications, also called loan modifications, are another tool that may help homeowners who have missed payments and entered the preforeclosure process. With a mortgage modification, the lender or loan servicer voluntarily agrees to "rewrite" the loan terms in some way, shape, or form.
Loan modifications are not common when it’s “business as usual,” but in times of economic downturns – like the mortgage meltdown and real estate crash starting in 2008. A modification can include changes to the term, payment, interest rate, re-amortization, or even loan principal reduction (in rare cases). However, the real value to a homeowner who has missed payments and facing foreclosure is that the lender may choose to take the sum of missed payments and late fees and catch them up somehow. In many cases, that means adding those outstanding balances onto the end of the loan as additional principal or working out some payment plan.
Either way, the goal of a loan modification is to keep the homeowner in the house and avoid foreclosure.
- Short sale
If a repayment plan, loan modification, or other solution isn’t feasible (or, not wanted!), the homeowner may opt to engage in a short sale. Short sales are a method of selling a home on the open market and avoiding a foreclosure when the property is upside down in value – the homeowner owes more than the property is worth.
So, if you owe $300,000 on your mortgage but the market has dropped, so the property is only worth $250,000, a short sale is your only option for selling (outside of coming up with the difference of $50,000 out of pocket – plus selling and Realtor fees!).
A short sale essentially has two parts or phases.
First, the homeowner lists their home for sale with a real estate agent or Realtor, just like they would with any property sale. The Realtor takes the listing and enters it into the local MLS just like any sale, but with a disclosure that it is a short sale. From there, they entertain buyers and accept offers just like any sale.
However, once a buyer is found and a fair offer made, the Realtor has a huge task in front of them – getting the lender or mortgage servicer to actually accept the sale, as the money they receive is "short" of the full amount. Basically, the lender may agree to take a loss – and therefore approve the short sale and allow it to proceed and close – and forgive a certain amount of the loan above and beyond the property's value.
That arrangement is typically negotiated by the real estate agent with the bank, but in many cases (and certain states), it’s best to get a real estate attorney involved. There also may be significant tax considerations to short sales, especially if someone is short selling a rental or investment property.
It’s important to note that a short sale doesn’t technically stop preforeclosure timelines or legal milestones, but we often see the bank will not be aggressive with foreclosure proceedings if a short sale is listed on the market and currently being negotiated.
Unfortunately, a high percentage of short sales never are approved and closed for various reasons, and they usually end up in foreclosure. But it is a useful option when the homeowner wants to voluntarily try to recoup the bank’s money (who loses way more if it does go to foreclosure), limit their own liability, and hand the keys over to an appreciative new buyer.
- Conventional sale
If a homeowner has missed several mortgage payments and the property is in the preforeclosure timeline, they can just opt to list the home for sale. Of course, they will need actual equity in the property to sell, or else it will be a short sale (above). Remember that even in cases where the break-even point between property value and what's owed is relatively close, the homeowner will have to pay Realtor's fees (typically 6% of the selling price). There will also be transfer fees, recording fees, transaction fees, and possibly other taxes and expenses. Therefore, you may need a minimum of 8-9% equity just to break even on a sale – with no profit in your pocket!
If the homeowner has missed payments and the property is in preforeclosure, the conventional sale (not short sale) will also have to proceed quickly, as the foreclosure timelines and legal milestones will not slow down or stop just because the property is up for sale. Of course, communication with the lender is advised even though it's a conventional sale, as they may not aggressively pursue foreclosure if they know the property will soon be sold, and they'll recoup their money.
- Deed in lieu of foreclosure
If you can’t come up with the funds needed to pay off your past missed payments and get back on track, your lender isn’t offering a loan modification, and a short sale isn’t for you for some reason, your options are dwindling.
One of the only measures that will technically keep you out of foreclosure is something called a deed in lieu of foreclosure. While the end result is the same – the homeowner loses the property back to the bank – a deed in lieu of foreclosure may have a few benefits.
Basically, you’ll negotiate the surrender of the house’s deed back to the bank, moving out of the house. But with a deed in lieu of foreclosure, you work with the bank or your mortgage servicer to make the best of a bad situation.
Not only will you keep an actual foreclosure off your credit report (the foreclosure process will be postponed or stopped), but the bank may agree to wipe out any mortgage debt that’s owed past the value they recoup. While that may not be a big bonus for most homeowners who have equity, there are certain states or situations when homeowners have recourse debt, which means they took a cash-out refinance, a HELOC, or it’s an investment property, etc.
With a deed in lieu of foreclosure, the bank gets the home back far earlier than if they had to foreclose, saving significant money and allowing them to resell it sooner. For that reason, they may work with some homeowners to grant a deed in lieu of foreclosure when the owner is in the preforeclosure process.
