When a homeowner owes more on a property than it is worth and is financially distressed the lender may agree to a mortgage payoff less than what is owed in lieu of foreclosure. This is called a pre-foreclosure or short sale. Buying a pre-foreclosure is very different from buying a foreclosure or a property the bank owns as part of its REO, real estate owned, portfolio. You have learn how to buy a pre-foreclosure. A step by step short-sale buyers guide makes the process a lot easier.

This kind of sale has advantages and disadvantages for all the parties involved. The seller gets out of a mortgage owing nothing but making nothing. The seller’s credit is damaged but not as badly as if the property had gone into foreclosure. The buyer gets a property at below market rates but may have to make extensive repairs to it. Purchasing is a complicated process that takes time and doesn’t always work. The lender loses money but usually not as much as if the property had gone into foreclosure.

If you decide to make an offer on one of these properties the lender will have to approve the sale. As outlined in the pre-foreclosure buying guide the seller fills out a short sale application and writes a hardship letter which affirms the seller can’t pay the difference between the buyer’s offer and the amount of the mortgage. This is backed up with documentation. If the appraisal and the offer are in line the lender may accept but require that the buyer pay for all necessary repairs and the closing costs.

A Pre-Foreclosure Buying Guide to Walk You Through the Process

1. Determine Which Properties Are Good Candidates for Short Sales

Do the research to identify potential pre-foreclosure prospects. You are looking for properties with mortgages that seem higher than market value. This is a good indication the seller will have trouble selling. If the owner has a lot of equity in a property you should strike it from your list. The lender probably won’t accept a short sale. It is more beneficial to foreclose and resell in this case.

2. Inspect the Property

The property must be thoroughly inspected in order to gauge the costs associated with repairing it. Depending on your situation a property in need of extensive repairs can be a good deal. This is the kind of property most buyers will pass on.

3. Gather the Financial Information

You have to know which lender holds the mortgage. You need to find out whether there are liens other than the mortgage on the property. A title search prior to closing is critical to ensure there aren’t any undisclosed liens against the property.

4. Get Your Financing in Order

The more cash you can offer the lender the more likely your offer will be accepted. The existing lender may be willing to loan you any additional funds you need. Financing must be in place in advance because lenders want to close quickly, sometimes within three weeks.

5. Discuss Your Offer With the Lender

Do not go to customer service or the collection department. Instead you have to insist on seeing someone in loss mitigation or resource recovery. You will need an authorization letter completed, signed, and notarized from the homeowner. This letter allows the lender to discuss particulars of the property with you.

6. Put the Proposal Package Together

No short-sale buyers guide would be complete without outlining the proposal package. Proposal packages consist of a short sale request application and the authorization letter. Along with these documents you have to include the purchase and sale contract. The contract must be signed by the seller and you. A sizable down payment should accompany the contract. The contract must stipulate that the offer is contingent on the lender approving the sale.

A hardship letter written by the seller must be included in the package. The lender won’t accept any short sale offer until the seller is at least 90 days behind in payments. The hardship letter must outline the seller’s financial situation and include the documents to back it up. A list of the repairs needed and other problems associated with the home should be included. The purpose of the letter is to convince the lender that selling to you now is a better deal than foreclosing and reselling later.

A detailed listing of the liabilities and costs is part of the package. You need to itemize exactly all that is wrong with the property and how much it will cost to fix it. Including photos is good as are repair estimates. The goal is to show the lender how much better it would be sell and let you handle all the problems.

Include a settlement statement outlining the purchase price, closing costs, and any other fees associated with transferring the property. This document should be prepared by a real estate attorney or closing agent.

7. Negotiate and Complete the Transaction

Prepare for the lender to make a counter offer or reject your offer outright. You should know beforehand what your limit is and be ready to walk away if the lender won’t negotiate. If all the parties reach an agreement it must be put in writing and signed by everybody. Once you close on the property you will be the proud new owner and ready to share your expertise on how to buy a pre-foreclosure.