Foreclosure is a process that starts when the borrower fails to make payments on their mortgage. When a property is foreclosed upon, the mortgage lender of that property takes its ownership.
In real estate, foreclosure plays an important role in mortgage lending. Thus, it is important to understand its definition and how it works. As a real estate professional, I help students learn various real estate terms and understand how they work.
In this post, I’ll define foreclosure and explain the process with the help of examples. After reading this post, you’ll learn the definition and process of foreclosure. Let’s dive in to learn more about when and how foreclosure occurs.
What Is Foreclosure?
Foreclosure is the legal process in which the mortgage lender takes possession of a property if a borrower fails to make mortgage payments.
This legal process starts when the homeowner has missed several payments. Foreclosure is the biggest financial crisis a borrower can face, and it can also result in property loss.
The foreclosure process takes several steps, during which the mortgage lender tries to resolve the issue and return the ownership to the borrower. However, the lender takes legal action if time passes and the borrower doesn’t make payments.
If a property is in foreclosure, it is owned by the lender or the lending institution that offered money to the borrower to buy that property. If the borrower doesn’t repay the money to the lender, the lender owns the property outright.
Why Does Foreclosure Occur?
Foreclosure in real estate is something that no borrower wants to face. It occurs due to a lack of home loan payments for any reason. There might be many reasons why a home might go into foreclosure. For example, a homeowner makes timely mortgage payments but suddenly faces a financial crisis. The borrower might face foreclosure because of the following:
- Loss of job
- Debt, such as credit card debt
- Unexpected medical bills due to a medical emergency
- Moving without being able to sell the property
- Divorce or separation
- Property maintenance costs
- Natural disasters
No matter the reason, if the borrower faces a financial crisis and can’t make home loan payments, foreclosure occurs. Economic depression is one of the major causes of foreclosures. In some cases, the homeowners owe more on their home loans than their home’s net worth. Thus, walking away is an easier option for them. In this case, the lender forecloses the property to cover the losses through the sale of the property.
Foreclosure Process and Stages
When a borrower defaults on the payments, foreclosure doesn’t occur immediately. It takes several steps before the lender can completely take ownership of the borrower’s home. The foreclosure stages can vary from state to state.
Each state has different laws and regulations that govern foreclosure. However, the timeline is more or less the same for every state. So, what happens during the process of Foreclosure? The following are the five main stages of the process of Foreclosure:
1. Missed Mortgage Payment
It all starts when the borrower fails to make the monthly payments on time. Due to hardship, the borrower may fail to pay mortgage payments on time. No homeowner wants to lose their home, but a financial crisis can result in missed payments on their mortgage. If the borrower fails to make payments, they must contact their mortgage lender as soon as possible and provide information about their situation.
The foreclosure process also costs the lender a lot; thus, they decide to avoid it first. When the borrower misses the first or second mortgage payment, there is no risk of foreclosure. The lender might give a grace period of a few weeks so that the borrower can make payment without any serious penalty. The lender might also warn of foreclosure if the borrower fails to make payments.
2. Public Notice of Default
After three to six months of missed payments, the lender contacts the local recorder’s office and files a notice of default. The notice of default will indicate that the borrower has defaulted on the mortgage. The lender will send the notice of default to the borrower through certified mail or might post a notice on the front door. The notice indicates the amount the borrower owes to the home on which the notice is posted.
A notice of default will also affect the borrower’s credit report and bring down the credit score. Thus, it gets more difficult for the borrower to get other types of loans or mortgages. At this point, the borrower can prevent foreclosure by putting a stop to the proceedings. This can be done by making mortgage payments.
After receiving the notice of default, the borrower enters the pre-foreclosure period. The period of foreclosure is anywhere between 30 to 120 days, depending on the state’s regulations. During this period, if the borrower can pay the amount indicated in the notice of default, they can prevent foreclosure.
The exact amount of time for pre-foreclosure depends on state laws. The borrower can also sell their home to repay the mortgage loan. This is called a short sale in which the lender and the borrower make an agreement.
