Real Estate Law

Foreclosure Basics 101

            Foreclosure is not a term anyone wants to hear, let alone a process someone wants to participate in. Certainly, a home or property is not foreclosed on when things are going well. Rather, foreclosure is commonly associated with devastating circumstances that can drastically alter someone’s existence: a recently deceased spouse, unemployment, exorbitant medical expenses, and general, unmanageable debt. Indeed, the dreaded word foreclosure also tends to create negative emotions towards those who experience it and can culminate in a stigma against a borrower.

Certainly, there are simple, practical steps a borrower can engage in at the get-go to avoid eventual foreclosure prior to even purchasing a home or property. However, if a borrower has already made their purchase and their property is now involved in the foreclosure process, hope is not lost. There can be available alternatives once the mortgagor has taken the initial steps to repossess the property up until the property is sold—and in some states there are remedies available post-sale, too. While there is no sugarcoating the reality that a foreclosure can result in weighty, long-term consequences, the consequences are likely to resolve with time and with a renewed commitment to debt management and consciously avoiding the same money mistakes the borrower has made in the past.

To begin, this article will explain what “foreclosure” means, examine the steps in the foreclosure process, discuss alternatives to foreclosure, provide possible strategies that can be utilized to avoid foreclosure, explore the possible advantages a foreclosure can present—although limited—and, to conclude, this article will navigate the undeniable consequences a foreclosure can cause.

            Foreclosure Explained

            “Foreclosure” is the term used to describe the legal action a mortgagor (a lender) takes to repossess property when the borrower cannot make their monthly payment. The “mortgage statement” will provide that, once the borrower does not make a payment or payments, the mortgagor retains the right to repossess the property to collect the balance on the outstanding mortgage.

            Foreclosure Types

Judicial Foreclosure

A foreclosure can be described as either “judicial” or “nonjudicial,” depending on the jurisdiction. First, we will discuss “judicial foreclosure.” In a state that uses the judicial foreclosure process, a court proceeding is necessarily required. To initiate the foreclosure process, the mortgagor will bring a lawsuit against the borrower. Once a lawsuit has been brought, a borrower is entitled to “notice” that the judicial foreclosure process has been initiated. The borrower receives notice when the borrower is “served with process.” It is never advisable to miss a court appearance once the party receives notice of a pending lawsuit.

Non-Judicial Foreclosure

In a state that utilizes the non-judicial foreclosure, no court proceeding is necessary. Rather than being served with process, the mortgagor will send the borrower a document called a “Notice of Default” (NOD) via mail. The NOD will tell the borrower the total amount owed on the mortgage, the past due amount, the foreclosure costs, and any late penalties owed. Generally, there is a 90-day interim period between the NOD and the property sale. This “grace period” allows the borrower time to obtain—and pay the mortgagor—the above-mentioned expenses. Or should the borrower be unable to come up with the money necessary to get caught up, this period can be used as a time where the mortgagor and the borrower attempt to agree to a new, more manageable mortgage agreement, also known as “mortgage modification”.

            The Foreclosure Process

            Now that we’ve developed an understanding of what foreclosure really means and the types employed across the U.S., let’s examine the steps a mortgagor must take to repossess a borrower’s property. Ultimately, the process can be reduced to six steps. Here, the process has been described in short, understandable terms and does not dive into the complete, more nuanced terms a borrower agreement would describe. However, here are the basics:

            Step 1: A Missed Payment or Payments

            As you are probably aware, a foreclosure will take place when a borrower miss—or continues to miss—their monthly mortgage payment. Typically, a mortgagor will grant a borrower a 15-day grace period to make their missed monthly payment. Should payment still be missing, the mortgagor will apply a late penalty in addition to the monthly mortgage amount. Certainly, a late payment is better than no payment. Once a borrower recognizes that they cannot make their monthly payment, it is crucial that the borrower contact the mortgagor and attempt to come to a resolution. Most mortgagors are sympathetic to a borrower’s plight and can work with the borrower to develop a plan to enable the borrower to make their payment(s).

            Step 2: The Borrower Defaults

            If no payment has been received and the mortgagor can’t reach a missing or uncooperative borrower, the mortgage is then in default. The period that must elapse prior to a borrower being declared in default varies by state. This could be the 16^th-day—once the 15-day grace period ends—or up to 30 days depending on the mortgagor and the terms laid out in the mortgage agreement.

