Foreclosure is the process by which a mortgage lender takes back property after a borrower defaults on his or her mortgage payments. Once the bank forecloses on a property, the lender sells it to make back some of the money they’ve lost.
While the process varies depending on where the property is located, here’s a rundown of what you can expect if you’re facing foreclosure.
Why do people default on their mortgages?
Often, the borrower doesn’t have the money to continue making mortgage payments. This can happen for a variety of reasons, including recent unemployment, divorce or separation, or insurmountable debt such as mounting medical bills.
Interest rate increases can also be the culprit. If the borrower has an adjustable-rate mortgage and interest rates rise, the monthly mortgage payment goes up, too. What was once an affordable payment can turn into an overwhelming financial burden. When that happens, the borrower may have no choice but to default.
Weak housing prices also come into play. As a last-ditch effort, a borrower may try to avert foreclosure by selling his or her home. However, in a weak housing market, that can be difficult or next to impossible. And if the borrower is underwater (owes more than the house is worth) the sale proceeds may not be enough to pay off the mortgage.
In many cases, a borrower who is stretched too thin can keep up the payments when the economy is good. But it’s easy to fall into default as soon as there’s an economic downturn.
The five phases of a foreclosure
While the foreclosure process varies by state, it usually follows these five basic steps:
- The borrower defaults on the loan.
- The lender issues a notice of default (NOD).
- A notice of trustee’s sale is recorded in the county office.
- The lender tries to sell the property at a public auction.
- If the property doesn’t sell at the auction, the lender becomes the owner.
Here’s a closer look at these five steps.
Step 1: Payment default
When a borrower misses at least one mortgage payment, they’re in default. In general, the lender sends a missed payment notice that indicates they haven’t received that month’s payment. The lender may offer a grace period -- say, 15 days -- after which they’ll charge a late fee and send the missed payment notice.
If the borrower misses two payments, the lender sends a demand letter. This is more serious than the missed payment notice. But the lender is probably still willing to work with the borrower to get them caught up on payments.
Step 2: Notice of default
After three to six months of missed payments, the lender records a notice of default at the County Recorder’s Office. The lender also sends the form to the borrower via a certified letter. At this point, the borrower typically has 90 days to pay the most recent bill and reinstate the loan. This is called the reinstatement period.
Step 3: Notice of trustee's sale
If the borrower can’t catch up on the loan within 90 days of the notice of default, the lender may proceed with the foreclosure process. The lender records a notice of trustee’s Sale at the county recorder’s office.
In addition, the lender must publish a notice in the local newspaper for three consecutive weeks before the home can be auctioned. Still, the borrower typically has until five days before the auction to get caught up on payments and avoid foreclosure.
Step 4: Public auction
The lender (or its representative) calculates an opening bid for the foreclosed property. That price is based on the loan balance and any liens and unpaid taxes plus the cost of the sale. Then the property is sold to the highest bidder at a public foreclosure auction.
After the sale is completed, the buyer receives a trustee’s deed (or other instrument) and becomes the official owner of the property. The borrower generally has three days to move out. If they don’t, the new owner can initiate the formal eviction process.
Step 5: Real estate owned property
If the property doesn’t sell at auction, it becomes a real estate owned property (referred to as an REO or bank-owned property). When this happens, the lender becomes the owner. The lender will try to sell the property on its own, through a broker, or with the help of an REO asset manager. To make the property more attractive, the lender may remove some of the liens and other expenses.
Meanwhile, the lender will ask the previous owner to move out. The lender may offer the previous owner “cash for keys” or relocation assistance to facilitate the move. If the previous owner doesn’t vacate the property, the lender can start the eviction process.
Catch up if you can
While foreclosure laws and steps vary by state, this is generally what happens during foreclosure proceedings. In most cases, lenders try to work with borrowers in default to get them caught up on payments.
Sometimes the borrower just needs a couple of months to get back on track -- for example, if they just started a new job. With that in mind, borrowers should talk with their lenders as soon as possible. The lender may have options, such as a short sale, that can prevent a foreclosure.
Other times, however, a foreclosure is unavoidable. In that case, it helps to understand the process. Any foreclosure is difficult enough to endure -- both financially and emotionally -- but knowing what to expect from the process if it happens to you can help you be a bit more prepared.