Pros and Cons of Investing in Pre-Foreclosure Homes

Foreclosures in the US are up for the first time since 2010.

In the first half of 2022, they reached 164,581, which is a 153% increase from the same period last year. As a real estate investor, this could be good news because homes in the foreclosure process often sell below market value. But first, you need to understand how foreclosures work.

In this article, we’ll discuss the difference between foreclosure and pre-foreclosure properties and the pros and cons of investing in pre-foreclosures.

What is the Difference Between a Pre-Foreclosure and a Foreclosure Property?

Though a pre-foreclosure and a foreclosure property are similar, they have important differences.

Pre-foreclosure refers to the period between when a homeowner defaults on their mortgage payments and the lender repossesses the home. Typically, the lender will send out a notice of default once the homeowner fails to make payments for three consecutive months. This is the first step in the foreclosure process.

Once a lien against a pre-foreclosure home is approved and activated (a process that can take anywhere from a few weeks to a year), the home is officially in foreclosure. At this point, the lender can seize the property designated as collateral in the mortgage agreement. But since banks don’t want to be in the landlord business, they usually try to turn around and sell the property at a public auction as quickly as possible.

What Are the Pros of Investing in a Pre-Foreclosure Property?

Pre-foreclosure and foreclosure are both challenging situations to be in as a homeowner.

But as an investor, they provide some unique opportunities. Here are the benefits of investing in pre-foreclosure properties:

Motivated Sellers

Most homeowners facing foreclosure want to get their hands off the property before the bank seizes it.

For one, a foreclosure could ruin their credit score by dropping it by 100 points or more. On top of that, foreclosure is a lengthy and complex process that involves a lot of financial and legal stress for the homeowner.

By taking a pre-foreclosure property off their hands, you can help protect them from foreclosure and possible bankruptcy and give them the money they need to put toward a more affordable home—all of which gives you more negotiation power to buy at a price below market value.

Better Property Access

Once a foreclosure property goes to public auction, you lose the ability to inspect it.

In other words, you must buy it as is or not at all. However, if you identify a property while it’s still in pre-foreclosure, you can have a regular home inspection and appraisal done.

Plus, you can work directly with the homeowner, who knows much more about the property than a bank. Having greater access to the property this way will help you make a more informed investment decision.

More Financing Options

Unlike foreclosure properties, which must be bought in cash most of the time, pre-foreclosures can be financed.

That means you can take out a mortgage for them just like you would for a traditional home. If you choose this route, it’s best to get a pre-approval letter from your lender. This will speed up the buying process and help ensure you close the deal within the pre-foreclosure time frame (which can be as short as a few weeks). Being able to finance a pre-foreclosure helps you leverage your capital and maximize how far it will go.

Faster Buying Process

Pre-foreclosures sell faster than foreclosures do because there’s less red tape and paperwork to deal with.

For example, you don’t need to bid at a public auction, and you need fewer approvals from the bank and government to make the deal go through. Plus, you’re dealing directly with the homeowner, who is often willing to move things along quickly since they’re working against a tight foreclosure deadline. If you want to buy an investment property fast, pre-foreclosures are the way to go.

Less Competition

Unlike foreclosure properties, which are advertised at public auctions, pre-foreclosure properties tend to fly under the radar.

Many real estate agents stay away from them because they don’t want to deal with the risks involved, and many buyers don’t think to look for them. Plus, many pre-foreclosures aren’t listed on the market in the first place. So if you choose to invest in this niche property type, you’ll face less competition and avoid getting caught in a bidding war, making it easier for you to find good deals below market value.

What Are the Cons of Investing in a Pre-Foreclosure Property?

As lucrative as pre-foreclosure investing can be, there are some downsides you need to be aware of before you dive in.

Here are all the disadvantages:

Poor Condition

It’s common for pre-foreclosure properties to be in bad shape.

After all, a homeowner who can’t make their mortgage payments probably doesn’t have the resources to take very good care of the home either. In fact, embittered homeowners might even take out their frustrations on the home by deliberately vandalizing it. For a house flipper or a wholesaler, this might not matter. But for a rental owner, this may create more work than anticipated.

That said, pre-foreclosures are usually in better condition than if you were to wait till they go into foreclosure, and you can still perform a home inspection to see what you’re getting into.

Tip: Use our Rehab Calculator to get a rough estimate of the necessary renovations before making an offer or spending any money. That way, you can know if it’s a profitable deal or not.

Higher Cost

While the process of buying a pre-foreclosure may be easier, and you may be able to get a better understanding of the property to help you decide if it’s a good investment, you may pay a little more than you would once the property goes to foreclosure.

That’s because banks are eager to get rid of foreclosures and are often willing to sell far below market value as a result. They want to turn foreclosures into cash, so they can lend the money to other borrowers at a profit. That’s how they make money.

Still, you can make a good return on a pre-foreclosure by finding the right deal. The trick is to identify pre-foreclosures not yet listed for sale so you can take advantage of the lack of competition.

Unpredictable Risks

No pre-foreclosure situation is the same, and you may encounter unexpected risks that jeopardize the deal.

For example, if the homeowner's financial situation changes suddenly, they may be able to pull themselves out of pre-foreclosure, leaving you without the property. Or they might sell it to the bank at the last minute in a short sale. Other times, an appraisal may value the pre-foreclosure home so low that lenders back out of offering you a loan because the profit potential is too small for them to be worth it.

All of these scenarios are potential risks that could cause your pre-foreclosure deal to fall through if you’re not careful. But if you develop good relationships with the homeowner and lender, you’re more likely to identify red flags before you get too invested.

Hidden Costs

Anytime you deal with a property in the foreclosure process (including pre-foreclosures), there may be hidden costs.

For example, a pre-foreclosure property may come with unpaid taxes or liens (such as from the IRS, state, or other creditors). If it does, you’ll be responsible for paying them once you become the homeowner.

Some sellers may be forthcoming about back taxes and liens attached to the property, but others may not. So you must be careful. That said, a title search and some thorough research can reveal such hidden costs to help you know exactly what you’re getting into.

Requires Investment Knowledge

To succeed in investing in pre-foreclosures, you must develop a deep knowledge of the property type.

The process of buying a pre-foreclosure is often complex and time-sensitive, and you need to run a lot of numbers to know which deals make financial sense. Of course, there will always be some risk involved, but you can minimize it by relying on good data, which leads us to our last point.

Use Real Estate Data to Find Off-Market Pre-Foreclosure Opportunities

With PropStream, you can find good pre-foreclosure deals in no time. We pull data from multiple sources (including the MLS and county records) to bring you over 46 million pre-foreclosure investment opportunities on one platform.

Propstream also lets you narrow down your pre-foreclosure search by property type, occupancy status, and whether or not the property is listed for sale. You can find pre-foreclosures that aren’t yet listed for sale, so you can contact the homeowner before your competition does.

This makes pre-foreclosure investing quicker, easier, and more lucrative than ever before. To get started, try a free 7-day trial of PropStream today!