            Step 3: The Foreclosure Process is Initiated

            Once the borrower is deemed to be in default, the process and timeline is almost completely dependent on whether the state is a judicial or non-judicial state. Both the judicial and non-judicial process are explained above and can vary in length depending on the circumstances.

            Step 4: Notice of Sale

            Once the process has been initiated and the mortgagor and borrower cannot come to an agreement on how to proceed with the mortgage, the borrower will be required to pay the total outstanding mortgage amount to avoid their home or property being sold. Here, the mortgagor will prepare to sell the property; the mortgagor will likely publicize the sale to attract potential buyers and will set a time and place to auction the property.

            Step 5: Sale and Eviction

            Once the property has been sold, the now-previous borrower must leave the premises as the mortgagor, and subsequently, the new buyer, repossess the property. A borrower who does not voluntarily leave will be evicted. Although unlikely, the sale could result in excess cash, to which the borrower—not the mortgagor—is entitled. Indeed, the mortgagor is only entitled to the amount that will cover the outstanding balance on the mortgage. If no one bids on the property, the mortgagor will purchase the property, and the property will become “bank-owned” (meaning it is owned by the mortgagor).

            Step 6: Mortgagor will Seek a “Deficiency Judgment” (if necessary)

            A “deficiency judgment” is sought when the property sale results in an amount less than what is required to pay the total outstanding mortgage amount. The mortgagor will ask the court to order the borrower to come up with the remaining balance. Although deficiency judgments are permitted in some states, there are several procedures established to avoid deficiency judgments.  A new appraisal may be ordered to establish the property’s revised valuation. Accordingly, the appraisal should somewhat accurately portray the property’s worth at the time of foreclosure. General, moderate deterioration does not have a major impact on the appraisal price. However, a new appraisal may come in at a lower value if comparable properties in the neighborhood are also losing value due to deteriorating market conditions since the property was originally purchased. Some states do not permit deficiency judgments to avoid incentivizing mortgagors from selling the property at too low a price.

Foreclosure Alternatives

            Mortgage Modification

            The most practical way to avoid repossession is through agreement between the mortgagor and borrower to change the mortgage agreement’s terms, making the borrower’s payments more manageable. As discussed above, mortgagors can be sympathetic to a borrower’s extenuating circumstances and can attempt to help a borrower keep their property. Accordingly, it is crucial that the borrower make the conscious decision not to actively avoid their mortgagor; not being available to negotiate can eliminate an otherwise amicable agreement that could result in more favorable terms to the borrower. In addition, many borrowers can utilize the “Home Affordable Modification Program” (HAMP). HAMP can serve as a mediator between the mortgagor and the borrower and assist the parties in coming to an agreement. Moreover, sometimes a mortgagor may be required to put a foreclosure on hold until it can be determined whether the borrower can be a HAMP recipient.

            The “Short Sale”

            A “short sale” can be utilized when the outstanding mortgage amount exceeds the property’s value. In a short sale, the borrower is essentially requesting that the mortgagor accept an amount lower than the total amount due on the mortgage and to dismiss the borrower’s obligation on the mortgage. Or much like a mortgage modification, the borrower can request that the mortgagor agree to accept payments on the remaining deficient amount over time. The downside to short sales is that they can take much longer than the typical foreclosure process would. Like a foreclosure, the borrower cannot retain the property and a short sale can result in negative consequences to a borrower’s credit. Also, a short sale might not be an appropriate alternative should the property be in disrepair; mortgagors can hold the borrower liable on any necessary repairs as the new buyer can seek a property inspection. In addition, foreclosure is a cash-only process—unlike a short sale—which permits the new buyer to mortgage the property, too.

            A Deed in Lieu of Foreclosure

            The “deed in lieu of foreclosure” process can be easily explained: foreclosure can be avoided when the borrower willingly conveys the title to their home or property to the mortgagor in order to be released on their debt “free and clear.”

            Strategic Default

            “Strategic Default” is not a foreclosure alternative per se, as its purpose is related to the borrower’s investment rather than their ability to pay. A borrower may choose to “strategically default” when their home or property is “underwater,” meaning the property cannot be sold at the price it is supposed to be worth. A home or property can be deemed underwater when the housing market has crashed, when the home generally becomes an unwise investment, or needs repairs exceeding the property’s value.

