What is a Foreclosure?

In real estate today, especially when searching for that perfect home, you may come across a foreclosed home.  Simply put, foreclosure is the process by which a homeowner’s rights to a property are forfeited due to their failure to pay their mortgage. 

If the home owner cannot pay the outstanding debt or sell it via short sale (see previous blog post from August 12^th to learn more about short sales), the property then goes to a foreclosure auction.  If the property does not sell at the foreclosure auction, it becomes the property of the lending institution that granted the original mortgage on that property.

It helps to remember that the word “homeowner” in this case is actually a misnomer – they are actually borrowers. When someone buys a home, they sign papers – one of which is the mortgage, or deed of trust. This document puts a lien on the purchased property, making the loan a “secured loan.”

When a lender loans you money without any collateral (credit card debt, for instance), the lender can take you to court for failure to pay.  However, it can be very hard to collect money from you. Lenders often sell this sort of debt to outside collection agencies for pennies on the dollar and write off the loss. This is considered an “unsecured loan.”

A secured loan is different because, although the lender may take a loss on the loan if you default, it will recover a larger portion of the debt by seizing and selling your property (that was put up as collateral).

Here are the five stages of foreclosure:

Stage 1: Missed payments

Foreclosure is a lengthy process, with specifics varying from state to state, but it all starts when a borrower fails to make timely mortgage payments. This is usually due to hardships such as unemployment, divorce, death or medical challenges.

Other times, a borrower may decide to stop paying the mortgage intentionally because the property might be underwater (mortgage exceeds the value of the home) or because he’s tired of managing the property. For whatever reason, he can’t or won’t meet the terms of his loan.

Stage 2: Public notice

After three to six months of missed payments, the lender records a public notice with the County Recorder’s Office, indicating the borrower has defaulted on his mortgage. In some states, this is called a Notice of Default (NOD); in others, it’s a lis pendens -- Latin for “suit pending.” Depending on state law, the lender might be required to post the notice on the front door of the property. This official notice is intended to make the borrower aware he is in danger of losing all rights to the property and may be evicted from the premises.

Stage 3: Pre-foreclosure

After receiving Notice of Default from the lender, the borrower enters a grace period known as “pre-foreclosure.”

During this time – anywhere from 30-120 days, depending on location of the home – the borrower can make arrangements with the lender via a short sale or make arrangements to pay the outstanding amount owed.  If the borrower pays off the default during this phase, the foreclosure process ends and the borrower avoids home eviction and sale. If the default is not paid off, foreclosure process continues.

Stage 4: Auction

If the default is not remedied by the prescribed deadline, the lender or its representative (referred to as the trustee) sets a date for the home to be sold at a foreclosure auction (sometimes referred to as a Trustee Sale). The Notice of Trustee Sale (NTS) is recorded with the County Recorder's Office with notifications delivered to the borrower, posted on the property and printed in the newspaper. Auctions can be held on the steps of the county courthouse, in the trustee’s office, at a convention center across the country, and even at the property in foreclosure.

In many states, the borrower has the “right of redemption” (he can come up with the outstanding cash and stop the foreclosure process) up to the moment the home will be auctioned off.

At the auction, the home is sold to the highest bidder for cash payment. Because the pool of buyers who can afford to pay cash on the spot for a house is limited, many lenders make an agreement with the borrower (called a “deed in lieu of foreclosure”) to take the property back. Or, the bank buys it back at the auction.

Stage 5: Post-Foreclosure 

If a third party does not purchase the property at the foreclosure auction, the lender takes ownership of it and it becomes what is known as a bank-owned property or REO (real estate owned).

Bank-owned properties are sold in one of two ways. Most often, they are listed with a local real estate agent for sale on the open market. Zillow (the website that is the source of most of this information) lists bank-owned properties for sale. Also, some lenders prefer to sell their bank-owned properties at a liquidation auction, often held in auction houses or at convention centers.

For more information on foreclosures, consult with your local real estate agent!