Thousands of foreclosures happen every day in the United States. People’s work, life, and financial circumstances aren’t static; they’re everchanging. If you or someone you know are going through the foreclosure process, it’s imperative to know your options so you can react quickly.
In this article, we’ll define what foreclosure is, why homeowners can go into foreclosure, and what each stage of foreclosure entails—including the options homeowners have to mitigate damage to their credit score or financial well-being.
What Is Real Estate Foreclosure?
Real estate foreclosure is a legal process involving a homeowner who misses multiple mortgage payments. Foreclosure happens in stages, each providing different options for the homeowner to pay the amount due.
If payments aren’t met within a specified time, the lender will attempt to recoup their investment via a public auction. If the house fails to sell during the auction, the lender takes ownership of the house and will attempt to sell the property.
Why Do Homeowners Go Into Foreclosure?
Before we explore the entire process of foreclosure, it’s essential to understand how it happens in the first place. Many homeowners are surprised when the housing market shifts underneath their feet, the notice of default shows up in the mailbox, or their interest rate increases—changing their monthly payment.
Here’s how the process begins in the first place:
1. Missing Payments
Skipping a monthly payment is always how the foreclosure process starts. Each lender and market has different policies, but most experts agree the foreclosure process will often begin after four missed payments.
2. Payment Changes
When the mortgage amount changes, it can put a strain on a homeowner’s budget and cause them to miss a payment. Here are a few of the usual suspects:
Adjustable-Rate Mortgages (ARM)
When the mortgage’s interest rate is periodically adjusted up or down based on broader economic factors, that’s an adjustable-rate mortgage (ARM). Mortgage payments will adjust accordingly, and homeowners may find themselves with a larger mortgage payment than they anticipated.
Adding an Escrow Account
Avoiding lump sum payments on mortgage insurance and taxes is a huge benefit of an escrow account. However, setting one up will increase a homeowner’s monthly payment. When property taxes are increased, or when school bonds or levies are passed, the required monthly escrow amount will also increase.
Property Tax Changes
County property value reassessments and the loss of exemptions have the potential to lower or raise a homeowner’s monthly payment. Large infrastructure projects, new public policies, or paying off a school bond can all change property taxes.
3. Affordability and Hardship
The best way to mitigate foreclosure risks is to formulate a comprehensive budget before purchasing a home. Homeowners should understand their budget limits and use these three rules to determine the amount of house they can afford.
As incredible as that sounds, that’s not always how it works in the real world. There are too many variables in daily life, such as losing a loved one, losing employment, divorce, natural disasters, and other unexpected expenses. These events can put financial stress on any homeowners’ shoulders, making it difficult to keep up on monthly payments.
How Does Foreclosure Work—Start to Finish?
If a homeowner misses a few payments, the lender typically allows a payment grace period and/or charges a late fee. If the missed payments continue, lenders will start calling and wondering why the mortgage isn’t getting paid. It’s best at this stage to accept the call and work on a solution before the home goes into the first stage, preforeclosure.
Missing consecutive payments (usually four in total) will begin the foreclosure process. The lender will send a notice of default or a lis pendens.
The notice of default officially starts the foreclosure process and is filed with the County Recorder’s Office or court. This notice states the lender will pursue the outstanding debt from the borrower.
The lis pendens is essentially the same as a notice of default. However, this is a formal notice and is accompanied by a court summons and foreclosure complaint with intent to auction the home.
The truth is that lenders don’t want homes to go into foreclosure.
Seizing and selling a property is expensive and time-consuming.
What Homeowners Can Do:
Homeowners DO have options and can usually work with lenders early in the process. There are services like foreclosure mediation, U.S. Department of Housing and Urban Development (HUD)-certified foreclosure counseling, government mortgage relief programs, and even home loan modification. These options exist to help homeowners get back on their feet.
If the homeowner can no longer afford the mortgage, they’ll either sell the home by traditional means or arrange a short sale with the lender’s permission. Short sales occur when a homeowner sells their property for less than the outstanding loan amount.
Auctions can go one of two ways depending on state and local laws, judicial or nonjudicial auctions. The main difference is the involvement of the court. The only way to reverse the process is to follow judicial dispute procedures, speak with a lender, or pay the balance.
1. Nonjudicial (Trustee’s Sale)
Nonjudicial foreclosures use a “power of sale” clause to give lenders the ability to sell the home through state-specific mandates. In nonjudicial states, the homeowner will receive a notice of default. Trustee’s sales are where the deed of trust (which is what’s used to buy the property) authorizes a third party (a “trustee”) to foreclose on the property.
In these circumstances, court-appointed officers don’t need to be involved. The lender will generally hire a third-party service to carry out the public auction. The proceeds of the sale go to cover the outstanding debt.
2. Judicial (Sheriff’s Sale)
Sheriff’s sales begin when a homeowner receives a lis pendens and a copy of the lender’s foreclosure complaint. There will also be a court summons allowing the homeowner to contest the foreclosure sale. If left unchallenged, the foreclosure sale occurs in the courthouse, courthouse steps, or online in some counties. The proceeds of the sale go to cover the outstanding debt.
If the home doesn’t sell in the auction, it moves into the last stage of foreclosure.
Real Estate Owned (REO) Properties
The last stage of the foreclosure process is where the lender takes ownership of the property following an unsuccessful auction. The lender will attempt to sell the REO property on the open market using real estate agents and public listings. Often in these circumstances, they will try to remove liens, expenses, and tenants to make the property more attractive for prospective buyers. It’s not uncommon for the previous owner to receive “cash for keys” incentives—which is essentially relocation assistance.
If the previous owner doesn’t vacate the property, the lender starts the eviction process.
The Bottom Line
Foreclosures are a legal process that starts with one event—the homeowner misses their mortgage payments. While this can happen for a few months, the lender will eventually file a notice of default or lis pendens. These official documents start the foreclosure process to go through a judicial or non-judicial auction, depending on state and local laws. If the house fails to sell during auction, the lender will assume ownership of the property and attempt to sell it on the open market.
If you’re involved in the foreclosure process, it’s always best to seek legal advice from a professional and keep in contact with your lender to explore your options.