Foreclosures

Foreclosure is the legal process by which a lender attempts to recover the amount owed on a defaulted loan by taking ownership of and selling the mortgaged property. Typically, default is triggered when a borrower misses a specific number of monthly payments, but it can also happen when the borrower fails to meet other terms in the mortgage document. The foreclosure process derives its legal basis from a mortgage or deed of trust contract, which gives the lender the right to use a property as collateral in case the borrower fails to uphold the terms of the mortgage document. While the process varies by state, the foreclosure process generally begins when a borrower defaults or misses at least one mortgage payment. The lender then sends a missed payment notice that indicates they haven’t received that month’s payment. If the borrower misses two payments, the lender sends a demand letter. While this is more serious than a missed payment notice, the lender may still be willing to make arrangements for the borrower to catch up on the missed payments. The lender sends a notice of default after 90 days of missed payments. The loan is handed over to the lender’s foreclosure department, and the borrower typically has another 90 days to settle the payments and reinstate the loan (this is called the reinstatement period). At the end of the reinstatement period, the lender will begin to foreclose if the homeowner has not made up the missed payments.

The Foreclosure Process Varies by State

Each state has laws that govern the foreclosure process, including the notices a lender must post publicly, the homeowner’s options for bringing the loan current and avoiding foreclosure, as well as the timeline and process for selling the property. A foreclosure as in the actual act of a lender seizing a property is typically the final step after a lengthy pre-foreclosure process. Before foreclosure, the lender may offer several alternatives to avoid foreclosure, many of which can mediate a foreclosure’s negative consequences for both the buyer and the seller. In 22 states judicial foreclosure is the norm. This is where the lender must go through the courts to get permission to foreclose by proving the borrower is delinquent. If the foreclosure is approved, the local sheriff auctions the property to the highest bidder to try to recoup what the bank is owed, or the bank becomes the owner and sells the property through the traditional route to recoup its losses. The other 28 states—including Arizona, California, Georgia, and Texas—primarily use non-judicial foreclosure, also called the power of sale. This type of foreclosure tends to be faster than a judicial foreclosure, and it does not go through the courts unless the homeowner sues the lender.

Can You Avoid Foreclosure?

Even if a borrower has missed a payment or two, there may still be ways to avoid foreclosure. Some alternatives include:

• Reinstatement: During the reinstatement period, the borrower can pay back what he or she owes (including missed payments, interest, and any penalties) before a specific date to get back on track with the mortgage.

• Short refinance: This is a type of refinancing where the new loan amount is less than the outstanding balance, and the lender may forgive the difference to help the borrower avoid foreclosure.

• Special forbearance: If the borrower has a temporary financial hardship, such as medical bills or a decrease in income—the lender may agree to reduce or suspend payments for a set amount of time.

Foreclosure Consequences

If a property fails to sell at a foreclosure auction or if it otherwise never went through one, lenders often banks typically take ownership of the property and may add it to an accumulated portfolio of foreclosed properties, also called real-estate owned (REO). Foreclosed properties are typically easily accessible on banks’ websites. Such properties can be attractive to real estate investors because in some cases, banks sell them at a discount to their market value, which of course, in turn, negatively affects the lender. For the borrower, a foreclosure appears on a credit report within a month or two and stays there for seven years from the date of the first missed payment. After seven years, the foreclosure is deleted from the borrower’s credit report.

How do Foreclosures Work?

People enter into foreclosure for various reasons, but it typically follows a major change in their financial circumstances. A foreclosure can be the result of losing a job, medical problems that keep you from working, too many debts or a divorce. Foreclosures often begin when the borrower stops making payments. When this happens, the loan becomes delinquent and the homeowner goes into default. The default status continues for about 90 days. During this time, the lender will get in touch with the borrower to see whether they will be able to pay the balance of the loan. At this point, if the borrower cannot pay, the lender may file a Notice of Foreclosure, which begins the process. The lender will file foreclosure documents in a local court. This part of the process usually takes 120 days to nine months to complete. If borrowers need extra time, they can challenge the process in court.

How do Foreclosures Relate to Debt?

Some people facing foreclosure find themselves in this position because of mounting debt that made it harder to make their mortgage payments. A foreclosure can add to your financial problems if your state allows a deficiency judgment, which means the borrower owes the difference between what is owed on the foreclosed property and the amount it eventually sells for at an auction. In cases when a lender does not use a deficiency judgment, a foreclosure can relieve some of your financial burden. Although it is a loss when a lender takes the home you partially paid for, it can be a start to rebuild your finances. It is a good idea to work with a financial adviser or a debt counsellor to understand what kind of debt you may incur during a foreclosure.

Foreclosure Procedure

If you (or a loved one) are facing foreclosure, make sure you understand the process. While there is variation from state to state, there are normally six phases of a foreclosure procedure.

Phase 1: Payment Default

A payment default occurs when a borrower has missed at least one mortgage payment. The lender will send a missed payment notice indicating that it has not yet received that month’s payment. Typically, mortgage payments are due on the first day of each month, and many lenders offer a grace period until the 15th of the month. After that the lender may charge a late payment fee and send the missed payment notice. After two payments are missed, the lender may send a demand letter. This is more serious than a missed payment notice. However, at this point the lender may be still willing to work with the borrower to make arrangements for catching up on payments. The borrower would normally have to remit the late payments within 30 days of receiving the letter.

