What is Foreclosure?
A foreclosure occurs when a mortgage lender takes legal action to take possession of a property that has fallen behind on its mortgage payments. A homeowner can also find themselves in foreclosure for unpaid property taxes. When there is a mortgage default, a lender can seek remedy by taking ownership and selling the mortgaged property to recover the amount owed. The uncertainties of the foreclosure process can be long, stressful, and devastating to a homeowner. Although the foreclosure process can vary from state to state, in this article, we will attempt to give a broad understanding of the foreclosure process.
What is the Foreclosure Process?
Foreclosure is a legal process in which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender by forcing the sale of the asset used as the collateral for the loan.
Homeowners must do their due diligence and make sure they are realistic regarding home affordability. The monthly mortgage payment will usually include interest on the borrowed amount, escrowed property taxes, and homeowners insurance. When borrowers fail to meet specific terms in the mortgage contract, defaults can occur. Banks usually will not fret over one missed monthly payment. The lender will only take action when a borrower misses consecutive monthly payments. Banks are not in the business of taking back homes, so they are often willing to work with homeowners to provide viable options to avoid foreclosure if possible. These options can include short sales, deed in lieu, forbearance, and loan modifications.
Short Sale: In a residential short sale, a borrower default usually has occurred and resulted in missed mortgage payments. The mortgage company can agree to accept less than what is owed on the mortgage to satisfy the loan balance in full. This is usually contingent on the present value of the real estate in its as-is current condition verified by comparable, non-foreclosed home sales. If a homeowner is experiencing a hardship, a short sale can be requested after one missed payment.
Deed in Lieu: A deed in lieu is the process of transferring title to a property in exchange for some consideration. It is often called "cash for keys." The bank will usually offer a small sum to the homeowner to help in their relocation. In return, the homeowner will sign a transfer of title, giving the lender control of the house. A deed in lieu saves the lender all of the excessive costs associated with a foreclosure auction.
Forbearance: Forbearance is when a lender allows the homeowner to pay off their loan over a more extended period of time than the standard payment schedule. This can be useful if the homeowner has financial difficulties and needs additional time to repay their mortgage debt.
Loan Modification: A loan modification is an agreement between a lender and borrower where the terms of the original mortgage document are modified to make it more affordable for the borrower. A homeowner may lower their loan's interest rate or extend the repayment term through a loan modification to bring their loan current.
Two Types of Foreclosure
Foreclosure laws will vary from state to state. There are two types of foreclosure commonly seen here in the United States. The first type of foreclosure is called judicial foreclosure. A judicial foreclosure is initiated by the lender filing a lawsuit against the borrower in court. The second type of foreclosure is called a nonjudicial foreclosure. The nonjudicial foreclosure process is initiated without going to court. The lender's attorney typically does nonjudicial foreclosures after the lender has already filed suit against the borrower. Finally, there is one more rare type of foreclosure called strict foreclosure. In a strict foreclosure, the court orders a defaulting mortgagor to pay the mortgage within a specific time frame.
Judicial Foreclosure
Judiciary foreclosure occurs when a court oversees the sale of the mortgaged property. This type of foreclosure requires a legal proceeding where a court issues a judgment against a property owner who has defaulted on their mortgage loan. To initiate judicial foreclosure, the lender files a lawsuit against the borrower. Usually, when a borrower misses three to six months of consecutive monthly mortgage payments, a lis pendens is filed, giving public notice that the mortgage is in default. After the homeowner is served with a public notice of default, the home is considered to be in pre-foreclosure. Once the judgment is issued, the bank can take possession of the home and sell it to recover the amount owed. The process of judicial foreclosure varies by state. In a judicial foreclosure, the lender can obtain a deficiency judgment against the borrower. In many states, the amount of a deficiency judgment is calculated by subtracting the loan principal, interest accrued, and attorney fees from the amount the lender bid at the foreclosure sale. After the judicial sale, the proceeds will first satisfy the mortgage balance; subsequent lien holders will get paid next, and then any other remaining proceeds will go to the mortgage borrower.
Nonjudicial Foreclosure
In a non-judicial foreclosure, the notice of default is recorded with the county recorder, and the borrower is notified of the property's sale by mail. The lender can initiate the foreclosure proceedings without going to court. This method of foreclosure does not involve a court hearing before entry of a foreclosure judgment. Power of sale clauses in mortgages or deeds is necessary for states with nonjudicial foreclosures so that the mortgage company can recover their losses if the borrowers stop making payments. With a power of sale clause, if the borrower goes into default, the mortgagee may exercise their option to sell the real estate in a foreclosure sale to recover the outstanding balance. The public auction will usually occur at the end of the foreclosure hearing. Banks usually prefer non-judicial foreclosures to avoid the high foreclosure costs associated with real estate attorney fees and the formal eviction process.
What Happens After Foreclosure?
Real Estate Owned By Bank (REO)
The lender will take the title of the property if there is no bidder at the foreclosure auction, and it will then become a bank-owned property REO (real estate owned). Bank-owned properties are sold in one of two ways. First, a local real estate agent will list these homes for sale on the Multiple Listing Service. The mortgage company will sometimes sell these bank-owned properties through bulk REO sales or liquidation auctions.
Redemption Period
Some states provide foreclosed homeowners with the right to redeem their property after a foreclosure sale. After a property is sold at a public auction (foreclosure sale), there is a period of time referred to as the "redemption period" during which you still have some rights. The length of time a borrower has to redeem their house will vary by state.
Consequences of Foreclosure
A foreclosure can severely damage a homeowner's credit score. A credit report can reflect a foreclosure for up to seven years. After seven years, the foreclosure will be deleted from the borrower's credit report. Borrowers are also negatively affected by the missed payments before foreclosure. A borrower's credit score can drop more than 100 points due to a foreclosure.