What is preforeclosure?

Foreclosure occurs when a lender takes possession of someone's home after they stop making monthly mortgage payments. It’s a stressful process that has serious, long-term consequences for your credit. Preforeclosure is an important early step in the process — it gives borrowers a chance to work out an alternative once their loan is in default but before foreclosure is finalized.

How do preforeclosures work?

Preforeclosure 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.

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.

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.

Preforeclosure vs. foreclosure

Preclosure begins when you miss the third payment and receive a notice of default. In preforeclosure, you still own the home and can live in it for the time being. However, once the actual foreclosure proceedings have concluded, you’ll lose all rights to the property.

Once you’re in default, the time between preforeclosure and foreclosure depends on your state’s laws.

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

The length of time you have between preforeclosure and foreclosure varies by state. Some lenders move quickly through the foreclosure process, depending on whether foreclosure is judicial (court hearing and order required) or nonjudicial.

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’s a red flag to any potential lenders.

Preforeclosure vs. short sale

Sometimes the terms preforeclosure and short sale are used interchangeably, but they are not the same. A short sale is when the lender allows a struggling borrower to sell their home for less than what they owe on their mortgage. The lender could require you to pay the difference or grant you a waiver of deficiency, forgoing their its to collect the remaining balance.

A short sale is typically used as a measure to avoid foreclosure. You might decide to go with a short sale even before preforeclosure if you’re worried you won’t be able to make future mortgage payments. Short sales tend to occur more often in economic downturns.

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. Some options to avoid foreclosure include:

1. Refinance your mortgage

You may be able to refinance your mortgage if you have a long payment history and have built up equity in the property. 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).

Refinancing will probably extend your loan term, especially if you want to reduce your monthly payments. Also, keep in mind that you’ll likely have to pay closing costs.

Refinancing is essentially starting a new mortgage loan, so you’ll have to submit an application and allow a credit check. It may take some time for the lender to review your application and make an approval decision. You may decide to pursue this option before you’ve missed a mortgage payment.

If you’ve already missed payments, your lender may allow a loan modification. The lender rewrites the loan terms (which may extend the loan), but you could have a lower monthly payment. It doesn’t hurt to ask your lender if you qualify for a loan modification — it won’t impact your credit and can keep you out of preforeclosure.

2. 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.

3. Borrow money to catch up on missed payments

Another alternative is to borrow money from family, friends or a personal loan company to get caught up on your payments. While it may not be ideal to ask for money, it could be a short-term solution to help you avoid foreclosure. These loans won’t impact your credit like other alternatives and might keep you from racking up added fees and interest.

How to buy a home in preforeclosure

Finding a home in preforeclosure isn’t a simple process. Often these homes are snatched up quickly by real estate investors who can pay cash.

You could start your search online — some properties are listed on real estate websites as being in preforeclosure. You may also seek a real estate broker with expertise in this area. They have contacts who can alert them to properties in preforeclosure before they hit the market.

Before you begin any home search, you’ll want to obtain preapproval from a mortgage lender. Preapproval ensures that you can make offers on homes within your price range.

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.