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Foreclosure FAQ 1. What is the modern definition of the word "foreclosure," and legally what does it mean?
2. How does foreclosure occur? What commonly causes/leads up to it?
3. What can homeowners do to prevent a foreclosure?
4. If it's too late to prevent foreclosure, what recourse does a homeowner have? Is there any way to reverse it?
5. What are the consequences/ripple effects of a home foreclosure (i.e., credit, etc.)?
6. Are there any prominent recent/new changes in foreclosure laws that homeowners need to be aware of?
7. Is there any protection/insurance you can purchase to prevent/stall a foreclosure?
1. What is the modern definition of the word "foreclosure," and legally what does it mean?
A foreclosure is a legal procedure that a lender initiates to reclaim ownership and possession of a property after a borrower fails to repay the loan in accordance with the contractual terms. Each state in the United States has its own legal procedures for taking foreclosure action. Background
Mortgages and Deeds of Trust
The foreclosure process — from its initiation to its completion — is determined by whether the instrument that created the borrower’s obligation to repay the loan was a mortgage or a deed of trust. Mortgages and deeds of trust are the legal instruments that create a lien against the borrower’s property. Nationwide, the states are about equally divided in their use of mortgages and deeds of trust, and a few state even use both. While both deeds and mortgages serve the same purpose, the major difference is found in the length of time it takes a lender to foreclose on a delinquent loan — approximately 12-18 months for a mortgage foreclosure compared to 4-5 months for a trust deed foreclosure. Lenders prefer trust deeds because there is no lengthy court action to reclaim their right to sell the property when the loan is in default. Judicial vs. Non-Judicial Foreclosure
Essentially, there are two types of foreclosure procedures; judicial foreclosure and non-judicial foreclosure. In California, for example, non-judicial foreclosures are more common than judicial foreclosures (lawsuits in court). A non-judicial foreclosure begins with the recording of a “Notice of Default” and ends with a “Trustee’s Sale.” The Trustee’s Sale is held like a public auction. The property goes to the highest bidder. If no one bids at the public auction, the property reverts to the foreclosing beneficiary (lender). Foreclosed properties are referred to as REOs (Real Estate Owned by the lender that foreclosed). In judicial foreclosure states like Florida, borrowers sign two separate instruments: the note (or bond), which is evidence of the borrower’s promise to pay the debt; and the mortgage, which is the legal instrument that creates the lien on the property as security for the debt. If the borrower cannot pay the mortgage, the lender hires an attorney, who begins legal action to protect the lender’s interest. The attorney files several documents: a summons directing the borrower (defendant) to appear in court, a complaint describing the lenders (plaintiffs) allegations of entitlement to relief and the relief sought, and a lis pendens, the legal document that gives notice to the world that there is a legal action pending on the property. Lis pendens is a Latin word meaning “lawsuit pending.” The documents are filed with the clerk of the court in the county where the property is located. If the borrower fails to respond to the notices within the statutory time limit, the attorney submits a report to the court requesting that the court appoint a referee. The referee reviews the facts and circumstances in the foreclosure action and renders a report to the court. Then a judge issues a Judgment of Foreclosure and Sale in favor of the foreclosing lender. The judicial auction is advertised and the property is sold at the auction to the highest bidder. (Back to Top) 2. How does foreclosure occur? What commonly causes/leads up to it?
A foreclosure occurs when a homeowner (borrower) fall behind on their monthly payments or fails to pay property taxes. Generally, after three months of late payments, a lender will begin the foreclosure process. Foreclosures are commonly caused by one or a combination of events, including an injury or illness that causes a homeowner to miss work, a job loss or drug and alcohol abuse. In many cases, a divorce can lead to foreclosure. Some people refinance their homes or take out an equity line of credit and the extra monetary obligation — caused by higher interest rates or adjustable rate mortgages (ARMs) — drains their savings and monthly income. (Back to Top)
