No one wants to think about losing their home. Even if you don’t own a home yet, just seeing the word “foreclosed” in real estate listings might make you nervous. Whether you’re in the general market or specifically looking at foreclosed homes to buy, it’s important to understand exactly what foreclosure is and what happens to houses and homeowners when the foreclosure process begins.
What Is Foreclosure?
Foreclosure happens when a borrower fails to pay their mortgage payments and the lender or mortgage investor must repossess and then sell the home. Foreclosure can also happen when the homeowner fails to pay their property taxes or homeowners association fees.
When it comes to understanding foreclosure, there are three important definitions to know:
- Foreclosure: the legal process in which a lender or mortgage investor takes back unpaid property
- Home in foreclosure: a property going through the foreclosure process
- Foreclosed home or REO: a property that has gone through the foreclosure process and is now owned by the lender or bank, also known as a real estate-owned property (REO)
Foreclosed homes and REOs are usually of particular interest to buyers, since these properties typically come at a lower price than comparable, non-foreclosed homes.
How Foreclosure Works
After the foreclosure, the mortgage lender will take control of the property and attempt to sell it to recoup the money it lost from the mortgage default. The lender is allowed to take back the home because a mortgage is a secured loan. That means the borrower guarantees repayment by providing collateral. If they can’t pay back the loan with money, they use the collateral instead.
In the case of a mortgage, the home is used as collateral and, upon signing closing documents, the borrower recognizes that the lender has the right to foreclose on the home if they default on the loan. This is also known as putting a lien on the title of the home. Once the mortgage is paid off, this lien on the title of the home is removed.
Why Do Homeowners Go Into Foreclosure?
At the time of getting their mortgage, most people are typically in a position to successfully make payments on their loan. And most lenders ensure this by verifying income, reviewing credit history and putting a limit on the borrower’s debt-to-income ratio (DTI). But despite all of these assurances, things don’t always go as expected, and there are a number of reasons a homeowner may fail to make their payments.
Many times, a person facing foreclosure has experienced a life event that changed their financial circumstances. Because of this, they can no longer afford their monthly payment. Examples of such events include:
- Loss of employment
- Taking on excessive debt
- Experiencing a medical emergency
- Incurring a large, unexpected expense
- Losing part or all of their income due to divorce or death
- Experiencing an increase in living expenses
- Relocating before selling the home
- Experiencing distress from a natural disaster
Increased Mortgage Payments
It isn’t just a hardship that causes homeowners to go into foreclosure. It could also be something as simple as an increase in their mortgage payment. For example, those with an adjustable-rate mortgage may have an increase in interest, which will raise their mortgage payment. Or, if there is an escrow shortage due to a rise in property taxes or insurance premiums, the escrow payment will increase. And since property taxes and homeowners insurance are typically paid through the monthly mortgage payment, the monthly payment will rise as well.
These instances are not uncommon with mortgages, and they depend on the terms of the mortgage in question. However, homeowners who don’t understand their mortgage terms may be caught off guard and unprepared for even the slightest change.
While most homeowners go into foreclosure because they cannot make their mortgage payment, some enter into foreclosure because they intentionally miss their payments. This often happens when their home is underwater and they no longer have any financial motivation to continue to pay their mortgage.
When a home is underwater, the amount owed on the mortgage is more than the home is worth. When they no longer have equity, some homeowners see no reason to continue making their payments. Instead, they “walk away” from the home, leaving the lender to deal with it.
The Foreclosure Process
There are two types of foreclosures:
- A judicial foreclosure involves going through a court and allows the homeowner to contest the foreclosure.
- A nonjudicial foreclosure does not require court action. The type of foreclosure and the process it uses will differ from state to state.
Whatever the type of foreclosure and whatever the state, the process generally involves five stages.
Stage 1: Missed Payments
No matter the reason a homeowner goes into foreclosure, the process begins the same way: with missed payments. Once the homeowner begins missing payments, they are no longer upholding their responsibilities of the loan, and the lender can come to collect.
What many homeowners don’t realize is the foreclosure process can be expensive for the lender, so they will want to avoid foreclosure, too, if possible. In most cases, lenders are willing to work with the homeowner to restructure the loan and lower or delay payments. If the homeowner needs additional assistance, they may find it through:
- Foreclosure mediation
- HUD-certified financial counseling
- Government mortgage relief programs
- Home loan modification programs
There are steps you can take to avoid foreclosure. If you are a Quicken Loans® client and need assistance, please call our customer service number at (800) 508-0944 so we can go over your options to help you get back on track.
Stage 2: Public Notice
Once the homeowner misses 3 – 6 months’ worth of payments, the lender will give a public notice or file a lawsuit with the court. Also called a Notice of Default (NOD), or lis pendens (suit pending), the public notice is a written notification to the homeowner that the lender will pursue legal action if the debt is not paid.
Stage 3: Foreclosure
Once the lender records the public notice, the foreclosure stage begins, and the home enters the early stages of repossession. At this point, the homeowner typically has 90 days to take action. If they want to avoid a foreclosure sale and avoid eviction, they have a few options:
- Reverse the default by paying the outstanding balance
- Sell the property because there is equity to complete a full pay off of the loan.
- Sell the property in a short sale before it goes to foreclosure
- Sign the deed over to the lender through a deed in lieu of foreclosure
The Short Sale Option
A short sale is a voluntary sale of the home before foreclosure. It is called a short sale because the sale price usually comes up “short” of the balance owed. When that happens, all of the proceeds from the sale go to the lender and the sale cannot happen unless the lender approves it.
