As a homeowner, foreclosure is a scary subject that most of us hope we will never have to be involved with in our lives. As an investor, foreclosure might sound like a great way to get a property at a low price. No matter why you are here, for one reason or another you need a deeper understanding of the foreclosure process. That is the purpose of this article, to untangle the mysteries of foreclosure. In this article we will discuss the definition of a foreclosure, the process of foreclosure, and ways that you might be able to stop it before it’s too late. Take a deep breath and let’s dive in.
What Exactly is Foreclosure?
Before we get into all of the details of foreclosures we should do some defining. What exactly is a foreclosure? In the simplest of terms, foreclosure is the legal process by which a lender attempts to recover the amount owed on a loan that the borrower has stopped making payments on. The end result of this process can be the seizure (lender taking possession) and sale of the property which was used as collateral on the loan. Now other failures to meet the terms of the mortgage can result in foreclosure, however, the most common case is in missed payments so we will focus on that today.
That Doesn’t Seem Fair!
You might be asking yourself, “why can they take my home from me?” The answer to that actually lies in the deed of trust contract. This contract is usually one of the many closing documents that you sign in the process of buying a home. In the contract it says that if the borrower fails to uphold the terms of the mortgage contract the lender has the right to use a property as collateral. All of those legal terms put together boil down to, if you miss payments on your mortgage, the lender or bank has the legal right to seize and sell your property.
A Few More Definitions
Another key distinction that you should be aware of is the difference between a home in foreclosure and a foreclosed home (often referred to as a real estate-owned property or REO). The main difference between these two definitions is where they are in the foreclosure process. A home in foreclosure is a property that is currently going through the foreclosure process. In contrast, a REO is a property that has been through the foreclosure process and is now owned by the lender or the bank. An REO is usually what you would be buying if you are interested in investing in foreclosed properties. It is also beyond the point of being able to stop the foreclosure process. However, homes that are in foreclosure still have a chance to put a stop to the process.
Foreclosure By State
The foreclosure process varies greatly depending on where you live. Just to start, the process can either be judicial or non-judicial and some states have both. Here is the difference:
Judicial
In a judicial foreclosure the lender must file a lawsuit in order to initiate the foreclosure. Both the lender and the borrower must attend court for the lawsuit. If the borrower loses the lawsuit the house will go into foreclosure and can be sold at auction.
Non-Judicial
In a non-judicial foreclosure, there is no court hearing and the process is generally much faster than in a judicial foreclosure. In this instance if the borrower stops making payments the lender is able to evoke the power-of-sale clause in the mortgage or deed of trust to recoup the balance owed. This clause allows a trustee appointed by the lender to sell the home to pay off the balance. In this type of foreclosure the lender must follow the out-of-court steps that are set forth by the state and in the mortgage agreement to begin the foreclosure process.
Laws By State
There are some aspects of the foreclosure process that are consistent no matter where you are in the United States. For example, each state has laws about the lender publicly posting notices, homeowner options for avoiding the foreclosure process by bringing the loan current, and the process for selling the property.
However, as with many things in the United States the laws on foreclosures vary significantly by state. For instance, in 22 states (including Florida, Illinois, Hawaii and New York), judicial foreclosure is the norm. Yet, in the other 28 states (including Colorado, Arizona, California, Montana, and Texas) nonjudicial foreclosure is the generally accepted practice. Because of these differences in state laws the timeline in which a foreclosure can occur varies greatly.
How Long Does It Take?
The length of the foreclosure process varies widely depending on state laws and willingness of the lender to work with the borrower. As of 2021, the average foreclosure spends about 922 days in process. This is longer than the 685 day average back in 2020. Let’s take a look at how foreclosure timelines vary based on judicial versus nonjudicial foreclosure processes.
Judicial foreclosure states tend to have the longest foreclosure processing time with Hawaii taking an average of 3,068 days, New York having an average of 1,822 days and Indiana taking around 1,217 days. In contrast, states with non judicial foreclosure laws take significantly shorter. In Wyoming the average time is 173 days, Arizona is between 90-120 days, and Colorado takes approximately 110-125 days. As you can see, the non-judicial foreclosure process decreases the wait time from years to only a matter of months. It is important to be familiar with the foreclosure laws and policies in your state if you are ever involved in this process. However, there are a few commonalities that we can point to in the process across all states.
Timeline
Although the length of the process itself can vary greatly, in all instances the lender has certain steps that they must follow in order to claim your property. It all starts with a missed payment.
