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Foreclosure procedures differ somewhat from state to state, but they generally follow the same set of steps in all jurisdictions. Understanding the process, and your options at each stage along the way, can help you reduce the distress and damage to your credit that foreclosure can bring.
How Does a Foreclosure Work?
Foreclosure is when a lender exercises its right to seize a mortgaged property after the borrower has failed to repay their loan. The process typically progresses by the following steps.
- Missed payments: The foreclosure process starts with a missed payment. If you're more than a couple of weeks late with a mortgage payment, you'll typically start hearing from your lender through some combination of mailed letters, phone calls and emails. These messages will notify you of your delinquency and remind you of your obligation to pay by the due date each month. You may also be told you owe a penalty or late fee. If the lender reports your late payment to the national credit bureaus, just a single missed payment could cause your credit scores to drop significantly. A missed payment doesn't doom you to foreclosure, however: If you cover the late payment (plus any fees), your loan will be restored to good standing and foreclosure won't even become a consideration.
- Mortgage default: If you go 90 days without making a scheduled payment, you are considered in default on a mortgage. Under most mortgage contracts, defaulting on the loan allows the lender to initiate the foreclosure process. In the course of defaulting on your mortgage, your lender will reach out and urge you to get current with your payments.
- Notice of default/intent to foreclose: After 90 days of missed payments, the mortgage lender typically notifies you by certified mail that you've defaulted and that they intend to begin foreclosure proceedings. This begins the phase of the process known as pre-foreclosure. The nature of what foreclosure proceedings entail and the legal timeline they must follow vary by jurisdiction, but they are spelled out in your mortgage contract. It's common for a default notice to indicate that the lender will file a court petition in 30 days seeking authorization to seize and auction the property. In some states, the court's review of the lender's documentation can take months; in others, authorization to foreclose can be granted within a week of the lender filing its petition.
- Public notice: Some jurisdictions publicize the names of individuals in default and subject to foreclosure—posting them to municipal websites and/or publishing them in local newspapers.
- Foreclosure auction: Once the lender gains legal authority to foreclose, all occupants must vacate the property. Then, the property is locked up and slated for public auction. Foreclosed properties are sold "as-is," and bidders typically have no opportunity to inspect them before the auction. Many foreclosures fail to sell at auction, and those that do sell typically sell for considerably less than their market value.
- Real estate-owned, or REO, property: If no one purchases the property at auction, it becomes what's known as real-estate owned. Ownership reverts to the lender, and the property becomes available through private sale.
How Does a Foreclosure Affect Your Credit?
A foreclosure will be recorded on your credit reports, where the entry will remain for seven years before expiring. A foreclosure can significantly lower credit scores, but the severity of its impact diminishes over time.
Damage to your credit is a major drawback, but it's just one of many difficulties foreclosure can pose:
- Being compelled to leave your home can be traumatic for you and your family members.
- Depending on local procedures, foreclosure can require time-consuming document preparation, court appearances and legal fees.
- Having to find a place to live in a hurry can limit your housing options or lead to choices you'll regret in the future.
Ways to Avoid a Foreclosure
If you're unable to cover your mortgage payments, foreclosure is a real possibility, but it's not inevitable. Taking decisive action, even if it's stressful and uncomfortable, can help you avoid the greater anguish, expense and damage to your credit that foreclosure can bring.
The worst thing to do when faced with foreclosure is to ignore communications from your mortgage lender. Every letter, email and phone message the lender leaves will include contact instructions, and the earlier you begin a conversation with the lender, the more options you will have.
Under the best of circumstances, dialog with the lender can help you come to an arrangement that lets you remain in the house. Even if that's not possible, working with your lender (possibly under the guidance of an experienced attorney) can allow for a better outcome than foreclosure. Some of these alternatives include:
- Loan forbearance: If you can't cover your mortgage because of a temporary income loss or reduction, mortgage forbearance could be viable for you. You'll need to ask the lender to consider it, and be prepared to show that you'll be able to resume payments within a year (and to make up missed payments). If you want to arrange this, it's best to ask for it before you miss any payments, or as soon as possible after you miss your first payment.
- Mortgage modification: If your household income has dropped, but you still have a steady income source, your mortgage lender may consider reducing your monthly payments in what's called a mortgage modification. The lender typically needs evidence that you can keep up with your new payments, so applying for a loan modification is much the same as applying for a new loan. Modified mortgage terms typically increase the number of payments you have left on the loan, which means higher interest costs over the life of the loan.
- Selling your home: If your home's market value exceeds the amount you owe on the mortgage, you can sell it and use proceeds from the sale to make new living arrangements. Time will be tight, so you may not have an opportunity to make significant improvements, but do your best to present the property in the best light possible (a real estate agent may be able to advise you on this). If you're in a hot real estate market, a quick sale may be feasible; but if the local market is slow or the property needs a lot of work, you may need to lower the sale price to hasten a sale.
Your property's market value may be less than what you owe on your mortgage, in which case you may be able to arrange what's known as a short sale, where the lender agrees to let you sell the house for less than what you owe. This can allow you to avoid foreclosure, but the lender will take all the proceeds of the sale, and you may still owe them some or all of the amount remaining on the mortgage. If you pursue this option, work with a real estate attorney who can help you negotiate the best-available terms.
- Deed in lieu of foreclosure. In a deed in lieu of foreclosure arrangement, you negotiate terms to turn over the property to your mortgage lender and vacate the property in exchange for them closing out your mortgage loan. The end result is the same as foreclosure—you must vacate the house—but you and the lender are spared the cost of court proceedings, and you may be able to arrange to stay in the house for a period of weeks or months to make other arrangements. Your credit will still take a big hit, because your mortgage will be listed in default. It's often wise to seek legal and financial advice if you decide to go this route, as you could still end up owing the lender money, and could be liable for income tax on any portion of your debt that's forgiven.
How Does a Foreclosure Sale Work?
Because they typically sell well below market value, foreclosed homes and real estate-owned properties can be tempting for bargain hunters and buyers looking for real estate to use as investment property. Foreclosure properties may require significant repair or renovation, so bidding for them at auction can be a risky business. These properties can be even more distressed after remaining unoccupied for months or even years.
Factor in competition from seasoned investors who come ready to pay cash, and who often know the market well enough to spot the most promising properties, and you'll see that purchasing a foreclosure can be especially tricky for first-time homebuyers.
Buying a foreclosure can nevertheless be a great opportunity if you're willing and able to do some rehabilitation work to get the place ready to resell, or to move in yourself. Taking a chance on a foreclosure could even help you afford a home if your credit is less than ideal. If you decide to go that route, you'd be wise to consult a real estate professional experienced in foreclosure purchases. The expense of engaging a real estate agent or attorney for guidance could spare you missteps that would potentially be far more costly.
The Bottom Line
Foreclosure is a stressful event that neither a homeowner nor a mortgage lender wants to pursue. Working together, borrower and lender can often find better alternatives. If foreclosure can't be avoided, its impact on your credit and your self-esteem can be significant, but with time both will heal.
Throughout the process and beyond, it's important to monitor your credit. Once the foreclosure process is complete, keeping a close eye on your credit can help you rebuild it and get back on track to borrowing again. A foreclosure will stay on your credit for seven years, and can significantly affect your credit prospects. Maintaining good credit habits going forward is the best thing you can do to make sure your scores eventually bounce back.