How To Avoid Foreclosure

             Use the Home or Property as a Rental

             Using the home or property that is in danger as rental property could be a reasonable way to create excess income that can be used to get caught up on—and subsequently manage—the borrower’s monthly payments. However, making the decision to use your property as a rental could result in unintended consequences: problem tenants, violating deed restrictions that limit the property’s use as a rental, disgruntled HOAs, and more.

            Forbearance Agreement and Prioritizing Debt

             A forbearance agreement can permit the borrower to make drastically lower payments—or no payments at all—during an allotted period (generally three to six months). This can be valuable when the borrower is expecting a short time decrease in available cash, as the borrower will need to convince the mortgagor that they can make the regular payment later. Once payments resume, the borrower will be required to pay the regular monthly payment plus additional payments to make up for those payments missed. Sometimes, the “makeup” amounts can be paid in a lump sum.

            When it comes to the need to prioritize debt, foreclosure as an ongoing threat can be a big “wake up call.” Should the mortgagor graciously grant temporary forbearance, a borrower should use this time to manage their existing debt to put themselves in a better position to pay their mortgage once it resumes. Everyone needs sustenance, shelter, and basic utilities; these are priorities. The borrower should attempt to eliminate the excess: cable bills, phone bills, credit card debt, etc.

            Refinancing and Redemption

            Most borrowers can opt to refinance their mortgage to get a better interest rate to pay the now-refinanced mortgage. In addition to the opportunity to refinance, all states permit borrowers to “redeem” their property by refinancing it up until the property is sold. While all states permit redemption pre-sale, only some states permit the borrower to redeem their property post-sale. The most obvious roadblock that will prevent redemption is a low credit score, which is likely a given due to the late or missed payments that gave rise to the foreclosure to begin with. Similarly, the “statutory right of redemption” (which is granted by state statutes) permits a borrower to repurchase their property by either: (1) paying the foreclosure price; or (2) the total amount owed on the mortgage plus additional costs.

Redemption laws will vary by state; some permit statutory redemption post-foreclosure while others permit redemption post-foreclosure. This can depend on whether the state is a judicial or non-judicial foreclosure state, whether certain conditions have been met, what the loan documents permit, and whether the total amount remaining on the mortgage can be paid (i.e., whether a deficiency judgment will be sought). The ultimate purpose in statutory redemption is to ensure that potential bidders bid at an equitable price, as a higher bid will prevent the borrower’s attempt to purchase their property, which could open the door to ongoing problems with the borrower’s ability to make prompt payments. 

            Bankruptcy

            Surprisingly, bankruptcy can prevent foreclosure—at least temporarily. When a Chapter 7 or Chapter 13 bankruptcy proceeding has been initiated, the borrower will be temporarily estopped in pursuing repossession. Accordingly, to estop a foreclosure, there must be an existing foreclosure to be stopped. Once the bankruptcy proceeding begins, the borrower will start making their monthly payments as they become due. The upcoming payments can be made pursuant to the borrower’s Chapter 7 or Chapter 13 bankruptcy plan, or through a direct agreement with the mortgagor. A borrower in bankruptcy can be provided with several months to get caught up on their late payments; and their payments can be spread throughout the bankruptcy plan during a 30-60-month period.

Advantages of Foreclosure

            Temporarily Living Rent-Free

            Although advantages are limited, they do exist. For example, one advantage is the opportunity to temporarily avoid rent. Obviously, a borrower is subjected to foreclosure due to their inability to make their monthly payment; the borrower likely needs an opportunity to temporarily avoid rent. Foreclosure can be lengthy, and the borrower is not required to leave their property’s premises until the property has been sold. The interim, rent-avoidance period can provide the borrower with the much-needed opportunity to locate other housing, secure more reliable employment, and explore other sources of income without being obligated to continue to pay their mortgage. Ultimately, a borrower can remain on their property—at least temporarily—whether their mortgage is paid or not.

            Excess Cash on the Property Sale

            As discussed above, although unlikely, the property once sold can result in excess cash once the total outstanding mortgage has been paid. This could provide a borrower with much-needed cash to move on.