4. Auction/ Notice of Sale
If the lender sees no chance the borrower will return the mortgage, they will file a notice of sale. The lender or the local representative will set a date for the home auction. The borrower will be notified, and the auction details will be posted in the newspaper and on the property.
The auction can be held anywhere, including the trustee’s office, county courthouse, at any convention center, or in the property that is to be foreclosed. In some states, the borrower can still stop the foreclosure if they come up with cash before his home has been auctioned off. This is known as the right of redemption.
5. Post-foreclosure/ Eviction
If the auction is successful, the borrower is given a few days to take their belongings and relocate. However, the lender takes ownership if a third party doesn’t buy the property during the auction. In both cases, the borrower has to move from the home. If the borrower doesn’t move from the home themselves, the law enforcement agencies will remove the borrower and their belongings legally.
When the lender takes ownership of the property, the property is called ‘Real estate owned’ or ‘bank-owned property.’
Types of Foreclosure
There are two main types of foreclosure which include judicial and non-judicial foreclosure. The types of foreclosure depend on how the lender deals with the foreclosure process.
Using a judicial foreclosure, the lender files a suit with the court to start the process. The court handles the entire process as the lender has filed a civil lawsuit against the borrower. Judicial foreclosure is further divided into two types:
- Foreclosure by sale
- Strict foreclosure
Foreclosure by sale requires a home auction in which priority hois given to the highest bidder. With strict foreclosure, the court gives a date to the borrower to repay the mortgage amount. If the borrower fails to pay, the court directly gives the homeownership to the mortgage lender.
Nonjudicial foreclosure is also known as statutory foreclosure. With this type of foreclosure, the lender can sell the property without involving the court. The lender follows the laws set by the state and sells the property at a public auction.
To use non-judicial foreclosure, the lender must add a power of sale clause to the mortgage agreement, that is, during the loan origination process. Without a power of sale clause, the lender can’t use the non-judicial foreclosure.
David purchases a home for $250,000. The mortgage has a term of 30 years and an interest rate of 4%. After ten years, David loses his job and still owes $190,000 on the mortgage. Unfortunately, the real estate market declined, and the home’s value dropped to $160,000. David tells the lender that he won’t be able to pay the remaining mortgage.
Thus, the lender and the borrower decide to participate in a short sale. The lender knows they will lose $30,000, but they still agree to sell the property to cover the amount of the mortgage. The home is assigned to a real estate agent who records the sale of the house for $160,000. The lender takes this amount, and David has to move from the property.
Frequently Asked Questions
What Is the Purpose of Foreclosure?
The main purpose of foreclosure is to recover the amount the lender gave to the borrower to purchase the property. The process helps the lender take ownership of the property and sell it to recover the amount. The foreclosure process varies from state to state, and most lenders try to work with the borrowers to avoid foreclosure.
What Is Foreclosure Payment?
A foreclosure payment is the full repayment of the amount that the borrower owes to the lender. If the borrower has two or three missed payments, they can make a foreclosure payment that includes a lump sum of the missed payments. The borrower can prevent a foreclosure on their home by making a foreclosure payment.
How Long Does Foreclosure Take?
Foreclosure is a long process as it consists of multiple stages. The process takes around 3 to 6 months after the first missed mortgage payment. If the borrower talks to the lender and tells them about their financial hardship, the lender can extend the grace period. On average, foreclosure can also take many years to complete.
What to Know for the Real Estate Exam
Foreclosure is a legal proceeding in which the lender takes control of the home after the borrower has failed to make the mortgage payments. It is an act in which the lender deprives the borrower to keep the ownership of the property because of non-payment.
If the borrower makes payments on time, they can avoid foreclosure. As the borrower makes payments on the mortgage, they also start building equity in their home. The borrower can also use their home equity line of credit to pay off the mortgage.
I hope that now you understand the process of foreclosure in real estate. If you want to learn other related terms, go through these easy-to-learn real estate definitions.