The Phases of a Foreclosure
No one wants to have to face a foreclosure, but it’s an element of the real estate world. From a job loss, to a divorce that interferes with finances, foreclosure happens to hundreds of thousands of houses in the United States per year.
The concept of losing your house to bank can seem scary and overwhelming, but when reality comes to call, it’s best to be prepared. This is what you need to know about foreclosure, including how to bounce back at the end of the process and secure a loan in the future.
What Is Foreclosure?
Foreclosure is the process of forfeiting a house due to an inability to make mortgage payments.
When a house is purchased for personal use or as an investment, it is traditionally done so through the use of a mortgage. This means that a loan is borrowed from the bank or private money to pay for the house. In exchange, the house itself is used as collateral. Until the mortgage is paid off, the house effectively belongs in part to the bank or private investor.
Most people are able to make their mortgage payments regularly, but when unexpected issues arise, like illness, divorce, a lost job, or a death in the family, it may be hard to find enough cash to make payments. Ultimately, the bank or private investor will take action in order to claim the property in exchange for a failure to pay. The process of taking the property back is called foreclosure.
The Stages of Foreclosure
Foreclosure is usually a long process. Unlike what pop culture may imply, foreclosure does not involve a swift removal from a house and immediate homelessness. Instead, homeowner are provided with adequate notice and plenty of opportunity to either rectify the situation or move out and secure another place to live. The process moves as such:
Default occurs when a single mortgage payment is not paid in full. Payments may be given a 15-day grace period before a notice is sent. If a payment is not provided by the end of the grace period, lenders will generally charge a late fee and send a missed payment notice.
If a second mortgage payment is missed, lenders are permitted to send a demand letter, or a more serious version of a missed payment notice. This letter usually demands payment within 30 days. At this point, a lender is still in a position to work with a borrower, so if payments of any amount are at all possible, now is the time to speak up.
Notice of Default
A notice of default is the second step in the foreclosure process and is generally issued when payments are at least 90 days late. This notice usually consists of a letter in the mail, but some states require that the notice be posted in a visible place directly on the house, like attached to the front door. The borrower is informed that the notice will be recorded, and that action must be taken. Usually, the borrower is given another 90 days to make good on payments and reinstate the loan. This 90-day period is sometimes known as a reinstatement period.
The loan will also be filed with the lender’s foreclosure department, and the formal foreclosure process will begin.
Notice of Trustee’s Sale
If the borrower does not take action to reinstate the loan, the next step is a notice of trustee’s sale. This notice must be recorded with the county, delivered to the homeowner, and posted in the newspaper for at least three weeks. This notice will state that the property will soon be up for public auction. The notice must also include the names of the property owners, a description of the property, the address, and auction information.
After notice has been provided to homeowners, filed with the county, and advertised, the property goes to auction. The lender will determine the starting price based on the value of the remainder of the loan, any liens on the property, unpaid taxes, and costs that arise from the sale. The deed upon sale will go to the property’s highest bidder. Anyone is permitted to attend public auctions for property and bid on houses. Buyers will usually have to pay in full, as financing is not often an option for an auctioned property.
After the sale is complete, the buyer is entitled to immediate possession of the property.
Real Estate Owned (REO)
In some cases, the trustee’s sales won’t be successful, and a public auction will not result in the purchase of a foreclosed property. When this happens, the lender becomes the permanent owner of the property. It’s not common for lenders to keep properties; instead, they are sold conventionally through a broker. Often, lenders remove liens and cover other debts to make the property more desirable to buyers.
Foreclosure properties are usually advertised as such. This is to let buyers know that properties are sold as-is and negotiations for additional repairs aren’t possible.
While the buyer has the option to vacate the property any time during the foreclosure process, and are encouraged to do so, they are not obligated to leave the property until eviction is complete.
Eviction in a foreclosure works in a similar manner to eviction under other circumstances. Tenants will be provided with a notice of eviction and provided with a time period to leave the premises. If tenants do not heed the notice, the local sheriff is often responsible for clearing the house and removing the tenants. If tenants do not remove their belongings, they will likely be placed into storage until the owners return for them.
After the former owners have vacated the house, the new owner is free to do as he or she wishes with the property.
How to Avoid Foreclosure
Foreclosure seems like a scary prospect when money is tight, but there are some steps homeowners can take to avoid the likelihood of foreclosure – even if a full payment is impossible. Ignoring the problem will likely result in the worst possible outcome, so don’t bury your head in the sand.
