Foreclosure 101: What is It and How Does It Work?
There’s bound to be at least one foreclosed property in any town, but foreclosure as a process might seem unclear to those new to the housing market or first-time homeowners. Foreclosure is a fate most people want to avoid, so learning about foreclosure and the many steps before it happens is the best way to protect oneself against it.
What is Foreclosure?
Foreclosure is a legal process in which the owner forfeits the rights to their property when they fail to pay their mortgage. This typically happens when the homeowner is unable to pay off the outstanding debt on their home or they have to sell the property through a short sale. The property will go into a foreclosure auction, and if the house isn’t sold there, then the lending institution who allotted the mortgage will repossess the property.
The reason foreclosure happens is that homeowners essentially borrow their home from the lending institution, and the mortgage is a deed of trust that the borrower will pay for the price of the home until the home is paid off. Mortgages are a secured loan, then. If a homeowner can’t pay off their home, the lender will seize and sell the property to pay off the debt on the property.
How Does the Foreclosure Process Look Like?
Foreclosure is not an overnight process. There are several steps to getting a foreclosure, as detailed below.
Homeowners Miss Their Payments
Homeowners rarely miss their payments due to negligence. The most likely cause for missed payments is because the homeowner fell on financial hardship, such as through unemployment, death of a family member or spouse, divorce, or medical challenges. Other times, the price of the mortgage might exceed the value of the home, and the homeowner decides to avoid paying for a property that’s essentially underwater. This reason is rarer.
Whatever the case may be, lenders want to avoid foreclosure as much as homeowners, as the foreclosure process is costly for both parties. Homeowners should discuss with their lender what options are available to them if they undergo hard times or find they’re paying too high for their mortgage, as foreclosure is not inevitable. However, lending institutions may be firm in their need for mortgage payments and continue on the foreclosure process.
Recording a Public Notice
After several months of missed payments, usually between three and six, the lender indicates that the borrower defaulted on their mortgage with the County Recorder’s Office. Some states call this a Notice of Default. Others call this a lis pendens, which is Latin for “suit pending.”
Again, it depends on the borrower’s location, but the lender might post a notice on the home’s front door stating the house is in threat of being foreclosed. The official notice will be filed away. Both will say the homeowner can potentially get evicted and lose all right to their property if they do not continue paying their mortgage. Throughout these public notices, one message is clear: the threat of foreclosure is imminent.
Once the borrower receives a Notice of Default from the lender, the borrower enters pre-foreclosure. Pre-foreclosure is a grace period where the borrower has anywhere between 30 to 120 days to pay the outstanding debt owed on the mortgage or arrange with the lender a short sale — when a homeowner sells their property for less than what they owe for it to avoid foreclosure.
Pre-foreclosure ends when the borrower pays off the default and other debt, and they will avoid eviction and sale of their home. If the homeowner still can’t pay off their debt, homeowners will continue in their foreclosure process.
Auctioning the Property
The lender will set a date to sell the home at a foreclosure auction, which is also known as a Trustee Sale. The kender will deliver a Notice of Trustee Sale to the County Recorder’s Office and notify the homeowner. Notifications of the sale will also be printed in newspapers, posted on social media, and posted on the property. These auctions can be held in a variety of places, including on the property of the foreclosure, a convention center near the home, or at the county courthouse.
In numerous states, the borrower can redeem their debt up until the moment the home will be auctioned off. If the borrow suddenly wins the lottery the day before the auction, they can stop the foreclosure from happening. That opportunity is rare, though, and the auctioning process will still occur. As with any auction, the property will be sold to the highest bidder who can pay in cash. Sometimes individuals buy the property at an auction, sometimes the lender repurchases the home during the auction. Whoever is the highest bidder, the home no longer belongs to the borrower anymore, and the home has officially been foreclosed.
