Foreclosure

Foreclosure is a legal process in which a borrower in default on a mortgage loses his or her property. The process allows a bank or other creditor to sell or repossess the property because of the borrower’s violation of the mortgage contract.

Types of Foreclosures

Depending on the terms of the mortgage contract, a creditor may initiate foreclosure proceedings at any time after the borrower has defaulted. Two types of foreclosures are most commonly used: judicial and non-judicial (also called power-of-sale). All states except Idaho use judicial foreclosures, in which a court gives the creditor permission to sell the property to the highest bidder. Notice must be given to the borrower that his or her property is going to be sold.  Conversely, non-judicial foreclosures do not involve court oversight. They are available only if the mortgage contract has a “Power of Sale” clause in it, which means the creditor may attempt to sell the property once the borrower is in default. Non-judicial foreclosures are available in many states, including California, New York and Texas. Other states, including Florida and Illinois, allow only judicial foreclosures.

Right of Redemption

An equitable right of redemption is a right that gives borrowers the chance to pay the outstanding debt on a mortgage after default but before foreclosure occurs. Many states allow redemption, but the laws vary on how long the period of redemption lasts. For instance, Illinois allows a seven-month right of redemption period from the time the foreclosure complaint is filed or three months from the time a final foreclosure judgment is entered.  California’s redemption law allows redemption for one year after the foreclosure sale has occurred, unless the lender made a full-price bid for the property. In that case, the redemption period is three months. Some state laws are not as specific. For example, Florida ends the period of redemption at the foreclosure sale but allows a court to “review the sale to ensure a fair price has been paid.” There is no time limit for this review, but customarily it is 10 days, just enough time to file the certificate of sale and for title to pass. Other states, such as New York and Texas, do not allow redemption rights.

The Foreclosure Process

The actual process of foreclosure varies from state to state. The usual timeline is between 90 and 180 days, but it may be as short as 60 days (typical in Texas) or as long as 210 days (typical in Illinois). The process usually begins with a notice to the borrower that he or she is in danger of defaulting on the loan. If payments are not brought up to date before the time specified in the notice, the lender will start foreclosing on the property. If the foreclosure is judicial, the lender must file a foreclosure complaint in the proper court. The court will review the documents and set a date for a foreclosure sale. The notice of sale, which specifies the time and place of the sale, then is sent to the borrower. The method of sale is typically an auction, and the property will go to the highest bidder. The opening bid is usually equal to the outstanding debt on the property. If the winning bid is not as high as the outstanding debt, some states allow a lender to sue the borrower and obtain a deficiency judgment for the remaining amount owed on the property. A deficiency judgment is a judgment against the borrower for the remaining debt on the foreclosed property. The creditor may enforce the judgment through the courts and use any means available under state law to collect on the judgment. Usual methods include placing a lien on the borrower’s property or garnishing his or her wages.  The process for a non-judicial foreclosure is similar, except the lender is not required to file any documents with the court to place a property in foreclosure. Another difference is that a few states do not allow deficiency judgments after a non-judicial foreclosure. For example, California allows deficiency judgments only after a judicial sale. Most states, however, including Illinois, New York and Texas, allow deficiency judgments regardless of what type of foreclosure brought about the sale.

How to Avoid Foreclosure

Most lenders have a grace period for when a late payment may be accepted without penalty. If payments will routinely be made during this grace period, you should let the lender know. If you still have a problem making payments, let the lender know that, too. Your lender might give you time to make up the payments before taking legal action. Lenders do not like to foreclose because they often end up losing money. Some lenders will even restructure a payment plan and let you make up the late payments over a period of time.  If the loan is an adjustable-rate mortgage (ARM), the lender might be able to freeze the interest rate for a period of time or even reduce the interest rate. The lender might also be able to increase the amortization period (the period during which the loan must be repaid), which will lower the monthly payments.  Another way to avoid foreclosure is to refinance the property. This option is available only if the property has enough equity, which is the difference between the property’s market value and the current balance on the loan. If the property does have enough equity, the lender can increase the balance due to include the overdue payments. In other words, the equity covers the back payments, and the loan is brought up to date. But because the balance has been increased, the monthly payments will increase as well.  When a lender files a notice of default, the ways to avoid foreclosure become limited. Some states, as discussed above, allow redemption rights. If redemption rights are not available or if you simply cannot keep up with the monthly payments, you might avoid foreclosure by selling the property. You should talk to a realtor to see if selling the property prior to foreclosure is a viable option.  One last effort available is to conduct a deed-in-lieu-of-foreclosure transaction. In simple terms, this deeds the property back to the lender. Although the lender is under no obligation to accept this (unless the mortgage contract states otherwise), this type of transaction is a good option for borrowers who want to avoid the stigma and credit hit that accompanies a foreclosure. Once the deed is handed to the lender, the lender forgives the mortgage loan and stops foreclosure proceedings. Although a deed in lieu of foreclosure may still damage your credit score, it is favorable to a foreclosure in that you may find it easier to purchase a home in the future. Last update: Oct. 29, 2008