- Foreclose on the property
If all else fails, the property will go from the preforeclosure process to an actual foreclosure, as the bank proceeds with the legal process of taking back the home.
Typical preforeclosure timelines
The preforeclosure process operates along certain defined timelines. These may vary slightly based on what state you are in and the foreclosure laws in that state, but all lenders and mortgage servicers basically function the same way. Like we mentioned above, there are options to prevent or at least stall or postpone the preforeclosure moving to an actual foreclosure, but a lot of that depends on the bank.
The homeowner misses their first mortgage payment.
Approximately a week-and-a-half to two weeks after missing your payment due date, your mortgage company will start assessing late fees, which will reflect in updated payments balances when they call you and mail new statements.
The homeowner will receive plenty of phone calls and inquiries from their mortgage bank, as they know that getting homeowners to pay and get back on track is statistically imperative in this early junction. Once the mortgage isn’t paid for 30 days or so, it will be reported as a late payment to the credit bureaus and reflect as a 30-day-late on their credit report.
Your mortgage company will send you a demand letter, formally requesting the entire outstanding balance of the loan since you failed to pay.
The same will happen, as the mortgage bank will get more aggressive with their contact and collection attempts, and a 60 and 90-day late will appear on the credit report.
Around 90 days
Typically, after three missed payments or about 90 days have passed without the mortgage being paid, the lender could first file a Notice of Default. This "NOD" formally notifies the homeowner that legal action will proceed if the payments (and now, mounting debt with late fees and charges and accrued interest) are not made. At this point, your loan “file” is referred to a foreclosure attorney within the bank’s department.
This segment of time is what’s most commonly referred to as the preforeclosure period. But remember that just because the lender can file a Notice of Default after 90 days, it doesn’t mean they will do so. There are times where lenders take much longer than 90 days to file the Notice of Default for reasons unknown. In some cases, when the homeowner and mortgagee is communication with the bank and trying to negotiate a repayment plan, loan modification, or even a short sale approval, the bank may hold off on filing a Notice of Default for the foreseeable future (or, until those efforts fail or come to a conclusion).
From Preforeclosre to Foreclosure
After the Notice of Default is filed, the home may be considered out of the preforeclosure process and marching towards an actual foreclosure.
The lender will still aggressively make attempts to collect the debt. If there is no loan modification, short sale, or other workout plan actively being negotiated, they typically will initiate foreclosure proceedings about 120-150 days after the first missed payment.
We talk more about the foreclosure process in detail here (ANISH – add link) but suffice to say it starts with the lender filing that default notice with your local County Recorder. From there, the foreclosure proceedings become a matter of public record.
The foreclosure timeline will continue, culminating with a judgment to foreclose around day 150.
Once a court grants that judgment to foreclosure, there usually is an appraisal (it could just be a “desktop” appraisal or involve an actual local sheriff supervising an on-site appraisal), so the court, the bank, and everyone involved can get a rough idea of the value and condition of the home versus what is owed.
A date will be set for the property to be sold at auction. But before that happens, there may be one final chance for the homeowner to exercise a right of redemption (depending on your state), coming forward with 100% of the funds necessary to pay the mortgage debt in arrears and reclaim the property.
However, in most cases, the bank will repossess the house and file an eviction with the local sheriff, getting the now illegally-present former homeowners out of their property.
In the quickest scenario, foreclosures take about 5-6 months to play out, although that may even be ambitious considering the different stages and the time it takes local courts to handle the foreclosure, sale, and eviction.
We’ve seen plenty of cases where these foreclosure timelines are stretched way out, for whatever reason, and some homeowners have still been in their houses for a year or two – or longer!) after ceasing to pay their mortgage!
Buying a home out of preforeclosure
That’s just a quick snapshot of the foreclosure process in its entirety, but we’re focusing on the preforeclosure process in this article, of course. And so far, we’ve only focused on the homeowner’s perspective.
But you may be reading this article because you’re more concerned with another aspect of the process: how can you buy a home or make a sound investment when a property is in preforeclosure?
Now, let’s talk about how someone can actually buy a home out of preforeclosure, which is the crux of how a savvy real estate investor can identify and take advantage of these opportunities for a financial windfall.
Reasons for preforeclosures
First, let’s look at the common reasons why most homeowners would fail to miss payments and fall into a preforeclosure on their property:
- Job loss
- Medical disability
- Failed business/investment
- Real estate market crashes (property values drop)
- Mortgage rates rise (adjustable rate loans get more expensive)
- Homeowners pass away, and their heirs or families mismanage the estate
- Property falls into serious disrepair (like water damage from a flood, etc.)
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