What is a Foreclosure?
A foreclosure is a legal process in which legal action is taken by a lender when the terms of the mortgage or trust deed are not met and the borrower is in default. A borrower is in default when the repayment terms stipulated in the trust deed or mortgage are not fulfilled. When the borrower defaults the loan becomes a non-performing asset and is no longer earning interest for the lending company. If the loan is no longer earning interest then it is not producing income for the lender. In order to recoup its losses the bank starts the foreclosure process. State foreclosure law dictates the path the foreclosure process takes. If the borrower is unable to cure the loan before the end of the foreclosure process, the property is sold at auction. Proceeds from the auction sale are applied to the defaulted mortgage debt.
Foreclosure Overview
Foreclosure is not a single isolated event, rather an on going process culminating in the repossession of property. State foreclosure law dictates the length of time it takes for a property to be officially foreclosed. As a result, the general phases of the foreclosure process will be discussed rather than a strict timeline to help you better understand what a foreclosure is. Remember these are just the general phases of the foreclosure process, it is important for you to read about and understand the foreclosure laws of your State to gain a deeper understanding of the foreclosure process in your area. ForeclosedHomes.com has compiled a comprehensive list of foreclosure laws for you to read at your convenience.
Pre-foreclosure phase
In pre-foreclosure the actual foreclosure action has not yet occurred. The borrower misses a payment and is now considered to be delinquent on a loan.
You cannot default on a loan by being one day late. The lender generally grants a borrower a brief grace period before taking any action. By day 15 the payment is usually considered “officially late”. At this time a lender will send a late payment notice or call the borrower and ask when he/she will be able to pay.
As soon as a borrower misses a payment, their written contract with the lender is broken and they are in default. If the borrower continues to be delinquent between day-45 to 60 the lender will send a demand letter by certified mail. The letter informs the borrower that he/she has officially breached the mortgage contract. This is the first time that the term foreclosure is officially mentioned. The demand letter informs the borrower of the steps that he/she needs to take to stop the foreclosure process.
At around 90 days the lender’s lawyers and foreclosure representatives may start filing court papers and/or record legal notice of the foreclosure status depending on state foreclosure law. A borrower must be at least 90 days behind on their loan payments before the formal foreclosure process can even begin; the entire process can take an additional 120 days or more before the home can be sold at an auction sale. The procedures at this point depend on State foreclosure laws.
Every state uses either a mortgage or a deed of trust to secure the interests of lenders who loan money for the purpose of buying real property. Each type of security instrument has unique characteristics that investors and homebuyers should become familiar with to better understand how real property is secured and by what type of instrument.
A mortgage is a security instrument used in some States by a borrower to pledge his or her right to real property to a lender as security for a loan described in a promissory note. The real property is the lender’s collateral for the promissory note, and the mortgage is the document that grants the lender certain rights pertaining to that property. A mortgage is a two party security instrument because two parties are involved, the borrower and the lender. The mortgage protects the interest of the lender if the borrower defaults on the loan. In order for the mortgage to be enforceable it must be signed by the borrower, acknowledged by a notary public, and recorded in the county in which the property is located. If the borrower defaults on the loan the lender has the right to foreclose on the mortgage to force the sale of the property in order to obtain payment for the promissory note. A promissory note is a legal document that specifies the repayment terms and conditions required by the lender. It is the written promise by the borrower to repay a specific amount of money to the lender. The promissory note specifies the interest rate, the term or length of the loan, the date payments are due, the amount that is due monthly, and whether or not there is any pre-payment penalty. When all of the conditions stipulated in the promissory note have been fulfilled, the lender must cancel the note and give the title back to the borrower. A promissory note does not need to be notarized but it must be in writing and signed by both parties entering into the agreement.
A deed of trust is used in place of a mortgage. It is a document that pledges real property as security for the repayment of a loan. A deed of trust involves three parties: The trustor, the trustee, and the beneficiary. The trustor is the borrower, the trustee is a third party entity with no direct interest in the property, and the beneficiary is the lender. The deed of trust is used to secure the interest a lender has in real property and is held by the trustee until the terms of the promissory note have been satisfied. In States that use a deed of trust, the trustee’s role is similar to that of a judge. The trustee makes a finding on the motion or action taken by the lender based up the provisions contained within the deed of trust. If the borrower pays off the loan the trustee must return the title to the borrower by conveying it back to him or her. If the borrower becomes delinquent on the loan, the lender can ask the trustee to file a Notice of Default in the county in which the property is located.
