What Is Foreclosure?

"Foreclosure" is the legal process that allows a lender, or the subsequent loan owner, to sell your home to satisfy a mortgage debt.

By , Attorney · University of Denver Sturm College of Law

A "foreclosure" is the forced sale of a property due to non-payment of a loan. If you default on a mortgage loan, the lender will use this legal process to sell your home to satisfy the debt you owe.

Some states require foreclosures to go through court (judicial foreclosures). In others, the process usually consists of out-of-court procedures (nonjudicial foreclosures).

At the end of the process, the lender will become the new property owner if no one else makes a bid at the foreclosure sale. If a third party makes the highest bid on the home, the lender applies the proceeds from the foreclosure sale to the borrower's outstanding debt.

Who's Who in the Mortgage Industry

The key parties involved in most home loan transactions and foreclosures are:

  • The borrower. The "borrower" is the individual (the homeowner) who borrows money and pledges the home as security to the lender for the loan. The borrower is sometimes called the "mortgagor."
  • The lender. The "lender" originates the loan. Sometimes, the lender is called the "mortgagee."
  • The investor. An "investor" buys loans from lenders. Fannie Mae and Freddie Mac are, for example, investors.
  • The servicer. The "servicer" handles the loan account. You make your monthly payment to the servicer. Often, the servicer is a third party that manages the account for a fee on behalf of the lender or an investor. A servicer's duties include collecting and processing loan payments, as well as initiating and monitoring a foreclosure when a borrower stops making payments.

How Home Loan Transactions Work

Buying a home usually involves a large amount of money, so it's common for a buyer to take out a loan rather than pay the entire amount in cash. As part of a home loan transaction, a borrower typically signs two main documents: a promissory note and a mortgage (or deed of trust).

The Promissory Note: Like an IOU

A "promissory note" is a document that contains a borrower's promise to repay the amount borrowed.

Mortgages and Deeds of Trust Give the Power to Foreclose

A "mortgage," or, in some states, a "deed of trust," is the contract that gives the lender the right to foreclose if the borrower doesn't make payments on the loan. When the lender records this document in the land records, it creates a lien on the home.

Endorsements and Assignments

Promissory notes are transferable, and banks often buy and sell home loans. When a loan changes hands, the promissory note is endorsed (signed over) to the loan's new owner.

The seller documents the transfer by recording an assignment of the mortgage or deed of trust in the land records.

How the Foreclosure Process Works

If you default on your loan by falling behind in payments or breaching the agreement in some other way, the servicer will probably refer the loan to an attorney or trustee for foreclosure.

Foreclosure works differently in each state, but the two basic types are judicial foreclosures, which go through the court system, and nonjudicial (out-of-court) foreclosures. Here's a brief summary of how both processes work, with more details below.

Judicial Foreclosure Process

In about half of the states, the lender must file a lawsuit in court to foreclose. After a judge approves the foreclosure, the home is sold to a new owner at a foreclosure sale, usually an auction. A couple of states allow strict foreclosures, which also go through court, but after a judge grants a foreclosure judgment, ownership of the home goes directly to the lender.

Judicial foreclosures typically take at least several months, sometimes a few years, to complete. You may live in the home without making payments while the foreclosure process is ongoing.

Nonjudicial Foreclosure Process

In the remaining states, the lender can use an out-of-court foreclosure process. (Judicial foreclosures are allowed in these states as well.) In a nonjudicial foreclosure, the lender must follow a series of specific steps described in the state laws before selling the home at a foreclosure sale.

The nonjudicial foreclosure process varies from state to state. Typically, the lender must record a notice in the land records and send a notice to the borrowers.

Nonjudicial foreclosures are usually faster than judicial ones, often taking just a few months or less.

What Are the Steps of Foreclosure?

No matter what state you live in, you can usually count on the foreclosure process having six basic steps.

Step 1: Payment Default

A "default" happens when you don't make a payment on your mortgage loan or if you violate the loan contract in some other way.