Missed Payments
The process of foreclosure all begins with that first initial missed payment. If you miss a payment on your mortgage you will receive a missed payment notice from your lender. If you fail to make the appropriate payment and you miss a second payment you will receive another notice from the lender. This notice is known as a demand letter. At this point you should start looking into financial relief options. Some that are available in the area of housing are: HUD-certified financial counseling, government mortgage relief programs and home loan modification programs.
The good news is that often, your lender will be willing to work with you to make up the missed payments. Especially if you live in a place with judicial foreclosures, the foreclosure process can be costly and time consuming for the lender. They are only interested in recouping their losses. If they can do so without a long and costly legal process they will. It is important to explore all repayment options with your lender as soon as you can to avoid going further into the foreclosure process.
Public Notice
If you have received the demand letter and still have not begun making payments on your loan, the next step is for the lender to give a public notice of default or to file a lawsuit with the court. This usually follows about 90 days after the initial missed payment. From that notice of default you will have 30 days to settle the payments and reinstate your loan. This 30 day period is known as the reinstatement period. After this period ends the foreclosure process begins. If you have looked into all your other options up until now, it might be time for foreclosure mediation, short refinance and special forbearance. A short refinance is when you work out an agreement for a new loan amount that is less than the outstanding balance. In this case, the lender may forgive the difference which could allow you to avoid foreclosure. In a special forbearance you can claim a temporary financial hardship (medical bills, decrease in income etc.). In this solution the lender may agree to reduce or suspend payments for a set amount of time.
Foreclosure
At this stage in the process the lender has recorded the public notice of default and the foreclosure process has begun. From here, you have 90 days to take action to avoid a foreclosure sale and eviction from the property. Your options become more limited at this stage. You can attempt to reverse the default by paying the outstanding balance on your loan. You can also try selling the property and using the equity to completely pay off the loan. You can also sell the property in a short sale or sign the deed over to the lender in a deed in lieu of foreclosure.
Short Sale
If none of the previously mentioned options are available to you, you might consider the short sale of your home. To clarify, a short sale is the voluntary sale of the home prior to foreclosure. The reason it is referred to as a short sale is because the sale price of the property is less than that of the balance owed. In that sense it is “short” the money owed. This particular sale must be approved by the lender and if it goes through, all proceeds go to them.
Some upsides of a short sale are that you have a little more autonomy in the sale process. You also will not receive the damage to your credit score that a full foreclosure process would cause. And there is always the chance that the home sells for more than anticipated and you might get to keep the excess money after the mortgage is paid off.
Deed In Lieu Of Foreclosure
Another option for avoiding full blown foreclosure is a deed in lieu of foreclosure. In this instance you as the homeowner would voluntarily sign the deed over to the lender or bank. This would release you from all mortgage obligations. The lender is less likely to pursue this option as it does not recoup the losses on the mortgage and frankly banks don’t want to be in the property management business. However, if all other options are unavailable to you, this might be a worthwhile final effort.
Auction
You have tried everything, selling the home in a short sale, making up the late payments or pursuing a deed in lieu of foreclosure and have still not been able to to avoid foreclosure. That means your property will now go to public auction. At the auction the minimum bid is usually set as the balance owed on the loan. After that, the property is sold to the highest bidder.
Post Foreclosure
If your home was sold at auction that is the end of the road for you. You must now move out of the property and allow the new owner to do with it as they please. If the home was not sold at auction the bank is now the full owner.
Oh No, My Credit!
As if losing your home isn’t hard enough, here is a look at what foreclosure does to your credit score. It turns out that a foreclosure will start affecting your credit before the process even begins. Your first missed payment will likely appear on your credit report within 30 days. As we mentioned earlier, you will likely not get a notice of default until you have missed payments for 90 days. After that the foreclosure process will begin and will show up on your credit report within a month or two. Depending on where your credit score started your score can drop anywhere from 100-160 points. And here is the kicker, a foreclosure will stay on your credit report for seven years after the date of the first missed payment.
Concluding Thoughts
The process of a foreclosure is a messy and difficult process for everyone involved. The best thing to do if you are faced with a tough situation like this is to take action as soon as you can. The longer you wait, the worse everything will become. If all of this sounds too complicated (which it very well might) it never hurts to seek professional help. Having someone who knows the laws and works through these things for a living could be a great asset. Best of luck out there!