A short sale is usually preferable for both the homeowner and the lender because:
- It will be less damaging to the homeowner’s credit and ability to obtain another mortgage in the future.
- It will help the lender recover as much of the loan balance as possible while avoiding the cost of a foreclosure.
- If the sale price is more than what is owed, the homeowner will get to keep whatever money is left after the mortgage is paid off.
The Deed In Lieu Of Foreclosure Option
Another way for both parties to avoid foreclosure is with a deed in lieu of foreclosure. In this transaction, the homeowner voluntarily signs the deed over to the lender or bank and is released of all mortgage obligations.
Again, by avoiding foreclosure, the homeowner’s credit and mortgage eligibility may take less of a hit. The lender may benefit by avoiding the costs and additional time involved in the foreclosure process. However, it may only approve a deed in lieu of foreclosure if the homeowner cannot sell the home in a short sale and there are no other liens on the property. Even then, the lender may not accept this offer.
If the homeowner cannot sell the home in a short sale, make up the late payments or pursue a deed in lieu of foreclosure, the home will then go to public auction.
Stage 4: Auction
When the time comes, the mortgage investor or its representative, the trustee, will put the home up for auction. Also known as a foreclosure sale, the auction is open to the public and will often take place on the steps of the county courthouse, in a conference room or convention center, or even online. Before the auction, a Notice of Trustee’s Sale (NTS) will notify the homeowner and the public of the auction and provide such information as a date, time and location.
Since the mortgage investor, terms of the loan and specific state guidelines control the policies of the auction, every auction will be different. However, you can expect similar processes and requirements.
At the auction, the minimum bid is normally set at the balance owed on the loan, and the foreclosed home is sold to the highest bidder. That person must pay cash for the full amount or a significant deposit immediately. Though the highest bidder is the winner of the auction, they may not necessarily win ownership of the home. In some states, the previous homeowner has a “right of redemption” that allows them to buy their home back even after it is sold at auction. Typically, they will need to pay the sale price or full loan balance, plus any interest and costs the bank incurred during the process. Depending on the state laws and the method of foreclosure, a homeowner’s right of redemption could be valid up to the time the court clerk files the certificate of sale, or as long as 1 year after the sale.
Stage 5: Post-Foreclosure
If the home was purchased at auction, the previous homeowner must move out of the home, and the new homeowner can do with the home as they please. Some people move into the home as their permanent residence while others rent out or sell the home and make a profit.
Oftentimes, the home does not sell at auction because the mortgage investor does not approve any bids or the pool of buyers who can pay cash is limited. When this happens, the foreclosed home becomes a bank-owned property, also referred to as a real estate-owned property. As stated before, an REO is not the same thing as a home in foreclosure. A home in foreclosure is going through the process of being repossessed by the bank, while an REO is a home that has already been repossessed by the bank. In an REO, the bank is the sole owner of the property.
As the owner of the property, the bank must pay property taxes on the home. Add that to the costs incurred during the foreclosure process and the money lost during default, and it’s easy to see why the bank will want to get rid of the REO home as soon as possible. However, a motivated seller doesn’t always mean the home will sell for dirt cheap. Keep this in mind when buying a home in any stage of the foreclosure process.
What To Know Before Buying Foreclosed Properties
It can be hard to pass up a good deal, especially when it’s on a large purchase like a home. That’s why many home buyers turn to foreclosed homes in hopes of getting more space in a better area and with a much lower price tag. But remember – the property may not be perfect and the process isn’t always easy. It’s best to know what to expect and what to be cautious of upfront before buying a foreclosed home.
The Foreclosure Market
Foreclosure purchases thrived in 2009 – 2010 when a recession-battered housing market hit its peak foreclosure rate. During that time, more than 5 million homes went into foreclosure, and home buyers could often purchase them at more than half off the original price in many areas across the U.S.
Now that the market is in better health and due to the foreclosure moratorium in response to COVID-19, foreclosed homes are at a 16-year low, with only 214,323 properties filing for foreclosure in 2020, according to the ATTOM Data Solutions 2020 Foreclosure Market Report. With less of these homes available at a higher value than before, the foreclosure market may be slowing down. But foreclosed homes are still priced much lower than the average American home for sale, and there is still an opportunity to find that great deal for the person who knows how to navigate the foreclosure market.
The Condition Of The Home
One important consideration is that the condition of a foreclosed home can be a toss-up. Typically, there are some issues with this type of home, and they can range from minor repairs to absolute deal breakers. Think about it: If the home is going through foreclosure because the person couldn’t afford their monthly payments, chances are they didn’t have the extra funds for other housing costs, including general upkeep, replacements and repairs.
The Purchase Method
There are also a few different ways to buy the home, and some methods will fit your goals better than others. How you purchase the home and from whom you purchase it will depend on if you are buying a home in foreclosure or buying an REO property. Because of this, there are specific factors to consider when purchasing from the homeowner (stages 1 – 3), at the auction (stage 4) or from the bank (stage 5).
The Bottom Line: Foreclosed Houses Can Become New Homes
For some buyers, the relatively low price tag of a foreclosed house can make a huge difference for their prospects of homeownership. Before you dive in, just make sure you know what you’re getting yourself into. Research where you can, and think carefully about whether you’re ready to take on some of the potential risks of purchasing foreclosed property.
If you’re ready to get started, you can get mortgage approval online through Rocket Mortgage®.
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