If you don't make your monthly payment on time and the grace period expires, your loan servicer can charge a late fee to your account. Often, mortgage payments are due on the first day of the month, and many lenders provide a grace period. The grace period is usually around ten or 15 days. Also, most lenders charge around 4-5% of the payment amount for a late charge. To find out your loan's grace period and late fee amount, check the promissory note you signed at closing. If you miss a payment, you become delinquent on the account.

After two missed payments, federal law usually requires the servicer to contact the borrower personally or by phone and in writing to discuss ways to avoid foreclosure and to describe various loss mitigation options.

Step 2: Notice About the Default

After you become around 90 days behind on payments, the servicer will probably send you a notification called a "breach letter" or "notice of default." This letter describes the default. Most mortgages and deeds of trust require this notification before the lender can accelerate the loan. The breach letter usually gives the borrower 30 days to pay the overdue amounts to reinstate the loan.

Also, some state laws require the lender to send the borrower a specific preforeclosure notice after a mortgage default.

Step 3: Foreclosure Process

If you don't reinstate the loan or work out a loss mitigation option, and become more than 120 days behind on the mortgage payments, the servicer may begin the foreclosure process. State foreclosure laws and the circumstances of your case determine whether the foreclosure process will be judicial or nonjudicial.

Judicial Foreclosures Go Through Court

Again, in a judicial foreclosure, an attorney files a lawsuit in court on behalf of the lender or investor to foreclose the home. You'll receive a copy of the complaint, sometimes called a petition, which starts the foreclosure. You then get a limited number of days, like 30, to respond to the lawsuit.

Most judicial foreclosures are uncontested, and the lender gets a default judgment against the borrower. But if you choose to file an answer and raise a valid defense, like the foreclosure process had procedural deficiencies, or you raise other substantive defenses or counterclaims, then the case goes through the litigation process like a regular civil action.

If you don't file an answer in court or if you file a response but the court decides the foreclosure should go ahead, the court will grant a judgment of foreclosure in favor of the foreclosing party and set a sale date.

Nonjudicial Foreclosures Generally Don't Involve Any Court Action

All states allow judicial foreclosures, but about half also permit nonjudicial or "power of sale" foreclosures. In a nonjudicial foreclosure, an attorney or trustee (on behalf of the lender or investor) completes certain out-of-court steps.

In a nonjudicial foreclosure, the foreclosing party has to notify the homeowner about the default and the foreclosure sale. Typically, a nonjudicial foreclosure involves one or more of the following steps, depending on state law:

  • mailing the borrower an official notice of default that tells how much time the borrower has to reinstate (while some people call a breach letter a "notice of default," this notice of default is different; sometimes legal terminology can be confusing)
  • recording the notice of default in the local land records office
  • advertising the sale in a newspaper for a few weeks before the sale, and
  • mailing the borrower a notice of sale that states when the property will be sold.

Depending on state laws, a borrower might get a combined notice of default and sale, just a notice of sale, or notice by publication in a newspaper and posting on the property or in a public place. To contest a nonjudicial foreclosure, you'll have to start a lawsuit.

A couple of states allow lenders to foreclose by court order, without holding a sale, in a process called a "strict foreclosure."

In a strict foreclosure, the lender goes to court to ask for an order declaring the borrower in default on the mortgage and permitting it to foreclose. If the court agrees that the borrower is in default, it will approve the foreclosure and give the title to the home directly to the lender. A foreclosure sale doesn't happen like with a judicial or nonjudicial foreclosure.

Strict foreclosure is only allowed in two states: Connecticut and Vermont.

Step 4: Foreclosure Sale

A foreclosure sale is typically an auction where the public, as well as the foreclosing lender, may bid on the property. The highest bidder becomes the new owner of the home.

How the foreclosure sale works, including the rules for timing and bidding, varies by jurisdiction. State statutes often govern foreclosure sale procedures, especially for judicial foreclosures, including minimum bid requirements, appraisal requirements, deposits, and completion. But some places let the local government official, usually the sheriff, handle the details of bidding procedures.

