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Pre-foreclosure is the time period that begins when a borrower defaults on a mortgage and ends when the lender either forecloses the property or agrees to an arrangement that allows the homeowner to stay put.
The pre-foreclosure period typically marks the borrower's last opportunity to take action to prevent the loss of their property and avoid the serious, long-lasting damage to their credit history that foreclosure can bring.
How Does a Pre-Foreclosure Work?
Legal requirements can vary depending on where you live, but the start of pre-foreclosure is fairly consistent in all jurisdictions, and includes the following steps, in order:
- Mortgage default: Pre-foreclosure typically can begin no sooner than 90 days after a borrower misses their first mortgage payment—that is, after they fail to make three monthly payments in a row. At that point, the borrower is considered in default on the loan.
- Notice of default: The pre-foreclosure period begins when the lender notifies the borrower by certified letter that they intend to begin foreclosure proceedings within 30 days.
- Public notice: In many states, when a lender issues a pre-foreclosure notice, the borrower's name is also posted to a public listing of individuals who are subject to foreclosure.
Finalization of a foreclosure order—which ends the pre-foreclosure period—follows significantly different timelines in different states. Some states require the lender to submit evidence of nonpayment for review by a judge—a process can take many months thanks to legal wrangling and crowded court calendars. Other states allow foreclosure authorizations within a few weeks.
When a home is foreclosed, occupants are evicted from the home, the locks are changed and, typically, the property is listed for sale at a public foreclosure auction. If it fails to sell at auction, ownership reverts to the lender—making it real estate owned (REO) property—and the lender arranges to sell it through a private sale.
What Should You Do if Your Home Goes Into Pre-Foreclosure?
If your home is in pre-foreclosure, you still have time to act. You'll need to move quickly, and your options may be limited, but they may keep you in the house or prevent some of the financial harm and damage to your credit that foreclosure can bring.
Make Up Missed Payments
Make payments against what you owe your mortgage lender. If you can find a new income stream, sell assets, arrange a private loan from a loved one, or otherwise make progress against what you owe, you may be able to prevent foreclosure. Work to make up any missed payments as soon as possible and, of course, keep up with future payments.
Seek Loan Forbearance
If your inability to make your mortgage payments is the result of a temporary loss or reduction in income and you're confident you'll be able to resume payments (and make up the missed ones) within the space of a year or so, mortgage forbearance could be a good option.
It's best to seek forbearance before you miss any payments, or as soon as possible after you miss your first payment. But if you can provide evidence of future income (such as a job offer, a contract for pending property sale or proof of inheritance), your lender may agree to a temporary suspension or reduction in your monthly payments even after you're in default on the loan.
Look Into Mortgage Modification
If your income stream has been reduced, but remains steady, your mortgage lender may be willing to adjust your monthly payment down to an amount you can afford in what's called a mortgage modification. The lender typically will need assurances you can keep up with the new payment arrangements, so the application process for a loan modification is essentially the same as applying for a brand-new mortgage. Note that modified loan terms typically increase the number of payments remaining on the mortgage, and lead to higher interest costs over the life of the loan.
Lenders generally are not obligated to offer loan modifications, or even consider requests for them, but it can't hurt to ask for one. In the wake of the COVID-19 pandemic, issuers of government-backed mortgages, including FHA loans, VA loans and USDA loans, have been ordered to work with borrowers to provide loan modifications whenever possible. Not only that, the federal government has asked lenders issuing mortgages that aren't backed by the government to be flexible about renegotiating loan terms.
Consider Chapter 13 Bankruptcy
Another option that's available if you have a steady income but a reduced paycheck is Chapter 13 bankruptcy. This procedure may allow you to stay in your home while you work through a court-ordered plan to repay a portion of your outstanding debts. This is a worse option than mortgage modification because it's not guaranteed that the court will allow you to stay in the house as part of its repayment arrangement.
