Foreclosures don’t happen the moment you miss a payment. There is a period, typically three to four months, when homeowners can work with their lender to get back on track or renegotiate the loan. This period is called preforeclosure.
Losing your house can be the most devastating setback of your lifetime. Apart from dropping your credit score by 100 points or more, it can leave your family homeless. Needless to say, keeping a roof over your head is the highest priority for most families. The good news is that U.S foreclosures dropped to an all-time low in 2021. However, there were still 151,153 properties with foreclosure filings. Understanding what preforeclosure is and how it works can help you if get into difficulties with your mortgage.
What does preforeclosure mean?
The four stages of foreclosure
You have heard about the four stages of grief. Well here are the four of foreclosure.
- The first stage describes a borrower in good standing. They are current with their mortgage payments but they know they will struggle to make payments soon.
- The second is the person who missed a payment or two. They need to catch up.
- Stage three is preforeclosure. You are in trouble, but there are still ways to make things right with the lender and continue to own and live in your home.
- The fourth stage is the person who is in foreclosure, the process of losing their home as it becomes property of the lender.
How does preforeclosure work?
If you have a mortgage, you’ve seen the monthly bill listing the payment due on the first of the month and a notation of a slightly larger amount if paid after a different date, about two weeks later. That extra time is called the grace period. The higher charge includes the late fee if the payment is made after that date.
You don’t go instantly into default on your mortgage if you are a day late. Generally speaking, if you pay within the grace period window, often 14 days, you are fine. Make your payment on or after the 15th day and you incur a late fee. You are still fine. Cross the 30-day line and you’ve missed a payment because now the next payment is due. The mortgage company will typically report you to the credit reporting agencies, which will hurt your credit.
You are now entering preforeclosure territory. Beyond the 30-day threshold, you are entering the payment due date and grace period for the second month. On day 45, you have exhausted the grace period for the second month. You have now missed two payments. The lender gets more and more proactive, reaching out and warning you. Once you get to the 90-, maybe 120-day threshold, you move out of preforeclosure territory. The lender can move into foreclosure proceedings.
It might vary by state, but if you miss three mortgage payments, the lender considers you in default on your mortgage. They send you a letter alerting you to this situation and outlining the consequences. Delinquency rates are low now, but there are still thousands of families that face the stress of being in default.
Most people consider keeping a roof over their heads the highest priority when it comes to paying bills. So, if you’re defaulting on your mortgage payments, chances are you are also behind on other bills, such as utility bills and credit card payments. This means in addition to the mortgage lender writing to you, your credit card company and the utility companies are likely sending letters with “Past Due” stamped in red.
Notice of default
The lender doesn’t simply send you a letter you might claim you never received. They file a notice of default with the local government records office. If you intended to sell the property, it lets people know there is money owed, in addition to what’s obvious.
Sale of the home
The lender is in the business of making loans, getting them paid off, and then lending money to others. When a lender forecloses, they retake possession of the property.
The occupants must leave and find someplace else to live. The lender then takes steps to sell the property, often at auction. The lender’s major objective is to recover the money they are owed. Bearing in mind they rarely, if ever, lend the full market value of the property, they expect to get back at least enough to repay the loan. Put another way, they don’t intend to auction off the property for less than they are owed.
What should I do if I can’t afford the payments?
If you are the borrower and realize you will probably default on your mortgage, contact your lender and try to work something out. They want to recoup what they are owed, but they might be agreeable to extending the length of the loan. You probably have equity in the house. You don’t want to lose that if you can avoid it.
When people owe money to someone, they often get angry when they aren’t getting paid and think you are ignoring them. Lenders will usually hire collection companies if you don’t make arrangements with them. When you owe money and can’t pay, it’s tempting to keep a low profile and ignore these attempts to contact you. This is a bad idea, especially with your lender. They don’t want you to lose your house. It’s expensive for them to foreclose. They may be agreeable to working something out. When you get a letter talking about defaulting on your mortgage because of nonpayment, you should call your lender and talk about your situation. You won’t be the first call like this they have received.
It is possible to avoid foreclosure with a mortgage refinance
It’s not easy, but in principle, you can avoid foreclosure with a mortgage refinance, but only if you apply for a refinance before you enter foreclosure. Your chances of approval will be much higher if you apply before you missed a payment. Obviously, this is not always an option. However, if you discover you are likely to get into financial difficulties in the future, you may have a window of opportunity to refinance your mortgage for one with a lower, more affordable, monthly payment.
What can a homeowner do to stop foreclosure?
Bear in mind the lender and the consumer protection agencies don’t want people to be evicted from their homes. Their motivation might come from different places, but everyone wants you to stay where you are if you can agree on your obligations and meet them. If a mortgage refinance is not an option, you still have other alternatives to consider.
1. Talk to your lender about repayment plans
Call up your lender. Tell them about your situation. Do this early, not at the last minute. They want to work with you, because continuing to get payments while you stay in your home is in everyone’s best interests. If this is a temporary problem, like you have a dry spell between consulting assignments, they may agree to fold in the past due amounts over the next several payment periods. This is a good strategy if you are confident your fortunes will change for the better very soon.
2. Ask for help
Let’s assume you have family and extended family. They are thrilled you could buy your own home. They want you to keep living in it. Ask them for financial help. If the worst happened and you were evicted, you would likely ask to live with them. Ask them for loans to help you stay in your own home instead. These loans should be in writing with terms spelled out. It shows you are serious about repayment. It is also important if you died because they would have a piece of paper showing a debt that should be repaid by your estate.
3. Discuss a loan modification with your lender
We’ve been in a low-interest-rate environment for years. Interest rates have been starting to increase. This means people with variable-rate mortgages can expect their monthly payments to keep increasing over time. Your lender might be able to change the terms to a fixed-rate mortgage. Your lender might be able to extend the terms of the loan, add the past due amounts into the new loan principal balance or change the interest rate.
