Most homeowners can’t afford to purchase their home outright, so they take a home loan from a bank or another mortgage company. The bank earns interest, and you, the homebuyer, can pay off your home as you slowly work towards fully owning it.
But what happens if you lose your job or start having financial difficulties? What if you can no longer make the monthly payments on the mortgage? This is when your home can go into foreclosure. In this article, we’ll talk about what foreclosure is, the process that’s involved, how to avoid it, and how, as a real estate buyer or investor, you can find foreclosed homes to purchase.
What is a foreclosure?
Foreclosure is a legal process that a lender initiates to recover the amount owed on a defaulted loan. This is done by taking over ownership of the mortgaged property and selling it. If the property doesn’t sell in a public auction, the lending institution takes possession of it.
It’s important to understand that while “homeowner” describes the person who has taken out a mortgage to purchase a home, technically, the house isn’t owned until the loan has been fully paid off. Therefore, if you default on your mortgage loan by missing several payments, the lender can take control of the property to recover their loss. Generally, lenders will try to work with borrowers to get them caught up on payments and avoid foreclosure whenever possible.
Following the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act placed a temporary moratorium on foreclosures, which meant that for a period of time, no foreclosures could take place. Instead, homeowners struggling to pay their mortgages could request forbearance. This relief program allowed homeowners to pause or reduce their mortgage payments for a few months with no increases or penalties. The Federal Foreclosure Moratorium ended on July 31, 2021.
Types of foreclosure
Depending on the state where the property is located, there are two main ways a home can be foreclosed on:
- Judicial foreclosure: With a judicial foreclosure, the lender must file a lawsuit to initiate the foreclosure. The borrower is then notified of a non-payment and has 30 days to make up the missed payments, after which the foreclosure process begins. Once the court orders the home’s sale, it is auctioned off to the highest bidder. Judicial foreclosure is the norm in 22 states, including Florida, Illinois, and New York.
- Nonjudicial foreclosure: Nonjudicial foreclosures, also called power of sale, do not need a court to get involved before a home can be foreclosed on. Instead, they rely on a power-of-sale clause in the mortgage or deeds of trust, which stipulates that if the borrower falls behind on their payments, the mortgage provider is allowed to put the house up for action. There is no court hearing in a nonjudicial foreclosure, which means it’s a lot faster and less expensive for the lender to sell the house and recover the loan. Nonjudicial foreclosure is primarily used in 28 states, including Arizona, California, Georgia, and Texas.
The process of foreclosure
Each state has laws around foreclosures, which are the last step in a lengthy process that can take several months or even years to finalize. Here’s how it generally plays out:
Step 1: Missed payments
Foreclosures start with payments that are past due, often caused because of financial hardship resulting from unemployment, death, divorce, or medical/health challenges. A delayed payment will likely only result in your being charged late fees, and a missed payment or two won’t start the proceedings, especially if you get in touch with your lender and work out a plan. Since a foreclosure costs your lender money, they are more inclined to work with you to avoid such an eventuality. However, once you’ve missed three to six months of mortgage payments, the lender will take action.
Step 2: Public notice
After three to six months of missed payments, the lender must file a Notice of Default (NOD) with the County Recorder’s Office. In some states, this is called a lis pendens, Latin for “suit pending.” You will also be notified via certified mail, and, in some states, the lender may be required to post the notice on your front door specifying how much you owe. A Notice of Default is the first step in the foreclosure proceedings and doesn’t automatically equate to losing your home. It is still possible, at this stage, to work out a plan with your lender or get current on your payments and stop proceedings entirely.
In a judicial foreclosure, the lender will file a lawsuit in court to foreclose on the home, and you’ll receive a copy of the complaint and have 30 days to respond to the lawsuit.
Step 3: Pre-foreclosure
Pre-closure is the grace period between the Notice of Default being posted and the auction or sale of the home. The number of days can vary by state, but typically it’s between 30 and 120 days. During this period, the borrower can still pay back the outstanding amount and prevent foreclosure and eviction. Another alternative is a short sale; the borrower can sell the home and use the money from the sale to pay the lender.
