People sometimes think that the lender (or subsequent loan owner) will "repossess" their home in a foreclosure. But this description of the process that a lender uses to get ownership of the property isn’t accurate—a foreclosure is different than a repossession.
Repossession is a self-help remedy that allows a creditor to simply take possession of an item; the creditor doesn't have to sue you first. In a car repossession, for example, the lender simply takes the vehicle back. With a foreclosure, however, the lender can't just take your home. Instead, it must go through a specific process (a foreclosure) and hold a sale, which is typically a public auction. Anyone, including the foreclosing lender, can bid on the home at the sale. Normally, the lender will bid on the property using what’s called a “credit bid.” If the lender is the high bidder at the foreclosure sale, it then gets ownership of the home.
Read on to learn more about how foreclosures work and how credit bids are part of the process. (To learn what to do—and what not do—if you’re facing a foreclosure, see Foreclosure Do's and Don'ts.)
People who take out a home loan usually sign a security instrument, either a mortgage or deed of trust. This document gives the lender the right to sell the property through a process called foreclosure if the borrowers don’t make the payments or violate the agreement in some other manner. The foreclosure process will be governed, in large part, by state law and will be either judicial or nonjudicial.
The lender starts a judicial foreclosure by filing a lawsuit in court. If the court agrees that the borrowers have breached the loan agreement, the court orders the home to be sold at a foreclosure sale. (In two states, Connecticut and Vermont, the court may give the home's title directly to the lender. This process is called a strict foreclosure.)
In a nonjudicial foreclosure, the lender follows particular out-of-court steps to foreclose. State law spells out exactly what the lender must do to complete the process. While the exact steps vary among states, the lender might have to do one or more of the following:
Once the lender completes the state-specific process, a foreclosure sale will take place.
At the foreclosure sale, which is an auction, the lender will usually make a credit bid. With a credit bid, the lender bids the debt that the borrower owes. Basically, the lender gets a credit in this amount. The lender can bid the full amount of the debt, including foreclosure fees and costs, or it might bid less. If the lender is the highest bidder at the sale and becomes the new owner of the property, but bids less than the total debt, it might be able to seek a deficiency judgment against the borrower. Whether or not the lender can get a deficiency judgment depends on state law.
Other parties who bid on a property at a foreclosure sale must bid cash or a cash equivalent, like a cashier's check. If a third party is the high bidder at the sale, the proceeds from the sale are used to repay the borrowers' debt. (If the proceeds aren't sufficient to pay off the full amount of the debt, the lender can, if state law allows it, get a deficiency judgment.) Often, though, the foreclosing lender is the high bidder at the foreclosure sale. After the lender buys the property at the sale and gets title to the home, the property is considered “Real Estate Owned” (REO).
If you’ve defaulted on your mortgage loan, consider talking to a lawyer to learn about the foreclosure procedures in your state and find out whether you have any potential defenses to the action. You can also ask a lawyer for information about loss mitigation options, like a mortgage modification or short sale. Or you may contact a HUD-approved housing counselor to learn about foreclosure alternatives.