4. Explore forbearance
Forbearance is similar to asking for a “time out” during the big game. Everyone agrees to take a break before restarting. After this “grace period” ends, you are often expected to catch up on all the back payments at once plus resume making regular payments. This might be a good strategy if you had a hugely valuable piece of artwork you have consigned to auction, yet there’s a time lag between now and the date of the sale, plus another lag between the day it’s sold and the date the auction house sends you the check. You need a little breathing room, but know the money is coming.
5. Pursue a preforeclosure sale (short sale)
A preforeclosure sale is similar to a short sale. A short sale occurs when the lender agrees to a lower repayment than it is owed. This makes it easier for the owner to sell a property that is currently underwater.
A preforeclosure sale, on the other hand, occurs when the homeowner chooses to sell the home to repay the mortgage balance in full. However, the asking price is usually less than the market value to help the property get sold faster.
Preforeclosure sales and short sales are often necessary when you buy properties when the market is high and prices then drop dramatically. Then, you are “underwater” on your mortgage. In other words, you owe more than the market value of the property. In such cases, you often need to talk to the lender about putting the house up for sale yourself. Whatever you get is applied towards the outstanding mortgage. If the market value of the house is lower than the mortgage balance, you will need to ask the lender to approve a short sale. You may wonder why a lender would accept a deal like this one? The short answer is that foreclosures are an expensive process so a quick short sale may be a win-win for everyone.
6. Sign a deed-in-lieu-of-foreclosure
A deed-in-lieu-of-foreclosure is similar to the short sale solution. You sign the house over to the lender. The house might be worth less than what you owe, but they are agreeable. The rest of your debt is forgiven. They own the house. You move out. They assume the task of selling it. Why would the lender agree to this? Again, because the foreclosure process is expensive.
Preforeclosure from the buyer’s point of view
You might be reading this and thinking “Here’s a way to buy a house cheaply.” You might be right, but bear in mind houses aren’t always occupied by owners. It might be income-producing property with renters. If the people living there feel they will be losing their home, they might do damage or at the very least, skip necessary maintenance. The house might be in poor condition.
This is a situation where an investor can buy from a motivated seller. They need to bear in mind repair work will likely need to be done before new renters can be brought in or the house put up for sale.
As a buyer, you might be approaching this from an owner/occupier point of view. Maybe it’s your starter home. Perhaps parents are buying it for their recently married child. It’s highly likely the house will need work done before it’s habitable. As the buyer, you need to plan for the financial expense of living someplace else, covering the carrying costs, and paying for needed repairs.
How to buy a preforeclosure property
Buying a property that is in preforeclosure can score you some real bargains. However, it is also the trickiest stage to purchase a distressed home. For starters, the property may not be for sale. The owners may be looking for a quick sale, but they may be trying to cure the default some other way.
- Search for preforeclosures using platforms like Zillow and RealtyTrac. Remember the owners of these properties could resolve their financial difficulties, so there is no guarantee these properties will still be in preforeclosure when you make your move.
- Visit the property. It’s very possible there are still people living in the home. So be smart about how you deal with the situation. In other words, don’t be creepy.
- Check the status of the property. You can either contact the trustee that set the foreclosure filings in motion or hire a local foreclosure specialist.
- Find out how much the owner owes on the property. You can get this information by checking public records. Then check what it is likely to go for if it’s listed as a foreclosure. These figures will help you decide what your offer should be.
- Estimate how much repairs will cost. Deduct your costs from the estimated value of the property to determine what your top offer should be.
- Get your financing in order before you make an offer. If you don’t have the cash to buy the preforeclosure property, make sure your lender has preapproved your loan and is ready to move as soon as the offer is accepted. The lenders below are a great place to start if you are comparing rates and terms.
Frequently asked questions
Is it a good idea to buy a preforeclosure?
It can be a good idea, but you need to know the extent of work that will need to be done before you can occupy it, rent it, or sell it. You need to know what this will cost you.
What is better: preforeclosure or foreclosure?
Preforeclosure implies the property is still occupied. Foreclosure means the lender owns it and the property is empty. It might have been unoccupied and neglected for a long time. Vacant properties are often targets for squatters and thieves. The condition of a preforeclosure house might be somewhat better.
How does buying a preforeclosure work?
Generally speaking, you are buying from the owner who owes money to the lender on the mortgage. You are usually buying in “as is” condition. So, you are basically paying them the mortgage balance, which they will then pay to the lender. Therefore, you are responsible for liens on the property.
How do you negotiate the purchase of a preforeclosure property?
If you are the buyer, expect the seller to set a purchase price that covers the mortgage and related sale costs.
- Preforeclosure is the period between missing mortgage payments and the time the lender takes steps to foreclose on the property. It often spans about three to four months.
- Foreclosure doesn’t sneak up on you. The lender will typically use multiple channels to give you notice.
- Talk with your lender. Their objective is to get the loan paid off. They are likely to offer you some options enabling you to stay in your home.
- Delinquency and foreclosure rates are low now, but thousands of families are still facing financial hardship and forced into preforeclosure.
Bryce Sanders is president of Perceptive Business Solutions Inc. He provides HNW client acquisition training for the financial services industry. His book, “Captivating the Wealthy Investor” is available on Amazon. Bryce spent twenty years with a major financial services firm as a successful financial advisor. He has been published in 40+ metro market editions of American City Business Journals, Accountingweb, NAIFA’s Advisor Today, The Register, LifeHealthPro, Round the Table, the Financial Times site Financial Advisor IQ and Horsesmouth.com.