Step 4: Auction
If, after the waiting period, neither a short sale nor a repayment has been made, a date is set for the house to be sold at a foreclosure action, also sometimes referred to as a Trustee Sale. In some states, borrowers have the right of redemption; that is, they can come up with the money owed and stop the foreclosure right up to the moment the home is auctioned off.
The home is sold to the highest bidder at the auction for a cash payment. If the home sells for less than it is owed, some lenders may try to recover the outstanding balance from the borrower. However, it’s important to note that many states now have anti-deficiency laws or restrict deficiency judgments after a foreclosure, so it’s best to know your rights before agreeing to anything in writing.
Step 5: Post-foreclosure
Once the home is sold, the borrower receives a written notice, giving them three days to move out. Foreclosures stay on your credit report for seven years.
If the home does not sell at auction, the lender takes ownership of it, and the home becomes a bank-owned property or REO (real estate owned). These properties are then listed for sale on the open market by local real estate agents. They can also be sold at liquidation auctions.
According to data from ATTOM Data Solutions, foreclosed properties in the first half of 2022 spent an average of 948 days in foreclosure. This means that even though a few missed payments can begin the process, there are still multiple opportunities for a borrower to avoid losing their home before a foreclosure sale. Here are some options:
- Contact your lender: The very first thing to do if you’re having difficulty making your mortgage payments is to contact your lender and ask about foreclosure prevention, loan modification, or mortgage relief options they may have available.
- Ask for forbearance: While Covid-19 related forbearance is no longer available, if you’re experiencing temporary financial hardship, ask your lender if they’ll agree to reduce or suspend payments for a specific period.
- Refinance your home: Refinancing is not possible once the foreclosure proceedings start. However, it’s worth looking at refinancing options if you foresee it happening. Pay attention to interest rates to ensure you can afford future payments.
- Apply for a short sale: In a short sale, you sell your home for less than what you owe on your mortgage, with your lender receiving all the proceeds from the transaction. Your bank or lender will have to approve this.
- Look into FHA programs: The Federal Housing Administration (FHA), part of the U.S. Department of Housing and Urban Development (HUD), offers assistance to FHA-insured homeowners facing financial hardship. Through their National Servicing Center (NSC), the FHA provides several loss mitigation programs that can offer homeowners in difficult situations with temporary relief. The Making Home Affordable Program (MHA) also has housing counselors you can call for free for advice and assistance.
- Sign a deed in lieu of foreclosure: If you cannot catch up on payments and don’t qualify for any loss mitigation options, consider signing a deed instead of foreclosure, which gives the lender the deed to your home and releases you from further payments. While you still lose your home, this option won’t impact your credit negatively as a foreclosure.
Buying a foreclosed home as an investor
With the Federal Foreclosure Moratorium ending last year, foreclosures have reached pre-pandemic levels nationwide, according to ATTOM’s August 2022 U.S. Foreclosure Market Report. It’s important to acknowledge the hardship that results in these filings. That said, homes in foreclosure do open up opportunities for buyers and investors looking for real estate deals and potential house flips. Some ways to purchase a foreclosed home are:
- Directly from the homeowner: A short sale can be an excellent way for a homeowner to avoid foreclosure and, therefore, damage to their credit score while allowing you to purchase a property for substantially less than its market value.
- At auction: A foreclosure auction is another way to purchase one of these properties. Be cautious, however. Auction purchases do not allow for inspections and can be risky.
- From the bank: If a property doesn’t sell at auction, it becomes real estate owned and can be bought directly from the bank.
- From the government: When properties with government-sponsored mortgages are foreclosed on, you have the option to buy the property directly from the government agency. This can often be a good deal since government agencies offer incentives and protections that commercial mortgage lenders don’t.
The bottom line
As a homeowner, a foreclosure can lead to losing your home, damaging your credit, and making it challenging to purchase again. When possible, you want to take the necessary steps to avoid foreclosure and negotiate a settlement with your lender that allows you to pay off your mortgage on a modified schedule.
If you’re ready to invest in real estate, we can help. With Arrived Homes, it’s easy to get started by purchasing shares in any of our rental properties for as little as $100, no matter your credit rating. To get started, browse through our available properties on this page.