The lender bids at the foreclosure sale using a credit bid. A "credit bid" is when the lender bids the amount it's owed on the loan rather than bidding with cash. Basically, the lender gets a credit at the sale up to the amount of the borrower's mortgage debt. The lender can bid the full amount of the debt, or it may bid less. If the lender bids less than the full debt, you might have to pay a deficiency judgment.

If a third party is the highest bidder at the auction, the proceeds from a foreclosure sale are first paid to the foreclosing lender and also toward the expenses of the sale. Then, if the sale brought in any surplus funds, those funds go toward paying off junior lienholders in the order of priority. If any money is left after all liens are paid off, the excess proceeds go to the foreclosed homeowner.

Step 5: High Bidder at the Foreclosure Sale Becomes the Property's New Owner

In most cases, the lender will be the highest bidder at the foreclosure sale. If the lender is the high bidder at the foreclosure sale and gets title to the home, the home becomes "REO," which stands for "real estate owned." Sometimes, people refer to REO properties as "bank-owned" properties. A property might also become REO through another liquidation process, like a deed in lieu of foreclosure. The lender will then try to sell the property on its own, through a broker, or by using an REO asset manager.

Again, the foreclosing lender usually makes the highest bid at the foreclosure sale. But keep in mind that other parties can bid on the home at the foreclosure sale. However, they'll have to pay cash or a cash equivalent, like a cashier's check.

Step 6: Eviction

You own your home up until the foreclosure sale. State law says how long you get to live in the property after a foreclosure sale. In some states, the law requires you to move out after the foreclosure sale to a new owner. In others, you get to live in the home until the post-sale redemption period expires or until some other action, like confirmation or ratification of the foreclosure sale, happens.

After your right to stay in the home ends, the servicer or REO management company (or a third party who was the highest bidder at the foreclosure sale) might offer you a deal called "cash-for-keys." In this kind of arrangement, you get money in exchange for agreeing to relocate (leave the property) without the need for an eviction. You can negotiate the terms if your loan servicer offers you a cash-for-keys deal. For example, you might ask for some extra time to live in the home or for more money.

But if you don't leave the property after your legal right to stay ends or work out a cash-for-keys deal, the home's new owner (again, usually the lender) will start an eviction. The process will either be an extension of the foreclosure action or a separate lawsuit. State law governs eviction procedures.

What Is a Redemption Period in a Foreclosure?

Some states have laws giving foreclosed homeowners a limited amount of time to regain ownership of the home ("redeem" the property) after a foreclosure sale.

To redeem, depending on state law, borrowers must reimburse the buyer for the amount paid at the sale or repay the full amount of the mortgage debt.

Deficiency Judgments After Foreclosures

If the foreclosure sale proceeds aren't sufficient to pay off the foreclosing lender, then it might be able to get a personal judgment, a "deficiency judgment," against you for the difference. Whether the lender can get a deficiency judgment depends on state law. Junior lienholders might be able to seek a judgment against you as well.

Deficiency judgments are unsecured, like credit card debt, and you might be able to discharge the judgment in a bankruptcy.

How Can I Stop a Foreclosure?

Depending on state law and your individual circumstances, you might have a defense against a foreclosure. A few potential foreclosure defenses include:

Again, in a judicial foreclosure, you get the opportunity to file an answer to the suit and raise your defenses. In nonjudicial foreclosures, you don't have an automatic means to bring up your defenses. To have your defenses ruled on by a judge in a nonjudicial foreclosure, you must file a lawsuit alleging that the foreclosure is illegal for some reason and ask the court to put the foreclosure on hold pending the court's review of the case.

You might also be able to stop the foreclosure process by filing for bankruptcy, reinstating the loan, or getting a loan modification.

You also get the right to redeem the property prior to the foreclosure sale (and stop the foreclosure process) by paying off the entire mortgage debt. To redeem, you have to pay the entire mortgage debt before the sale happens.

What Is Reforeclosure?