            A Finding of Unconscionable Terms in a Mortgage Agreement During Judicial Foreclosure

            When a borrower is experiencing an extreme or excessive struggle in making their payment—whether it be due to a huge interest rate or unreasonable terms contained within the mortgage agreement—it could be due to “unconscionable” terms. The term “unconscionable” can be explained as “unfair or oppressive terms to one party.” Should a court determine that a mortgage agreement’s terms are unconscionable, the court can side with the borrower and excuse their nonpayment, ordering that the mortgage terms be modified. While any borrower can argue based on "unconscionability"—not only those subject to judicial foreclosure—an argument that a mortgage agreement’s terms are “unconscionable” is more common to judicial foreclosures given the court’s already-required involvement in the foreclosure proceeding.

            Consequences of Foreclosure

            A repossession can result in consequences that surpass a person losing their home. Indeed, it can impact every aspect of a borrower’s livelihood: their credit, their ability to obtain a loan later, their opportunities to secure employment and housing, and combating misplaced stigmas surrounding their credibility. However, despite the overwhelming consequences, there is redemption. With time and a pledge to stay the course required to build credit, a commitment to debt management–and seeking the support a credit counselor can provide—a now-previous borrower who has experienced repossession can reclaim their opportunity at home-ownership, their independence, and ultimately their livelihood.

            Drop in Credit Score

            The most obvious consequence associated with foreclosure is a dramatic decrease in a borrower’s credit score. The higher the borrower’s credit score prior to foreclosure, the more drastic the drop. Indeed, the Fair, Isaac and Company, a credit analytics organization, better known as FICO, has measured as much as a 100-point decrease post-foreclosure.

            Problems in Obtaining Another Loan

            A foreclosure will unarguably harm a borrower’s chances at securing a later loan. In some cases, it could take up to seven years to become eligible on a backed loan (particularly when a borrower engages in strategic default, discussed above).

            Admission of Foreclosure on Job Applications

            Employers regularly review prospective employees’ credit reports as a factor in the hiring process. Naturally, this can damage a borrower’s employment prospects. However, whether a previous foreclosure is important to an employer can depend on the position the employee seeks. For example, an employer attempting to hire a call center representative may be less likely to consider a foreclosure appearing on their credit report than if the position demands strong financial and banking skills. However, even when a foreclosure would be material to a borrower’s employment, an employer’s sympathy should not be underestimated. An employee’s willingness to hire an employee with a foreclosure on their “record” could be tied to the circumstances that led to the foreclosure.

            Inability to Secure Housing

            Landlords, like prospective employers, regularly review potential tenants’ credit reports. Accordingly, a competitive housing market could put a potential tenant with a past foreclosure at an immeasurable disadvantage. Indeed, renting rather than owning is likely the only option available—at least during the next several years post-foreclosure—as a tenant with a foreclosure under their belt can expect their credit to be totally shot. Even when a landlord doesn’t actively view potential tenants’ credit report, a landlord will assuredly inquire into a tenant’s experience with foreclosure via the rental application.

            The Stigma of “Immorality”

            As acknowledged above, there is an inherent stigma associated with a borrower that will exceed the foreclosure process. Once the property has been sold, the borrower has “paid the price” outlined in their mortgage agreement: repossession and eviction. However, this doesn’t seem to avoid the long-lasting stigma associated with foreclosure. Ultimately, the borrower has also endured other substantial and unimaginable hardships like the ones discussed above that gave rise to foreclosure: death, divorce, illness, unemployment, etc. And, as we’ve discussed, the post-foreclosure consequences are equally harsh: credit elimination, an inability to secure housing and unemployment, and more. It is important, as a society, that we recognize that a single mistake can result in losing everything—no one is exempt. While we are quick to recognize a struggling borrower’s shortcomings, we are slow to recognize what could also be considered the “immorality” and unethical nature mortgagors can exhibit, as we are borrowers can be seen as no more than the mortgage agreement they agreed to. Certainly, in this sense, the unequal power dynamic between mortgagors and borrowers could stand to be improved. However—in the end—both mortgagors and borrowers are nothing more than mere cogs in an ever-changing housing climate.

            If you are considering purchasing a home or are worried that your home could be repossessed, consider speaking to an experienced attorney that can address your individual circumstances. No matter your current position, an attorney can assist you in developing a plan that can assist you in meeting your objectives.