You made smart decisions on the path to realizing your dream of homeownership. You prioritized your spending and saved enough money for a small down payment. Your mortgage broker was creative, accommodating and worked out a loan that fit your budget. You signed the closing papers, got the keys, moved in and settled into what you hoped would be a long stay in your home. Then the unthinkable happened. You got laid off from your job. Or maybe you or a family member had an accident that strained your finances. If you're in the National Guard, you may have gotten called into active duty, forcing you to close your business temporarily. Or perhaps your variable rate loan increased your monthly payments and your home didn't appreciate enough to refinance. All of these scenarios play out every day in real life, and the sad result can be foreclosure.
If you suddenly find that you can't afford to pay your monthly loan payment, your lender has the legal right to repossess your home and resell it to recoup the cost of the loan. Foreclosure is a legal course of action in which nobody really comes out on top. It's a stressful and unfortunate situation for the homeowner and lender alike. Many people remain in denial about their finances, making the situation worse. As unfortunate as the foreclosure process may be, there are things you can do to save your home if you're faced with it.
As the real estate bubble in the United States has begun to burst, the foreclosure rate has soared. The housing boom saw unparalleled growth from 2001 to 2005. Adjustable rate mortgages (ARMs) and subprime loans made buying a house possible for many people who never thought they had the money or credit to do so. ARMs have low initial rates that typically go much higher after the first year or two. Subprime loans allow people with poor credit to secure financing at high rates. Mortgage brokers used both of these methods to get loans secured, and many of the borrowers soon found out they couldn't afford their monthly payments.
Here are some startling foreclosure statistics in the United States, according to CNN Money:
- Nearly 1.3 million homes were foreclosed on in 2006.
- Colorado had the highest rate of foreclosure -- one out of every 376 houses.
- The total number of filings is up 43 percent from 2005.
- Real estate experts predict even more foreclosures in 2007.
Additionally, a recent poll shows that more than six in 10 homeowners wish they better understood the terms of their loan, and 60 percent of borrowers in mortgage trouble aren't aware of services that can help them avoid foreclosure [source: FDIC].
In this article, we'll look at the foreclosure process and help you understand the different types of foreclosure. We'll also let you know some steps you can take to avoid it and how it can affect you and your community.
The Foreclosure Process
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.
- The mortgage lender will file suit with the court system.
- You'll receive a letter from the court demanding payment.
- Typically, you'll have 30 days to respond with payment to avoid foreclosure.
- At the end of the payment period, a judgment will be entered and the lender can request sale of the property by auction.
- The auction is carried out by the sheriff's office, usually several months after the judgment.
- Once the property is sold, you're served with an eviction notice by the sheriff's office, and you must vacate your former home immediately.
Power of sale:
- The mortgage lender will serve you with papers demanding payment.
- After an established waiting period, a deed of trust is drawn up that temporarily conveys the property to a trustee.
- The trustee will sell the house at public auction for the lender.
- Many times, these foreclosures are subject to judicial review to make sure everything was carried out legally.
- There is usually a requirement for the lender to post a public notice of sale for the auction.
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.
How to 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:
- The Federal Housing Authority (FHA) is willing to help. If your loan is FHA-approved, you can get in touch with an FHA housing counselor who will walk you through possible solutions. This counselor will negotiate with the lender for you and will even help you work out a monthly budget plan.
- If the area where you live or work has been declared a natural disaster by the federal government and you're facing foreclosure, the FHA provides relief plans to assist you. In most cases, you can get up to three months' relief from your monthly loan payments while you work out your home or work situation.
- Forbearance is when your lender agrees to suspend your payments temporarily if you agree to another option to satisfy your loan amount. The option is usually reinstatement -- you pay the outstanding amount in one lump sum. If you know you have a large amount of money coming your way soon, these options are good ways to prevent foreclosure.
- Mortgage modification is when your lender agrees to change the terms of your mortgage to make it more affordable for you.
- You may be eligible for a partial claim if you're able to begin making payments again but not able to bring your account current. Your lender would assist you in getting an interest-free loan that will bring your account current and you can resume payments. Payment on this loan can be delayed for a period of time.
- If you aren't able to keep your home, you can sell it to pay off your loan. If this is the case, call your lender -- it can suspend your loan payments while you sell your house and may even accept less than the loan amount if you sell it quickly. A final option is to surrender your deed-in-lieu of foreclosure. This is when you simply hand your property back to your lender.
In the next section, we'll look at some of the effects foreclosure can have on you and your community.
Effects of Foreclosure
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.
Related HowStuffWorks Articles
More Great Links
- "About the Servicemembers Civil Relief Act." Department of Homeland Security, 2007. http://www.uscg.mil/legal/la/topics/sscra/about_the_sscra.htm
- Apgar, William C., Mark Duda, and Rochelle Nawrocki Gorey. "The Municipal Cost of Foreclosures: A Chicago Case Study," February 27, 2005. http://www.nw.org/network/neighborworksProgs/foreclosuresolutions/ documents/2005Apgar-DudaStudy-FullVersion.pdf
- Christie, Les. "Crime Scene: Foreclosure." cnnmoney.com, November 19, 2007. http://money.cnn.com/2007/11/16/real_estate/suprime_and_crime/index.htm?section=money_topstories
- Christie, Les. "Foreclosure Rates up big in December." cnnmoney.com, January 2007. http://money.cnn.com/2007/01/16/real_estate/December_foreclosures_up_from_2005/index.htm
- "Foreclosure procedures by state." Realty Trac, 2007. http://www.realtytrac.com/education/noframes/foreclosurePro.html
- "Foreclosure Statistics." fdic.gov, 2007. http://www.fdic.gov/about/comein/files/foreclosure_statistics.pdf
- "Foreclosure." Encyclopedia of Everyday Law. Ed. Shirelle Phelps. Gale Group, Inc., 2003. eNotes.com. 2006. November 29, 2007. http://www.enotes.com/everyday-law-encyclopedia/foreclosure