By Elspeth Crawford
Many homeowners these days fall into the unfortunate situation of not being able to afford their home loans. When the Grim Reaper of mortgages comes around, foreclosure is his scythe.
Foreclosure is a catch-all term for the legal process by which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments by forcing the sale of the asset used as the collateral for the loan, typically a house. Foreclosures are governed by the law of the state where the mortgaged thing is.
The foreclosure process is triggered once the borrower (mortgagor) falls so far behind on her payments that she enters default. The conditions for entering default vary, based on state law and terms in mortgage agreements. Once a borrower enters default, she starts to accumulate late fees, legal fees, and other charges that are added to her outstanding debt, as determined by the mortgage agreement and state law.
It’s important to note the lender does not have to foreclose; they are free to negotiate with the borrower. For example, they might agree to adjust the terms of the mortgage, refinance, allow the borrower to sell the property, or allow the mortgagor to make up for his or her missed payments.
Types of Foreclosures
Generally, there are two varieties of foreclosures: judicial foreclosures, which require a court order, and non-judicial foreclosures, which do not. In judicial foreclosures, the mortgagee must go to court and prove that it owns the mortgage and has the right to foreclose on it. Non-judicial foreclosures allow a mortgagee to foreclose without going to court. This is cheaper and quicker than a judicial foreclosure. Non-judicial foreclosures may only be used where the mortgage has a power-of-sale clause. These clauses most often appear in deeds of trust, a type of real estate secured lending instrument similar to a mortgage.
Most mortgages now include acceleration clauses. According to these clauses, if borrowers fall far enough behind in their payments, the rest of the loan is due immediately. Mortgagors usually invoke these clauses as a prelude to foreclosure. Most states regulate acceleration clauses, either generally, as specifically as applied to mortgages, or both.
In recent years, lenders frequently bundled groups of mortgages into mortgage-backed securities, and then sold shares of the securities to investors. As a result, some mortgages have many owners. Others have changed hands so many times that it is difficult to determine who actually owns them. As a result, it is often difficult for the mortgagors to modify the terms of their mortgage. Similarly, mortgagees might have trouble proving that they own a mortgage they want to foreclose on.
Right of Redemption
In some states, mortgagors have a right of redemption that allows them to get back foreclosed property. If the original mortgagee owns the property, mortgagors may exercise the right by paying the bank the unpaid balance of their mortgage. If the property was already resold at auction, mortgagors must pay the purchaser whatever he or she paid for it. Rights of redemption only last for a limited time, which varies by state.
The foreclosure process differs state by state, but we can take a look at the general steps that are taken. If you're faced with foreclosure, it's important that you research your state's laws and practices.
Foreclosure proceedings can begin after a single missed payment, but it isn't very likely. Most banks and lenders have a grace period for late payments, usually with a fee added on. It typically takes being a full 30 days late for the alarm bells to go off. After the second missed payment, you'll be getting some phone calls. Many lenders will only accept both late payments to bring the loan current. They also may refuse any partial payments.
Once you fall three months behind, things get serious. This is typically when most lenders will begin the foreclosure process in one of two ways: judicial sale, which requires that the process go through the court system, or power of sale, which can be carried out entirely by the mortgage holder.
All states allow judicial sale, while only 29 allow power of sale. If your state allows power of sale, the loan papers will usually have a clause that says this method will be used. Power of sale is typically faster than the judicial route. Let's look at both methods.
Power of Sale:
Both types of foreclosure require that any other involved parties be notified of the proceedings. For instance, if the homeowner took out another loan against the house with a third party, that lender must be contacted and its loan amount must be paid from the auction proceeds. If the third-party lender isn't paid, it can apply the mortgage to the new property owner. Many times, the lender will actually buy the property back and attempt to sell it through the real estate market at a later date.
There can also be deficiency judgments made against the borrower if the sale of the property doesn't satisfy the amount of the loan. The entire difference between the two can be required, although some states only require that difference between the fair value of the property and the loan amount be paid.
There's one more type of foreclosure that's almost completely obsolete, called strict foreclosure. In these cases, once judgment is made on the lawsuit, the property is automatically assumed by the mortgage holder. Only Connecticut and Vermont still allow this practice.