What Happens After Foreclosure
If a third-party bought the property, the home would belong to them. If the lender takes ownership of the home, the property will then be known as a bank-owned property or real estate owned property. Local real estate agents can list the property on the open market or post the property on real estate websites such as Zillow, Realtor, or Trulia. The home can also be sold off at a liquidation auction.
What Options Do Borrowers Have During Foreclosure?
Getting that first public notice of potential foreclosure can scare homeowners. Especially if the homeowner is missing mortgage payments due to falling onto financial hardships, it might seem like foreclosure is inevitable, but it’s not. There are several options borrows have if they’re facing foreclosure.
Ask for Forbearance
This is when a homeowner asks to make no payments, or pay smaller payments for a short period. Forbearances can help people who are down on their luck and need time to recuperate financially before they resume mortgage payments. If homeowners have been diligent payers for a long time, most lenders will understand and afford such a grace period for trustworthy borrowers.
A loan modification is when people can ask to have their monthly mortgage payments altered because of serious life events that will have long-lasting impacts on the homeowner’s ability to pay their mortgage. An example can include getting a divorce, receiving a serious injury that impairs the homeowner’s ability to work, or having an ill family member to take care of.
To file for a loan modification, the homeowner can work with a local non-profit agency that specializes in helping people get modified loans (info). This agency can guide the homeowner through the process. The steps may be different depending on location, but the general process includes:
- Completing the loan modification package, which will involve submitting pay stubs, a budget, a hardship letter, and other documents the loan servicer wants. The documents must be up to date and present, as one faulty file could cause the whole application to be voided or delayed.
- Communication. If the homeowner has questions, they should ask them. They shouldn’t feel like they’re bothering anyone in this situation when it comes to something as serious as potential foreclosure. The homeowner should ensure and double check that they have the correct documents and that they are doing the process as efficiently as possible.
- The homeowner should also keep in touch with the loan modification agency to check their process. Sometimes reaching out to an agency can bump their application to the top of the file. While loan modification agencies surely deal with many applicants, consistent reaching out and maintaining a polite demeanor can work wonders for speeding up the bureaucracy.
- Be tenacious. If a homeowner does not hear back from the loan modification agency, they should keep reaching out and calling to them. Don’t think that everything will work out fine if the homeowner is having trouble paying a mortgage. Sometimes it can take the reduced mortgage to stay on top of payments, so don’t skip out on this process.
Reinstate the Loan
If a homeowner can scrounge up the money, reinstating the loan involves paying the past-due amount, such as missed payments, late fees, interest, and more. The homeowner would typically also have to pay the bank’s costs and expenses in trying to enforce the mortgage, such as paying the court and attorney’s costs on the foreclosure actions if the process got that far.
Refinance the Mortgage for Better Loan Terms
Refinancing involves replacing a homeowner’s old mortgage with a new one. The new mortgage should ideally have a lower interest rate, which equates to lower monthly payments. The refinancing could also involve playing with the repayment period. A 20- or 30-year mortgage would have smaller payments monthly than the 15-year mortgage, so changing up the loan would force the homeowner to keep debt over their house longer but make paying those debts easier.
Deed in Lieu of Foreclosure or Short Sale
A deed in lieu of foreclosure is when the lender agrees to take back the property instead of foreclosing. A short sale is when the bank lets the homeowner sell their house to a new owner for less than what the mortgage debt was worth. Both allow the homeowner to avoid foreclosure, despite them ultimately losing their house.
Talking to a Local Lawyer
Talking to a lawyer who specializes in real estate or foreclosure can help people facing this tough situation. The lawyer could analyze local and state laws about foreclosure and see if there are any ways the lawyer can help the homeowner. Even if it’s just a quick consultation, a lawyer can help point someone in the right direction on how to navigate the difficult legal proceedings in a foreclosure.
When Is It Too Late to Stop a Foreclosure?
