Pre-Foreclosure - How To Invest
By investing in properties "pre-foreclosure," you get ahead of the crowd and possibly
get a great price. The downside? You may have to walk a fine line between helping an
owner and taking advantage of him.
Pre-foreclosure is simply that time between when the home owner gets the notice that
he is in default on the mortgage loan, and when he finally loses the home. This may
be where the most money is made on "foreclosures". By going straight to the owner
before the home is lost, you are a step ahead of investors who wait for foreclosure sale
or wait until the bank owns the property.
Are you taking advantage of an owner when you make a profit off of his financial
troubles? Maybe. You might also be helping him make the best out of a bad situation.
You really can do the latter and still make a good profit. Let's look at some examples
Example of Pre-Foreclosure Deals
There are essentially two ways to help an owner who is in default on his mortgage
loan. The first is to find a way to help him stay in his home. The second is to help him
salvage his credit and get something out of the home he is losing.
Most owners who are seriously in default will simply lose the home. They will also
wreck their credit, and lose most or all of their equity - unless an investor steps in to
help. This is why you can feel good about making a profit from a home owner in
Suppose you put an ad in the paper, something to the effect of "Losing your home?
Let's talk." You get a call from a woman who is several months behind in her
mortgage payments, and is about to lose her home. With back payments, her loan
balance or payoff amount is about $95,000. The home is probably worth $130,000.
You ask her about her financial situation, to determine if she has the income to
eventually get caught up and make the payments on time. You ask her if she mainly
wants to stay in the home or if she just doesn't want a foreclosure on her credit report.
She says that she is ready to move. She could try to sell the home to pay off the loan
and have a bit of cash left over, but there isn't time. She doesn't want the bad credit,
but she also doesn't want to lose all of her $35,000 in equity.
You agree with her assessment of the situation. You explain that if she did try to list
the property with a broker, she would have a sales commission and other costs, which
together could be $10,000. She also would likely have to sell it for $120,000 to get it
sold fast. In this best case scenario, she might get to keep $15,000 of her equity. But it
is risky, because if it doesn't sell and close in a few weeks she loses everything.
You tell her that you can buy the home for $107,000 and pay all the closing costs.
This will leave her with $12,000 and no foreclosure on her cred it report, so she may
be able to borrow again for a home when she is ready. She says no. You explain that
after the costs of buying and selling the home, you will make $10,000, and though
you understand she is losing some equity, you just don't do deals for less than $10,000
profit. You wish her the best.
Soon she calls back and accepts your offer rather than lose her home and equity and
credit rating. You have to have a line of credit ready or cash in the bank for deals like
this, because time is of the essence. You also have to treat people well. In the example
above, you might even offer another $500 cash if the house is left clean and ready to
Look at the numbers, paying particular attention to the expenses you'll have in buying
and selling a property. You can see that there has to be a fair amount of equity in a
property to be able to help the owner and help yourself. Verify exactly what the
payoff amount on the loan is before you sign any contract. Owners are often
Other Pre-Foreclosure Examples
A friend of mine liked to help people stay in their homes when the were in default on
their loan. He felt this was easier and more profitable. There are several ways to do
this. One obvious way, if there is a lot of equity in a property, is to put a second
mortgage on it in exchange for making up the back payments. Sometimes a family has
trouble that really is temporary, and once caught up on their mortgage payments, they
will be able to pay them on time again, along with a payment to yo u.
Suppose the home is worth $185,000, and they owe $115,000 on it. They need $4,000
to catch up back payments and no longer be in default. A loan fee of $1,000 and
interest at 5% higher than current mortgage rates might make for a decent return on
your investment. A second mortgage on a property with so much equity makes it a
Another way to help owners stay in their homes is to buy the home and rent it back to
them. They get to avoid having a foreclosure on their credit report, maybe get a little
cash, and they don't have to move. You should of course, have positive cash flow and
a good profit if you should need to evict them and sell the home.
You could also make it a lease-option deal. In this way, if the previous owner gets
into a better financial situation, he can buy his home back. Of course the purchase
price will be high enough to give you a good profit.
If you have a lot of cash to invest, you can buy the home and sell it back to the owner
on payments. Of course you will have to sell it for at least $10,000 more than you
bought it for, and you will have to have charge high interest. If this is likely to cause
some bad feelings for the person who will be living in your investment, you may want
to consider another way.
You could provide the cash for him to refinance and so keep the home. Since you may
have to foreclose on the loan, so you want to do this only when there is a lot of equity.
Charge high interest and high loans fees (perhaps rolled into the loan), and make it a
balloon loan, with the balance due in three or five years. Explain that you do this for
the profit, but it at least gives the owner a chance to keep his home, and he can
refinance at better rates when he is doing better financially.
A Little Pre-Foreclosure Trick
Here is a a little trick used by an investor I met in Arizona. A holder of second
mortgage in default has the right to foreclose and take the property. But in Arizona at
that time (and possibly in other states - but ask an attorney), the law also said that if
the holder of a second mortgage foreclosed on a property, he had the right to assume
the first mortgage loan - without qualifying, and regardless of whether it was normally
an assumable loan.
This investor "helped" people facing foreclosure, using this little known law. For
example, suppose there is house that would make a nice little rental property. The
owners owe $60,000, and it might be worth $80,000, but they are about to lose it. The
payments and interest rate on the loan are lower than what is currently available.
This investor would convince the owners that rather than them losing everything, he
would give them the $2,500 necessary to make up the back payments, and also
$10,000 cash to walk away. Actually he loaned them the total of $12,500, and put a
second mortgage on the property. But they were instructed to never pay on the loan.
He made the terms outrageous enough that they weren't inclined to anyhow.
In this way after they missed their first payment, he could start the foreclosure
process. Once he had foreclosed, under the law he could assume that first mortgage
with its excellent terms. Now he had a nice rental that would cash flow, and with
some built- in equity from the start. The previous owners got their cash, and perhaps a
big black mark on their credit report from the foreclosure.
Pre-foreclosure investing can get very creative. These few examples are just a
sampling of ways it has been done.