Foreclosure is a process that a lender takes to recover their loss, by selling the collateral used to obtain the loan, like a home. If a borrower isn’t able to pay their mortgage, the lender will eventually have the right to evict them and sell the home.
What Is Foreclosure?
Some loans require the borrower to put up collateral to back the loan. The term collateral refers to any asset the borrower uses to secure the loan to make it less risky for the lender. The type of collateral typically depends on the kind of the loan – if you borrow money to buy a car, that car will often represent the collateral. If you’re taking out a mortgage loan, your home plays the role of the collateral until you pay off the loan obligation.
Collateral motivates the borrower to avoid defaulting on the loan and encourages them to make their payments on time. If the borrower defaults, they risk losing the collateral that was backing the loan. When a loan is connected to real property, the lender can go through a legal process called “foreclosure” to take possession of the real estate if the borrower defaults on their loan obligations.
During this process, the lender claims the right to take the asset into their possession, and the borrower no longer has any rights to their home. If they are already living there, they must move out because the lender will generally sell the property to the highest bidder. By selling the collateral, the lender recuperates the money that the borrower failed to pay back, which includes both the principal and interest.
When Does Foreclosure Happen?
Even though you might be planning to make your payments on time and you are a completely trustworthy client at the moment of signing the contract and taking out the loan, things can change. Life is unpredictable, and you may face serious medical issues, get fired from your job, get a divorce, or some other event that may prevent you from working and earning money. If that happens, you lose the means to pay off the debt.
Foreclosure is not an inevitable consequence if you are late with one installment for one day. Being late 10 to 15 days will inflict additional interest and fees to your monthly payments. If you miss four payments in a row, your problem grows. However, each lender has its own procedure regarding how many missed payments or late payments they will tolerate before starting the process.
Your loan may become delinquent after you miss a payment. This means you have failed to do something you are obligated to do by law or a contract, which in this case is paying an installment for your loan. If your loan becomes delinquent, you are usually granted a certain grace period by your lender within which you can make up for the missed payment. It’s highly recommended to catch up on the installments as soon as possible. The more you owe, the harder it is to make up for the missed payments, especially after late fees are added.
If you fail to catch up on your payments, the lender will typically wait up to 120 days and then they will begin the foreclosure process. This timeline depends on the lender, but they are often obligated to wait for at least three months before they begin the foreclosure process. The lender will notify you of this event, and you will generally still have a chance to avoid foreclosure and catch up on paying back your debt.
What Is Pre-Foreclosure?
Foreclosure seems to be the solution to a situation where the homeowner is not able to resolve the missed payments in any possible way. However, there is a process called pre-foreclosure, during which the borrower is offered several possibilities to avoid foreclosure and stop the lender from forcing them out of the property. Pre-foreclosure can last up to 120 days and starts after you’ve been officially notified that the lender is ready to begin the foreclosure process.
A notice of default on the property is also filed in many states, and it will become public record once it is filed with your County Recorder’s Office. Sometimes, depending on which state you live in, this notice has to be posted to your front door, as a type of warning that you are very close to losing your home.
When you get a notice of foreclosure, you are typically presented with three options.
- You can pay back the whole loan at once.
- You can make up for the missed payments and continue paying off the rest of the debt in monthly payments as you originally agreed.
- You can sell the property yourself and not let it go into foreclosure.
In some states, like Florida, the lender must have the court’s permission to move forward with the foreclosure process. This is considered a legal action, and there needs to be a short trial. However, it takes a long time, sometimes almost two years, to finish the whole process and finally sell the borrower’s home.
In other states, more precisely 28 of them, the lender does not need the court’s permission and supervision to start a foreclosure. In those states, the only situation when the court might be involved is if the borrower is suing the lender.
Provided there is a very good reason for a lawsuit against your lender, the lender might just adjust your repayment schedule to allow you to organize your finances better and find the means to pay back the loan. This is called mortgage modification or a special forbearance. This action allows you to postpone your installments temporarily. However, if you are still unable to avoid foreclosure and the pending lawsuit, a legal eviction from your home may be inevitable as the process continues.
What Comes After the Pre-Foreclosure?
The next step for the lender after the pre-foreclosure period is to sell your home. The property is not sold the usual way, such as through a single buyer and seller, but at a foreclosure auction. Some buyers may use this process to their advantage, because foreclosure properties typically end up being more affordable compared to homes sold on the regular market, but these sales may also include some unpleasant emotional events when the homeowners are involved.
When the lender, or their trustee (their representative), sets a date for the auction, which is also known as a trustee sale, they need to inform the borrower and the public of the event. The County Recorder’s Office takes record of the Notice, which is also published in the newspaper, posted on the front door of the property, and the borrower gets one copy as well. In a number of states, you are allowed to pay off the debt and stop this process until the very moment when the auction starts.
In a typical case, the highest bidder has the right to the property, and they need to pay in cash. If this does not happen, the process enters into the last stage, sometimes called post-foreclosure. This is when the lender has the right to claim the ownership of the property. The property is now considered REO, or real estate owned. This type of real estate is then sold by a real estate agent, or at a liquidation auction.
The lender can hold the auction in different places:
- The trustee’s office
- At the property being sold
- The county courthouse
- A Convention center
The Sheriff’s office in the county where the property is being sold will generally dictate where the property will be sold.
Once you are done with foreclosure, your former home is sold and your debt is paid off, you may think your troubles are over. However, there is something else the lender may do that could lead to more financial issues on your side.
A deficiency judgment is an action that your lender can take to make you pay the difference between the money you owed for your home when foreclosure started, and the money your home was sold for at the auction or sale. Thirty eight out of fifty states allow lenders to use a deficiency judgment.
What Are the Effects on Your Credit Score and Credit Report?
Other than losing your home and being in debt, foreclosure can also have some other negative impacts on your financial future.
The next time you order a credit report, if it has been at least a month after the foreclosure, the foreclosure will appear on it, and it will only disappear after seven years. This means that any prospective landlords, employers, or lenders will be able to see this information as well. This may affect your eligibility for a loan you might apply for in the next seven years and limit your options when it comes to rates and other terms.
Even if you used to have a good credit score, a foreclosure can have a considerable impact on it. After your home has been foreclosed, your FICO score may drop by anywhere between 85 and 160 points. The effect foreclosure has on your credit score depends on multiple factors, like your previous FICO score and other negative entries you may have in your report.
Can Foreclosure Be Avoided?
As mentioned, before foreclosure is actually happening the borrower has several opportunities to avoid it. They are presented with a number of options during pre-foreclosure, before the lender is ready to issue the NOD and move on to the auction stage.
Sometimes, the borrowers are able to renegotiate the terms of their mortgage loan before they have to face a missed payment. When they realize they might experience some financial hardship, they communicate that information to the lender and look for the most suitable option for both parties.
Another way homeowners try to avoid being evicted and having their home sold is through MHA programs offered by their state. MHA stands for Making Home Affordable, and this kind of program is dedicated to providing advice and assistance to those who cannot keep up with their mortgage payments. This help is free of charge and the borrower in need can reach a counselor through a hotline that is available 24/7. An interested person can also find a counselor within their area or call the state’s housing agency.
The best case scenario would be to avoid foreclosure if possible. Even though it does not affect your creditworthiness like bankruptcy might, it does lower your credit score and stays on your credit report for seven years. During this period, your loan options are limited because the lenders can have insight into your credit report and a notation about foreclosure might raise some red flags. However, it is not completely impossible to get a loan despite foreclosure, and it is more than possible to bounce back and rebuild your credit score after this event.
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