A homeowner can stop a foreclosure up to the auction. Once the house has been auctioned off, the homeowner no longer retains the rights to their property, and they will have taken a massive hit to their credit. However, the longer the foreclosure process continues, the harder it will be for a regular middle-class American citizen to get their home back, as the lender will require the homeowner to not only pay their missed payments but any legal fees accrued during the foreclosure process. Ideally, a homeowner would make up their payments a couple of months after missing a mortgage payment and halt the foreclosure process altogether, but the sooner the payments are made up, the better.
If the homeowner wishes to retain their property, they can do so even after it’s been foreclosed as many state laws allow homeowners to repurchase their property even after the lender has taken it back. This option won’t avoid the reduced credit score or potential bankruptcy homeowner could face due to foreclosure.
How Does Foreclosure Affect a Homeowner’s Credit Score?
Despite unforeseeable circumstances, even the most diligent credit card owner can have their home foreclosed and take the credit hit. Foreclosures will hurt a homeowner’s credit score, meaning it will be harder to take out credit cards and loans for the next several years after the foreclosure. If they do manage to get a credit card or loan, they will most likely have to pay higher interest rates on them. Also, some employers or landlords will look at credit score to determine if that homeowner will be a suitable candidate for employment or tenancy, so a low credit score can discount people from high-quality jobs or housing.
After a foreclosure, a homeowner’s credit score can be expected to drop around 200 and 300 points, depending on the circumstances of the foreclosure. If the mortgage payments were missed simply because of apathy, such as if the homeowner refuses to pay, their credit score would drop harder than someone who fell onto a tough financial situation, especially if that homeowner worked extensively with non-profit agencies to adjust their mortgage before defaulting on payments. Still, if a homeowner had an excellent credit score around 800 points, their credit would be near 500 to 600 after the foreclosure.
While this drop in credit score can lead to further hardships, a homeowner can improve their credit report after seven years if the foreclosure was an isolated incident, especially if the homeowner didn’t default on many other payments. As the homeowner goes forward, they should do their best to pay bills on time and minimize debts owed to credit card companies or other lenders. Both of these tactics help improve credit scores.
How Long After a Foreclosure Must a Person Wait Before Buying Another House?
Foreclosures are scary and stressful, and it can lead to trust issues between people and buying property again. However, foreclosures are not the end-all to home ownership, and people who have had previous foreclosures can still buy a home in the future.
However, people will have to wait about three to seven years after they’ve had a foreclosure, depending on the reason the homeowner defaulted, the type of loan the person is applying for and that person’s current credit score, along with other factors.
For example, foreclosures hit record highs in 2009 when the housing bubble burst. Many people had to default on their loans due to economic hardships that were through little fault of their own. Lending companies would be more lenient on someone who experienced such a foreclosure versus someone who wasn’t able to manage their finances responsibly and had to default on their loans due to irresponsibility. Those who lost their homes due to illness and divorce, along with economic hardship, will have to wait less time to get another home.
The length of time a person has to wait before getting another home also depends on the lender. Different lenders have different requirements with people who previously experienced a foreclosure. Others might be more lenient to those with such a history, but they could be predatory towards vulnerable people who want to buy a home again. While people with previous foreclosures may want to buy a home as quickly as possible, they should be wary of people who offer short turnaround after a foreclosure.
Main Takeaways from Foreclosures
The best thing to know about foreclosures is to avoid them, as they only lead to headache, financial troubles, and credit pains. People should save up as much money as they can to create an emergency fund for when times get hard. Even if it’s saving 1% from every paycheck, that small fund can mean the difference between falling underwater on mortgage payments.
If a homeowner finds they might be starting on the path to foreclosure, they can talk to their lender to see what options are available. A lender wants to avoid foreclosure as much as the homeowner, so the two might be able to strike up an agreement that suits them both. In the case of an emergency, the homeowner can seek crowd-funding or put on an estate sale to get quick cash to pay their mortgage. While foreclosures are serious threats for anyone experiencing financial hardships, education, creativity, and humility are the best way to avoid them.
Department of Housing & Urban Development support: