What is preforeclosure?

Preforeclosure defined

Preforeclosure is the period after you’ve defaulted on your mortgage, but before the lender takes possession of your home. It is the first step in the foreclosure process. Usually, you won’t face preforeclosure until you've missed three monthly payments — at this point, the loan is in default, and the mortgage lender must follow a legal process to proceed with foreclosure.

This period is an opportunity for the homeowner to pay off the outstanding debt or potentially sell the property before it goes into foreclosure. If not resolved, this process can ultimately result in the property being repossessed by the lender. It's important to note that the specific rules and timelines for preforeclosure can vary based on state laws and the terms of the mortgage agreement.

How do preforeclosures work?

In preforeclosure, the lender or servicer will send you a notice of default, which is a legal document that alerts the borrower of their failure to fulfill the obligations outlined in the mortgage agreement. It may also state the actions the lender intends to take if the payments aren’t made current.

The notice of default is also filed with the local recorder’s office in case the lender has to file a lawsuit later. Generally, the lender moves forward with foreclosure within 30 days of sending this notice.

» MORE: How to lower your monthly mortgage payments

Negative effects of a preforeclosure

If you think you’ll miss a mortgage payment or have already skipped one, it’s important to contact your lender as soon as possible to discuss your options. One option your lender may present is mortgage forbearance, which is a temporary pause or reduction in payments.

You’ll need to act quickly in preforeclosure — foreclosure can happen rapidly if you don’t.

Preforeclosure and foreclosure both have negative impacts on your credit score. While preforeclosure is not a specific entry on your credit report (like foreclosure), the missed payments are noted and can bring your score down significantly.

Foreclosure has more severe penalties to your credit and will stay on your credit report for seven years. During that time, it can be a red flag to any potential lenders if you want to buy again or to landlords if you plan to rent.

» MORE: How to build credit

How to stop foreclosure

Fortunately, preforeclosure doesn’t mean foreclosure is inevitable. You can take some steps to halt the process, like refinancing, opting for a short sale or borrowing money from loved ones.

“A lot of lenders and banks will work with you if you are falling behind in your mortgage payments,” said Maureen McDermut, a real estate agent in Santa Barbara, California. “Upfront communication will help you understand what your options are, and the truth is mortgage companies do not want you to default or go into foreclosure, so they will often allow you to set up alternative arrangements.”

Some foreclosure alternatives include:

1. Contact HUD for counseling

“You can contact the Department of Housing and Urban Development, as they have a list of housing counseling agencies that can assist you,” McDermut said.

Foreclosure avoidance counselors are free in every state, so be wary of anyone asking for a fee or claiming to be a foreclosure counselor who is not HUD-approved. Your counselor will help you determine the next best steps and help you apply for a loan modification or refinance program if you are eligible.

2. Refinance your mortgage

One way to prevent foreclosure is to refinance your mortgage, which essentially restarts your mortgage. Depending on your current credit score, a refinance can help you secure a lower interest rate or extend your loan term, which can lower your monthly payment. If your home’s value has increased since you purchased it, refinancing could lower your monthly payments and help you eliminate private mortgage insurance (PMI).

3. Ask about loan modification

Some lenders might agree to modify the terms of the mortgage, making the payments more affordable. Loan modification is different from refinancing and could involve extending the term of the loan, reducing the interest rate or even deferring some of the principal.

Loan modification options can vary by lender, and as a reviewer in Connecticut found out, it is important not to take lenders on a verbal word.

“[My lender] told me they would modify the loan and put the deferred payment, [sic] at the end of the loan,” he said. “Now tells me they wouldn't do that and are demanding the entire $19,000 payment at once and will be foreclosing on me…”

Robert continued to say that the lender refused to take further payments from him in order to expedite the foreclosure process.

» MORE: Loan modification vs. refinance: how to decide

4. Opt for a short sale

It could take some time to sell your home, even at a deeply discounted price. A short sale may not be an option for everyone, depending on how far along you are in the process, so it’s critical to contact your lender earlier rather than later to discuss your alternatives. Your lender will have to approve any short sale.

Note that a short sale will negatively affect your credit, but not necessarily as much as a foreclosure (if there’s no reported deficiency balance). A short sale is a “derogatory item” on your credit report and may stay there for up to seven years.

» MORE: What is a short sale, and should you buy a home through one?

Bottom line

Lenders must follow a specific legal process in order to foreclose on a property. The first step is sending a notice of default, which signals preforeclosure and lets the borrowers know the foreclosure process has begun.

The most important action to take if you’re in default is to contact your lender or servicer as soon as possible — preferably before you miss any more payments. The sooner you make the lender or servicer aware of the problem, the more likely it can offer a solution that will help you stay in your home. You can also seek out foreclosure avoidance resources from your state’s housing agency.