The Non-judicial foreclosure process is completed based on compliance with the requirements established by state statutes. Non-judicial foreclosure is practiced in title theory States. In other words States that use a deed of trust to secure a lien against real property rather than a mortgage. In title theory States the deed is placed in trust with a third party, called a trustee, until the loan has been paid in full. Once the borrower has met all of their obligations the trustee must return the title back to the borrower. The deed of trust contains the power-of sale provision that authorizes the lender to sell the borrower’s property through a trustee rather than a judge. If the borrower becomes delinquent on the loan, the lender can instruct the trustee to file a Notice of Default (NOD) in the county in which the property is located. Upon default of payment of the loan, the lender must send a notice of default letter to the borrower. This notice can be sent to the borrower by certified mail or delivered personally by the lender. In some States a notice of default will also be recorded with the county recorder at the same time a letter is sent to the borrower. The Notice of Default is the borrower’s official legal notice that because of the non-payment and default of the loan, a non-judicial foreclosure process has commenced and that the lender intends on proceeding with the sale of the property at a public auction. A typical notice will include items such as the name and address of the borrower, the name of the lending institution, the name of the trustee, the original amount of the loan, and the balance owed on the loan. In the event that the borrower does not set up a payment plan to repay the loan or does not pay the loan in full and cure the default a Notice of Sale or Notice of Trustee Sale will be sent by the trustee to the borrower. A Notice of Sale will also be recorded at the county recorders office and the notice will be published in the areas legal publications. The purpose of this document is to notify the borrower and others of the exact time and date the property will be put up for sale by auction. The date of the sale is usually about 2 to 4 weeks after the borrower first received the Notice of Sale. Non-judicial foreclosure process can take between two to four months to complete depending on state foreclosure laws.
Judicial foreclosure is practiced in lien theory States, or those that use a mortgage to secure a lien against real property. The lien theory requires that a borrower pledge the title of the property to the lender. In the event of default the lender seeks compensation from the borrower through the courts. The judicial foreclosure process is used in States that recognize mortgages as the primary legal instrument securing a lenders interest. In the judicial foreclosure process, the lender files a complaint that declares its intent to take legal action against the borrower. The complaint states what debt is owed and explains why the lender should be allowed to recover the property from the borrower in lieu of a debt settlement. A notice of Lis Pendens usually accompanies this complaint. A Lis Pendens means a notice of pending action. The borrower is notified that there is intent to cure a default by the lender by mail and through publication. The borrower has the right to cure the default by bringing all payments current and paying any related foreclosure costs that the lender may have incurred. If the borrower cures the default, the lender must then issue a satisfaction of mortgage or a discharge of mortgage, to clear the title to the property. If the borrower fails to respond to the complaint within the statutory time limit the lenders attorney submits a report to the court stating the facts of the case and requests the court to appoint a referee. The referee reviews the facts and circumstances in the foreclosure action and renders his or her report to the court. The judge then issues a judgment of foreclosure in favor of the lender. Judges often look at foreclosure cases as a simple one: either the borrower made his payments or not. Without proof of payments, there is little defense. Most judges approve the foreclosure awarding judgment to the lender. If the court finds the complaint to be meritorious, an order of foreclosure will be issued. The court then issues a writ authorizing the sheriff to sell the foreclosed property to the highest bidder at a public auction. The judicial foreclosure process takes approximately 12 to 18 months to complete depending on State foreclosure laws.
Auction sale phase
The auction sale represents the ending of the pre-foreclosure phase. It is in this phase that the property is auctioned off at the county courthouse in a public sale to the highest bidder. Legal notices are posted at the courthouse or in local newspapers to announce that the lender intends to sell the property at a public auction. Anyone can attend the auction and bid. The opening bid at a foreclosure auction is based on the total amount owed to the foreclosing lender, interest incurred, late charges, penalties, any liens placed on the property by other institutions, and may include fees incurred because of the foreclosure proceedings. If no one at the auction places a bid above the opening bid amount the foreclosing lender gains possession of the property. Bidding procedures vary from State to State so make sure you become familiar with the bidding procedures in your area before you start bidding at a foreclosure auction. Some States require foreclosure auction bidders to bring the full amount they want to bid in the form of cash or a cashier’s check to the auction. In other States, bidders are required to bring a percentage of the bid amount to the auction and pay the rest of the amount within 30 to 90 days. The property is sold to the highest bidder. At most auctions the lender is the successful bidder on the property. The lender may bid a specific dollar amount or simply present the debt owed as the bid amount. The winning bidder receives the property in the same legal condition the property was in before the mortgage was created.
Redemption period phase
State foreclosure laws determine the existence of a redemption period. Whether or not your state has a redemption period depends on whether it is a title theory or lien theory state. Most title theory States do not have mandatory redemption periods, but most lien theory States do. Redemption periods vary from State to State and can range from a few days to over a year. In this phase the ownership rights of the property have been transferred to the successful bidder at the auction sale. Although the winning bidder technically owns the property, her ownership may be limited by a State-mandated redemption period that gives the defaulting borrowers the opportunity to redeem themselves. If the borrower can come up with the full amount of money owed to the lender, they have the legal right to redeem the property by purchasing it back from the lender.
Post foreclosure phase
Post-Foreclosure is the last phase and is where the ownership rights of the property have been transferred to the lending institution that brought about the foreclosure action. The redemption period is past and the borrower no longer has any rights or claims to the property. When ownership is transferred to the lender it becomes a non-performing asset and is referred to as Real Estate Owned, or REO. In the post-foreclosure stage properties are generally listed for sale through a network of real estate agents who help them dispose of the properties on the open market.