FrontDoor.com

So you want to buy or invest in residential foreclosures? Not quite sure where to start? Get to know the three very different "faces" of foreclosure buying. Each has its own unique characteristics related to time, money, risk, emotional element and potential profits. Select the one that is the best fit for you.

FACE ONE: Pre-Foreclosure

The pre-foreclosure period begins when a homeowner gets behind on his or her loan, and ends with the foreclosure sale. The pre-foreclosure phase itself is divided into two stages.

• The first stage covers the period of time beginning when the homeowner misses his or her first mortgage payment, and ends in the final month preceding the impending foreclosure sale. During this time, if a homeowner is not already marketing their home, it will be up to you to reach out to and find these distressed homeowners through mailings, ads ("We buy homes fast" and "We have CASH for homes") and networking.
• The second stage occurs during the final month leading up to foreclosure. The precise laws differ from state to state, but most states require some form of public notification of a pending foreclosure. You can look for these notifications, many of which have ample contact information to approach the distressed homeowner. Many larger communities have a number of online and subscription services which compile the pending foreclosures in a specific geographic range. You can also network within your local real estate investors association or do an Internet search (e.g., "foreclosure listings") in order to find these publications and services.

You can think of buying a pre-foreclosure as a win-win situation. You get a home at a discount, while the homeowner with built-up equity gets some quick cash and avoids a damaging foreclosure on their credit record. For tips on working with homeowners, read this. There are also opportunities to work with some of the foreclosing lenders directly (with the distressed homeowner's approval, of course), as it is in the lender's interest to avoid costly foreclosures.

PROS: Pre-foreclosures can be very lucrative. A typical pre-foreclosure might have an investor paying off a distressed homeowner's $220,000 loan, giving the distressed homeowner $25,000 in cash to walk away with, and taking over the $350,000 property.

CONS: The primary negative associated with pre-foreclosures is the taxing emotional element that can come with constantly dealing with homeowners involved in a downward spiral. Simply put, this will not be feasible for every investor.

Case in point: Almost 20 years ago, we were fresh out of one of those "get rich quick" seminars. Our model was to focus on pre-foreclosures, and we went to only one home. The family we visited was the most likeable family. The husband was a veteran, and both he and his wife lost their jobs within a short time of each other. When visiting the home their little girl took my hand and showed me the "doggie window," the hole in the kitchen door for their family dog to go in and out of the house. I left this visit emotionally drained and with a sour feeling in my stomach. This was the last pre-foreclosure we ever visited.

For more tips on how to buy during pre-foreclosure, read this.

FACE TWO: Foreclosure Sale

This occurs when the loan on the home is not brought current by the distressed seller or the home is not sold. Again, the procedures and processes differ from state to state, so research the process in your state. For many states, the sale of the property takes the form of an old-fashioned auction on the courthouse steps (in several states, this occurs on the first Tuesday of every month).

PROS: Like pre-foreclosures, the foreclosure sale also can be a quite lucrative way to purchase property. However, unlike pre-foreclosures, there is no emotional element other than controlling your adrenaline at the foreclosure sale.

CONS: You may not be able to access the property, which makes assessing repairs and improvements challenging. You may need to quickly assess the title and any liens (this can lead to mistakes and can be costly). Many states require certified funds at sale or within a very short timeframe (such as 24 hours). Having access to large sums of cash or fast financing limits this face to a subset of experienced and well-financed investors. If you're interested in this face, go to a foreclosure sale and see how one works firsthand.

For more tips on how to buy during a foreclosure sale, read this.

FACE THREE: Post-Foreclosure

If the property is not sold in pre-foreclosure and not purchased at the foreclosure sale, then it goes back to the bank or other lien holder who secured the loan.

With interest only, 100 percent financing and other loans offered in recent years requiring little down payment, record numbers of properties are going through the foreclosure process without attracting investor interest in the pre-foreclosure or foreclosure sale stages. These properties eventually land on the desk of someone within a financial institution (bank, mortgage company, etc.) that has the responsibility of disposing of these properties. Many institutional lenders carry so many properties that they have entire departments dedicated to this task, often referred to as REO (real estate owned) or Post-Foreclosure Departments.

• Those who are happy to work with an investor directly, bypassing listing the property with a real estate agent
• Those who first indicate plans to list their REO property, but can be persuaded by the skillful investor to delay the listing until the investor has a chance to see the property and make an offer
• Those who will not consider working with an investor directly, but will instead list their properties with selected real estate agents

PROS: Sellers have no emotional tie to the property. For financial institutions, this is a business transaction. Also, the more REO properties a bank or lender has on its books, the more likely the lender will act quickly at a discount to investors.

CONS: Financial institutions may not get back to you right away, so be patient. Also, getting a 30 percent discount is not as common in this face as it is when you buy during pre-foreclosure (and even some foreclosure sales). But it is possible to find discounts of 10 percent to 20 percent.

For more tips on how to buy a post-foreclosure, read this.

MORE...

• Foreclosure Buying Guide
• How to Break Into The Foreclosure Market
• Advantages and Disadvantages of Buying a Foreclosure
• Working with Distressed Homeowners
• Tapping the Growing Short Sale Market

Andy Heller and Scott Frank are co-authors of the Fortune Magazine-recommended book Buy Low, Rent Smart, Sell High. Combined, they have been investing in residential real estate for over 40 years and have purchased and sold approximately 100 residential properties on a part-time basis.