Foreclosure is a legal process in which a lender attempts to recover the amount owed on a defaulted loan by taking ownership of and selling the mortgaged property. Typically, this happens after the borrower stops making mortgage payments.
Here’s how the foreclosure process generally works:
- Default: The borrower defaults on their mortgage loan by failing to make the required payments.
- Notice of Default (NOD): After a certain number of missed payments (typically 90 to 120 days), the lender records a Notice of Default at the county recorder’s office. This notice indicates that the borrower has defaulted on their mortgage payments. The borrower is given a certain period (usually 90 days) to settle the payments and stop the foreclosure process.
- Notice of Sale: If the default is not remedied within the time frame, the lender will then issue a Notice of Sale, which states that the property will be sold at auction. This notice is published in local newspapers and posted on the property as well as in public places.
- Auction: If the borrower does not pay the outstanding amount, the property is sold at a public auction. The highest bidder becomes the new owner of the property.
- Post-foreclosure: If the property is not sold at auction, it becomes the property of the lender. These are also known as bank-owned or real estate owned (REO) properties.
Foreclosure laws and procedures vary by state in the U.S., so the process can differ somewhat depending on the location. Furthermore, the borrower usually has a right to bring the loan current by paying off the default amount and the pending balance during a “grace period” known as pre-foreclosure.
Foreclosure can have significant negative impacts on the borrower’s credit score, and it can be a complex and stressful process. Therefore, it’s often in the best interest of both parties to avoid it if possible, by means such as loan modifications, short sales, or deed in lieu of foreclosure arrangements.
Example of Foreclosure
Here’s a hypothetical example of how a foreclosure might unfold:
Let’s say a person named John took out a mortgage loan to buy a house worth $300,000. His monthly mortgage payment, including interest and taxes, comes to $2,000. John was making payments on time and everything was going well for the first couple of years.
However, John suddenly loses his job and is unable to find a new one quickly. As a result, he can no longer afford his monthly mortgage payments. He misses his payments for four consecutive months. After 120 days of missed payments, the lender (the bank) files a Notice of Default (NOD) at the county recorder’s office. This notice informs John that he is in default and needs to pay the outstanding mortgage payments to avoid foreclosure. The amount now due includes the missed payments plus late fees.
Despite his best efforts, John cannot secure the necessary funds to bring his mortgage current within the given 90-day period. The bank then issues a Notice of Sale, announcing that the property will be sold at a public auction due to John’s failure to pay the outstanding mortgage payments.
At the auction, the house is sold to the highest bidder, and the proceeds of the sale are used by the bank to repay John’s debt. If the auction does not bring enough money to cover the owed amount, the bank might have the right to pursue John for the remaining debt, depending on the state laws and the specifics of the mortgage agreement.
If the house isn’t sold at the auction, it becomes a bank-owned property, also known as a Real Estate Owned (REO) property. The bank can then sell it through a real estate agent to recover their money.
This foreclosure will negatively affect John’s credit score and could prevent him from obtaining another mortgage for some years. Therefore, it’s usually beneficial for homeowners like John to explore alternatives to foreclosure, such as loan modifications, refinancing, or selling the home themselves before it gets to the foreclosure stage.