How Foreclosures Work

The foreclosure process differs by state, but we can take a look at the general steps that are taken. If you're faced with foreclosure, it's important that you research your state's laws and practices.

Foreclosure proceedings can begin after a single missed payment, but it isn't very likely. Most banks and lenders have a grace period for late payments, usually with a fee added on. It typically takes being a full 30 days late for the alarm bells to go off. After the second missed payment, you'll be getting some phone calls. Many lenders will only accept both late payments to bring the loan current. They also may refuse any partial payments.

Once you fall three months behind, things get serious. This is typically when most lenders will begin the foreclosure process in one of two ways: judicial sale, which requires that the process go through the court system, or power of sale, which can be carried out entirely ­by the mortgage holder.

All states allow judicial sale, while only 29 allow power of sale. If your state allows power of sale, the loan papers will usually have a clause that says this method will be used. Power of sale is typically faster than the judicial route. Let's look at both methods.

Judicial sale:

Power of sale:

Both types of foreclosure require that any other involved parties be notified of the proceedings. For instance, if the homeowner took out another loan against the house with a third party, that lender must be contacted and its loan amount must be paid from the auction's proceeds. If the third-party lender isn't paid, it can apply the mortgage to the new property owner. Many times, the lender will actually buy the property back and attempt to sell it through the real estate market at a later date.

There can also be deficiency judgments made against the borrower if the sale of the property doesn't satisfy the amount of the loan. The entire difference between the two can be required, although some states only require that difference between the fair value of the property and the loan amount be paid.

There's one more type of foreclosure that's almost completely obsolete, called strict foreclosure. In these cases, once judgment is made on the lawsuit, the property is automatically assumed by the mortgage holder. Only Connecticut and Vermont still allow this practice [source: Realty Trac].

In the next section, we'll give you some tips to help you avoid foreclosure.

Foreclosure is bad for both the lender and the borrower. The homeowner loses his or her house, and the lender loses anywhere from 20 to 60 cents on the dollar [source: FDIC]. This is important to remember if you fall behind on your loan. The single most important step you can take to avoid foreclosure is to communicate with your lender. Most people are scared and embarrassed to the point that they ignore calls and letters from their lender. This is human nature, but it's the worst thing you can do if you want to hang on to your home.

Many lenders will work with you to avoid the foreclosure process. They will deal with your case on a personal level, and your circumstances will be taken into account. If you only fall one or two payments behind, the mortgage holder will mail you a loan workout package that will help you catch up with your loan. The package consists of information, instructions and forms regarding your ability to make payments.

If your situation is temporary, there are some other solutions:

­In the next section, we'll look at some of the effects foreclosure can have on you and your community.

The most obvious effect of foreclosure is that you now find yourself without a home. Many people rely on family at this point to get them through the coming months. Some people are able to afford to move into an apartment while they get their finances back on track. Sadly, some people that suffer foreclosure find themselves homeless. Most states have homeless prevention programs that assist people who are down on their luck and in need of a boost. If you've been foreclosed on and have no housing options, check with your state and local department of human services to see if they can assist you.

Your credit rating is another way foreclosure can affect you. While being foreclosed on does have a negative impact on your credit rating, it doesn't damage it beyond repair. Credit ratings are based on your credit history, so the foreclosure will be factored in along with everything else. If you had a good rating before you fell behind on your loan, you might be surprised at how high your credit score is after you foreclose.

The most important thing to do after foreclosure is to try and repair your credit. Make sure all your other accounts are current and paid up. You may try and secure a smaller loan -- making payments on this loan will help you repair your credit. You may even be able to secure another home mortgage at a less-than-prime rate with a large down payment.

If you've been foreclosed on, you may have trouble finding or keeping employment. Some employers require a good credit rating to get hired, and foreclosure can even be grounds for termination. Stress and depression are also common effects of foreclosure. A lack of self-esteem and self-worth are typically associated with people that have lost their homes.

The trickle down effect of foreclosure can also have a serious impact on your community. One foreclosure can ring up as much as $34,000 in local government agency bills. Trash removal, unpaid utilities, sheriff and police costs, inspections and potentially even demolition of the property all contribute to that cost. Property values also decrease near foreclosed properties. In some housing markets, up to $220,000 in reduced property value can be expected [source: Apgar, Duda, Gorey].

You can learn more about foreclosure and the housing market by looking into the links on the next page.