A Chapter 13 bankruptcy also does even more damage to your credit than a foreclosure does. It is considered a severe negative event in your credit history, and remains on your credit reports for seven years, dragging down your scores the entire time.
Consider a Deed in Lieu of Foreclosure
In a deed in lieu of foreclosure arrangement, you agree to vacate the house and turn it over to the lender in a way that bypasses the legal formalities of foreclosure. While you still lose the house, you may be able to negotiate forgiveness of some or all missed mortgage payments, and you'll avoid having a foreclosure appear on your credit reports.
A mortgage closed through a deed in lieu of foreclosure will appear as a negative entry on your credit report and it will have negative consequences for your credit scores, but they are typically less severe and shorter-lived than those of a foreclosure (or of a bankruptcy).
How Does Pre-Foreclosure Affect Your Credit?
There is no formal entry on a credit report that indicates a mortgage is in pre-foreclosure, so pre-foreclosure has no direct effect on credit scores. The events leading up to pre-foreclosure, as well as steps taken during it, can have major consequences for the borrower's credit, however.
Since pre-foreclosure typically only occurs after three successive missed mortgage payments, a borrower's credit score has often taken a significant hit by the time pre-foreclosure begins. One missed loan payment has a significant negative impact on credit scores, and three consecutive missed payments can cause a major reduction in scores. This effect is magnified if the borrower has missed payments on other bills, such as credit card payments or car-loan installments.
If pre-foreclosure leads to foreclosure, that will be noted on your credit reports. Foreclosure can have a more severe and long-lasting negative effect on your credit scores than accumulated missed payments, and it will remain on your credit report for seven years.
How to Buy a Home in Pre-Foreclosure
Some homeowners in pre-foreclosure may try to sell their home as a short sale, which gets them out from under the loan but requires them to accept less than they owe on their mortgage. Doing so can allow the distressed homeowner to avoid foreclosure without the expense of marketing the home for sale.
A home for sale while in pre-foreclosure may be a challenge to buyers, however. Many houses in pre-foreclosure are not listed for sale, but it still may be possible to identify them and make a successful purchase offer. A successful purchase of an unlisted pre-foreclosure property requires knowledge of how to identify desirable pre-foreclosure homes, as well as the diplomatic skill to navigate the purchase.
Purchases of homes in pre-foreclosure are special instances of short sales. As such, the deals typically require approval from the lender, which can prolong or otherwise complicate the sales process.
A pre-foreclosure property may have fallen into disrepair by the time a potential buyer sees it, and it may require considerable investment to make them ready for occupancy or resale. For these reasons, it's generally not advisable for newcomers to the real estate marketplace to seek a pre-foreclosure as their first home. Even homeowners with experience buying and selling homes would be wise to take these tips to heart when considering a pre-foreclosure purchase:
- Work with a real estate agent or mortgage broker with a track record of handling pre-foreclosures. They can help you locate eligible properties, sort out the ones that meet your needs, and assist with approaching the homeowner.
- Consider using an online service such as Zillow.com to identify pre-foreclosure properties in your area, bearing in mind that the homeowners listed may not be interested in selling, and may even be out of pre-foreclosure by the time you can contact them.
- Unless you're prepared to make a cash offer on a pre-foreclosure, get a mortgage pre-approval to demonstrate to the seller that you're ready and able to move forward quickly on a sale.
It's Possible to Avoid Foreclosure
Pre-foreclosure is a stressful but pivotal period of time that no homeowner wants to experience. It can be an opportunity to act and stop foreclosure before you lose your home and incur deep, lasting credit damage.
If you're facing pre-foreclosure, don't panic, don't give up, and by all means don't ignore communications from your lender. By working with them, you may be able to come up with options that prevent pre-foreclosure from leading to foreclosure. Throughout the process, it's wise to keep a close eye on your credit report and scores. Whether your home is ultimately foreclosed, or you're able to avoid it, it's important to monitor changes to your score and get strategic about keeping it in good shape, or rebuilding it if need be.