3. What can homeowners do to prevent a foreclosure?
The best time to prevent a foreclosure is when buying a home and when creating a monthly budget. A potential homebuyer should carefully evaluate how much he or she can afford in terms of the down payment, monthly payment (including taxes and insurance) and overall interest paid over the life of the loan. The buyer should not buy a home that requires a monthly payment — now or when the payment increases if it’s an adjustable rate loan — that is more than one-third of the homeowner’s monthly income. And the buyer should not pay more in interest over the life of the loan than what the property is reasonably expected to appreciate over the life of the loan. Every homeowner should create a monthly budget to make sure there is money available to pay the mortgage payment each month. In addition to budgeting for the actual payment, homeowners should build savings into their budget and continue to add to their savings until they have at least enough to pay for six months worth of living expenses. This will ensure that the homeowner will have a cushion on which to fall in the event of a job loss or other incident that causes them to lose their monthly source of income. Homeowners who have already defaulted on their monthly mortgage payment still have the opportunity to stop the foreclosure with the following options:
- Reinstatement. The reinstatement option gives the homeowner the opportunity to make up back payments plus any incidental charges such as attorney fees, filings, posting notices and trustee service charges. The payment of the reinstatement amount will cancel the foreclosure and enable the borrower to continue as if no default occurred.
- Redemption. In order to redeem the loan, the borrower must pay off the loan in full. This may be accomplished through refinancing the loan (with a cosigner perhaps) or by a relative or friend bailing out the owner in return for an equity position.
- Deed in Lieu of Foreclosure. For owners who know they have no opportunity to reinstate, redeem, or even sell their property, a deed in lieu of foreclosure may be a viable option. Here, the owner turns over ownership of the property over to the bank and avoids the trauma of foreclosure. This option will reduce the negative impact on the owner’s credit.
- Sell the Property. If the homeowner has enough equity, they can sell their home before the lender forecloses. Selling the property may be the smartest choice. Selling the property will prevent the owner from losing their equity and damaging their credit.
- File Bankruptcy. Although not a permanent cure, filing bankruptcy can temporarily halt the foreclosure process. Essentially, there are two types of bankruptcy categories: Liquidation bankruptcies, which fall under Chapter 7 of the United States Bankruptcy Code; and reorganization bankruptcies, which fall under Chapter 13 of the United States Bankruptcy Code. Bankruptcies are expensive. Homeowners should seek the advice of a real estate attorney.
- Renegotiate with the Lender. The most overlooked of all the foreclosure prevention options that an owner has is the opportunity to renegotiate the existing loan with the lender. The lender does not want the property, and any plan that will enable the loan to be back in service for the lender’s loan portfolio will be looked upon favorably by the lender.
4. If it's too late to prevent foreclosure, what recourse does a homeowner have? Is there any way to reverse it?
If the homeowner does nothing and the home goes to the auction, the borrower loses everything. Once the bank forecloses a home there is nothing the homeowner can do. Renegotiating the loan is probably the best way to avoid foreclosure. In other words, working out a payment plan that works for both the homeowner and the lender is the best way to avoid foreclosure. (Back to Top)
5. What are the consequences/ripple effects of a home foreclosure (i.e., credit, etc.)?
Two immediate effects of foreclosure are that the borrower losses their home and the second is that their credit is badly damaged. In addition, a foreclosure can drag down the prices of surrounding homes. If there are enough foreclosures in an area, that can eventually result in a slowdown of home price appreciation in the area. (Back to Top)
6. Are there any prominent recent/new changes in foreclosure laws that homeowners need to be aware of?
The rules regarding foreclosure purchases are changing. An increasing number of state attorney generals, legislators and community groups are trying to regulate subprime lenders and so called “foreclosure rescue specialists” who are engaged in home-stealing scams powered by fraud and deception. But some of these proposed new laws are so broad they may snare legitimate investors. State lawmakers have been busy crafting laws to stifle foreclosure rescue specialists, mortgage fraudsters and "equity-stripping" schemes, according to Peter G. Miller, author of The Common-Sense Mortgage. Recent examples of legislation addressing such issues can be found in California (Civil Code 2945), Illinois (SB 2349), Maryland (SB 761), Minnesota (325N ), New York (SB 4744) and Rhode Island (H 7650). (Back to Top)
7. Is there any protection/insurance you can purchase to prevent/stall a foreclosure?
No insurance can prevent or stall foreclosure. The best advice to protect a homeowner from foreclosure is don’t overextend yourself financially. Don’t take out risky loans like adjustable rate mortgages (ARMs), no-interest loans or no-money down loans (100 percent financing). If you can’t afford a home with a traditional 30-year fixed rate loan, then you probably should not buy it. In other words, be conservative with your finances. (Back to Top)
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