Maybe you've already lost your home to foreclosure, and you're trying to recover—emotionally and financially. Now imagine this: You get a letter from the lender that foreclosed your home saying that the lender is foreclosing again. But you already went through a foreclosure. It sounds like you're about to go through a reforeclosure.

A reforeclosure is sometimes necessary to eliminate title issues missed in the first foreclosure. (Some states, like New York, call this process a strict foreclosure or a reforeclosure; again, sometimes legal terminology can be confusing.)

Purpose of the Original Foreclosure

The goal of a foreclosure is to eliminate the owner's interest in the home and wipe out any junior interests in the property. So, before foreclosing, the lender will order a title search from a title company.

The title search shows all of the parties with an interest in the subject property, like lienholders, judgment holders, and others. The foreclosing lender will then include the parties whose interests it wishes to foreclose in the foreclosure to clear them off the property's title.

Purpose of a Reforeclosure

Homeowners occasionally face back-to-back foreclosures when the title to the property has problems after the first foreclosure. The second foreclosure is called a "reforeclosure." (Sometimes, instead of reforeclosing, a lender can amend a foreclosure complaint in a judicial foreclosure to add parties left out of the original complaint. But the lender must amend the document before the foreclosure is complete.)

When a subordinate lienholder or other junior interest is omitted from a foreclosure, its lien or interest isn't extinguished—unlike the lien or interest of a party appropriately named and served in the foreclosure. The purchaser at the foreclosure sale (usually the foreclosing lender ) then takes title to the property subject to the omitted lien or party. Unless the excluded parties agree to release their lien or sign a quitclaim deed, a reforeclosure is often required to clear up the title.

Why Is Clear Title Important?

Without clear title, the lender can't resell the property to a new owner. So, depending on state law, the lender might then opt to reforeclose to deal with the parties inadvertently left out of the foreclosure.

The reforeclosure cleans up the property's title and gives the lender clear ownership.

What Kinds of Mistakes Might Lead to Reforeclosure

A lender might choose to reforeclose if the foreclosure sale has already taken place and, for instance:

  • After searching the public records, the title company didn't include a junior lien on the title report. As a result, the lender's attorney didn't include the junior lienholder in the foreclosure.
  • After searching the public records, the title company didn't include a judgment lien in the title report. As a result, the lender's attorney didn't include the judgment holder in the foreclosure.
  • The lender's attorney didn't name a particular defendant (like a nonborrowing spouse) or didn't name the defendant correctly (such as naming a trustee as both an individual and in their capacity as a trustee) in the foreclosure.
  • The lender's attorney didn't properly review the title search and, therefore, didn't include all parties with an interest in the property in the foreclosure.

How Reforeclosure Generally Works

Generally, the right to reforeclose passes with the property's ownership. Because the foreclosing lender is usually the high bidder at the foreclosure sale and becomes the home's new owner, it will typically conduct the reforeclosure. But if a third party buys the home at the foreclosure sale, that person or entity might reforeclose.

A reforeclosure complaint (lawsuit) will allege that the omitted lienholder or other party's interest is inferior—that is, it has a lower priority—than the foreclosed mortgage. The complaint will further state that the lienor or other party was inadvertently left out of the foreclosure and, if it had been included, the foreclosure sale would have removed it from title.

Assuming the newly-named defendant doesn't answer the suit or redeem the property by paying off the mortgage debt, the court enters a judgment of foreclosure. The lien or other interest being foreclosed is then extinguished, and another foreclosure sale is held. The purchaser at the foreclosure sale gets title to the property free of the interests of all parties foreclosed in the original lawsuit and those named in the reforeclosure.

Talk to a Lawyer

While this article provides a general picture of how foreclosure (and reforeclosure) works, laws vary from state to state. To get specific information about your state's foreclosure procedures and how they apply to your particular situation, consider talking to a local foreclosure attorney.

Losing your home foreclosure once is stressful enough, let alone twice. If you've received notice that the lender is reforeclosing and have further questions, consider talking to a local lawyer to learn about the process and your rights.

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