Phase 2: Notice of Default (NOD)

A notice of default is sent after 90 days of missed payments. In some states the notice is placed prominently on the home. At this point the loan will be handed over to the lender’s foreclosure department in the same county where the property is located. The borrower is informed that the notice will be recorded. The lender will typically give the borrower another 90 days to settle the payments and reinstate the loan. This is referred to as the “reinstatement period.”

Phase 3: Notice of Trustee’s Sale

If the loan has not been made up to date within the 90 days following the notice of default, then a notice of trustee sale will be recorded in the county where the property is located. The lender must also generally publish a notice in the local newspaper for three weeks indicating that the property will be available at public auction. All owners’ names will be printed in the notice and the newspaper, along with a legal description of the property, its address, and when and where the sale will take place.

Phase 4: Trustee’s Sale

The property is placed for public auction and will be awarded to the highest bidder who meets all of the necessary requirements. The lender (or firm representing the lender) will calculate an opening bid based on the value of the outstanding loan and any liens, unpaid taxes, and costs associated with the sale. When a foreclosed property is purchased, it is up to the buyer to say how long the previous owners may stay in their former home. Once the highest bidder has been confirmed and the sale is completed, a trustee’s deed upon sale will be provided to the winning bidder. The property is then owned by the purchaser, who is entitled to immediate possession.

Phase 5: Real Estate Owned (REO)

If the property is not sold during the public auction, the lender will become the owner and attempt to sell the property through a broker or with the assistance of a real estate owned (REO) asset manager.8 These properties are often referred to as “bank owned,” and the lender may remove some of the liens and other expenses in an attempt to make the property more attractive.

Phase 6: Eviction

The borrower can often stay in the home until it has sold either through a public auction or later as an REO property. At this point an eviction notice is sent demanding that any persons vacate the premises immediately. Several days may be provided to allow the occupants sufficient time to remove any personal belongings. Then, typically, the local sheriff will visit the property and remove the people and any remaining belongings. The latter are placed in storage and can be retrieved at a later date for a fee.

Pros and Cons of Buying a Foreclosed Home

Pros

• The Savings: Without a doubt, the main attraction of buying a foreclosed home is that it’s probably going to cost a lot less than a comparable property that isn’t in foreclosure. After all, lenders just want to cover their losses. Their main goal is to get foreclosed houses off their books and try to make as much back as they can. So, if your budget isn’t giving you a lot of options, you may consider looking at foreclosed homes.

• The Timeframe: Another ideal aspect of buying a foreclosed home is that the timeframe it takes to close could be a lot shorter. If a bank finds out you’re applying for financing to purchase one of their foreclosed homes, they have quite the incentive to move your application to the front of the line. Instead of waiting 45-60 days to get approved for a mortgage, you might hear back in a week or two.

Cons

• Most Foreclosed Homes Are Sold “As Is”: The vast majority of foreclosed homes are put on the market “as is.” The banks are already operating at a loss, so they’re usually not going to invest even more money into a foreclosed house, even if repairs are desperately needed. As we just covered, there’s almost always an investor willing to buy a foreclosed property, even if it needs a lot of work before it will attract any interest. To an experienced real-estate investor, it’s worth the investment because of the rock-bottom price. This is why you also can’t expect a lot of wiggle room where the terms are concerned. Investors who thrive on buying foreclosed homes won’t care about terms if it means they can purchase a cheap home to flip.

• You May Need to Wait for the Previous Owners to Move Out: Imagine you’ve bought an incredible home, one you’d otherwise never be able to afford if not for the fact that it was recently foreclosed on. You’re ecstatic! You cannot wait to move in. Unfortunately, the original owners are in no rush to move out. That’s right. Just because you’ve purchased the home doesn’t mean they can’t keep living there. In fact, in some states, foreclosure laws include a redemption period for the original owners. Once their home is sold, they could have months to essentially buy it back uncontested. Those are months you simply have to wait around to hear whether or not you need to keep looking for a new home.

The Timeframe (Again)

That shortened timeframe can work against you, too. Banks aren’t waiting around for the best possible offer. They’re going to sell to whoever gets closest to the total mortgage amount. That means you have to move fast if you want to buy a foreclosed home and you may not have time to consider all of your other options. You might buy an amazing home only to later realize that, if you had just slowed down and explored the local market, you could have had the house of your dreams. Likewise, just because a bank is motivated to provide you with financing doesn’t mean they’re going to give you the best possible option. They don’t want to be in the exact same situation with this house a year down the line, so the mortgage they offer may not be as generous as what you’d otherwise qualify for. Throughout the foreclosure process, many lenders will attempt to make arrangements for the borrower to get caught up on the loan and avoid foreclosure. The obvious problem is that when a borrower cannot meet one payment, it becomes increasingly difficult to catch up on multiple payments. If there is a chance that you can catch up on payments for instance, you just started a new job following a period of unemployment it is worth speaking with your lender. If a foreclosure is unavoidable, knowing what to expect throughout the process can help prepare you for the six phases of foreclosure.