- Review your rights. All of the information regarding foreclosure is stated in your mortgage loan documents. Be sure you are familiar with the policies surrounding your mortgage, as well as what will trigger the foreclosure process. Review things like payment due dates, late fees, and the grace period before a notice of default is provided.
- Talk to your lender. You may believe that letting a lender know you are having financial difficulties is asking for trouble, but this isn’t the case. Talk and see how you can work together.
- Stay on top of mail and communications. If your lender is considering starting foreclosure, you will likely be notified by mail. Ignoring mail doesn’t give you a chance to intervene, so open all mail from your lender and their associates as soon as possible. Things like notices of default, for example, will often come by mail. Not receiving this sort of document can mean missing the reinstatement period, at which point foreclosure is inevitable.
- Talk to a counselor. HUD-approved foreclosure counselors exist to support those facing foreclosures. Counselors may be able to offer guidance, provide financial resources, or represent you in negotiations with lenders.
- Prioritize your mortgage. After your health, your house should be among your top priorities. Anything extraneous should be preserved until after mortgage payments are made. Food costs, clothing costs, and transportation costs can be minimized if needed, but your mortgage is unlikely to change. Plan accordingly.
No matter best efforts, sometimes foreclosure is unavoidable. However, the more steps you can take to prevent the process, the better.
Recovering After Foreclosure
While it may feel like life is over and homeownership or investing a new property is an impossibility after a foreclosure, this is not the case. It is possible to purchase a house and get a mortgage after foreclosure, and millions of people manage to accomplish this each year. However, it won’t be as easy as choosing a new house immediately and closing on a loan.
Credit Score Impact
FICO credit scores are an extremely important part of securing a mortgage. The higher your score is, the more likely you are to receive a mortgage that meets your needs, including a reasonable principle amount and a good interest rate.
Unfortunately, foreclosure can have a significant negative effect on credit score. Those with higher scores are hit harder, too – a starting credit score of around 780 can expect to fall around 150 points, while a credit score of 680 will drop around 100 points. Bringing credit up after a foreclosure is not easy and takes time. Even with perfect behavior on all other factors that affect credit, a foreclosure can still prevent scores from rising to a good or excellent level.
Foreclosure stays on a credit report for seven years. After this point, the foreclosure drops off and will no longer be a red flag to lenders.
Due to the challenges that arise during the foreclosure period, most lenders require a waiting period to provide loans to those who have gone through foreclosure. This can vary from lender to lender, but often spans two to seven years.
Improving Your Chances After Foreclosure
If you are hoping to purchase a house or invest in a property after foreclosure, follow these tips to improve the likelihood of a successful purchase:
- Make all payments on time. When your credit is poor from a foreclosure, there’s no room for error. Make all loan payments and credit card payments on time.
- Keep credit utilization low. Credit utilization refers to the amount of available credit in use at any one time. For example, if you have a credit card with a limit of $10,000 and have $3,000 in expenses, this is a credit utilization of 30%. Credit utilization should stay below around 30% to prevent a negative impact on credit score.
- Increase savings. A down payment is an important part of buying a house and an investment property and the more savings, the chances are higher to get funded.
- Don’t close lines of credit unless necessary. Credit history plays a role in credit score. Even if you don’t use your oldest credit card, closing it can shorten credit history and hurt credit scores. (On the other hand, paying off other loans, such as a car loan or student loans, this is necessary and should be handled as normal.)
- Create good habits. Many foreclosures are the result of unforeseen and unpredictable circumstances, but making changes early can help prevent issues in the future. The more wiggle room you have available, the more prepared you will be to weather financial storms that occur when buying or investing in a house.
Ultimately, your credit plays a huge role in your ability to secure a loan. Even though the foreclosure will be a scarlet letter affecting outcome, perfecting your credit in other ways can result in a large rebound after seven years, when foreclosures are removed from credit reporting.
Buying Your Next House or Investment Property
When your credit score has rebounded and you’re on solid financial footing, purchasing a house or purchasing an investment property is possible. Be sure you are in a solid financial position with a steady income, emergency savings, and a healthy down payment. Getting a loan after foreclosure, especially within a few years of foreclosure, can be challenging, but it is absolutely possible. Bottom line: whether it’s to buy a house or invest in a property in the future, you will be able to do so.
Scott Clift is a licensed real estate broker with Westpark Loans. He has been in the real estate industry since 1994. His team of seasoned professionals specialize in providing real estate loans for investors and other self-employed individuals. When you are ready to invest in real estate, call Westpark Loans to secure your financing at (844) 574-LOAN or by visiting westparkloans.com.