What Does Foreclosure Mean?

Foreclosure means a lender attempts to reclaim a home or property because the borrower did not make loan payments.

In simpler terms, foreclosure means you can lose your home because you didn’t pay the mortgage.

And that leads to a lot of challenges and painful complications with a residence, the legal system and future credit.

It helps to understand the details. When someone buys a house, they typically do not have enough money to pay for the purchase outright. So, they take out a mortgage, which is a contract that states you borrowed the money for the house from a lender and agreed to pay that money back over time.

If the borrower does not pay or is unwilling to continue to make mortgage payments, the lender will institute a legal process (foreclosure) to take back the property.

In 2023, there were 357,062 foreclosure filings on properties in the U.S. That represented 0.26% of housing units.  In 2021, the foreclosure rate dropped to near zero (.11%) thanks to federal help that kept people in their homes during the COVID pandemic. However, from 2021 to 2023, the foreclosure rate increased by 136%.

Facing a foreclosure can be daunting prospect, especially when those having trouble handling the mortgage are unsure what to do. Across the country, six out of 10 homeowners said they wished they understood their mortgage and its terms better. The same percentage of homeowners also said they were unaware of what mortgage lenders can do to help them through their financial situation.

“How it affects people depends on the individual, like human nature,” Ben Hillard, a foreclosure attorney for The Castle Law Group in Largo, Fla. “Some folks freak out. They care about their particular house. They’ve been there 25 years, raised their kids there and they don’t want to leave. Others have the attitude that they’ll go buy another house.

“It can be traumatic, or it can’t be, but having a lawyer who is good helps with that. A lot of my time is spent with people telling them they will be OK. I try to make them mentally comfortable, let them know that, yes, this is the situation you’re in, but it’s not life or death and you’ll get another house.”

What Is Foreclosure?

Foreclosure is a legal process in which a lender takes control of a home or property  because the borrower does not make mortgage payments.

Typically in foreclosure, the lender – a bank or mortgage loan business – takes possession of the home and sells it to recover their loss.

Mortgage loans are secured by the real estate that applies to the loan. That makes the home “collateral,” so the lender can legally repossess it if the borrower fails to make mortgage payments.

The foreclosure process varies by state. Generally,  federal law states a lender cannot foreclose unless a borrower is at least 120 days (four months) behind on mortgage payments.

Prior to this extreme step, lenders may try to work with the borrower to help him or her catch up on payments and avoid losing their home. Lenders would prefer to have people continue paying the mortgage rather than risk losing money on foreclosure.

A step-by-step foreclosure process commonly goes this way:

• You borrow money for a home.
• The lender provides the money with the home as collateral.
• You fail to make timely payments over a period of time.
• The lender may reach out to see if it can help by refinancing.
• If this fails, the lender forecloses, which means it takes possession of the home with the intent to sell.
• Once the entire legal process is complete and the home is sold, you must move out.

As we will explain, foreclosure has a devastating effect on a credit score.

Why Does a Property Go Into Foreclosure?

A variety of financial problems lead to foreclosure. Any are serious enough to cause difficulty in making mortgage payments.

Most are unforeseen, some are bad luck. Unforeseen problems can lead to financial struggles that may affect a borrower’s ability to make regular monthly payments.

Among them:

• Loss of employment – Losing a job is mentally and financially traumatic.
• Excessive debt – Which emphasizes the importance of keeping credit card bills manageable.
• Medical debt – Few envision a serious illness or surgery.
• Other debt, especially credit card debt.
• Divorce – Division of property and assets can lead to financial struggles.
• Relocation before selling the home. Managing one mortgage is tough. Managing two can be overwhelming.
• Natural disaster – Floods, fires, hurricanes, and earthquakes are painful experiences.

What Is the Foreclosure Process?

The foreclosure process is distinct for each of the three main kinds of foreclosures: Judicial, non-judicial and strict.

• Judicial foreclosure: The most common foreclosure, this is a court process that allows the homeowner to fight the foreclosure and avoid being foreclosed.
• Non-judicial process: Allows lenders to foreclose on property without a court order. This process is not available for traditional mortgages, and is available only in certain areas and states where local laws apply.
• Strict foreclosure: The lender goes to court and a judge to declare you in loan default on the mortgage. The court can immediately approve the foreclosure and give the property to the lender.

Lenders must comply with the Fair Debt Collection Practices Act, a law that is meant to ensure lenders or third-party collectors do not harass homeowners who may be in default. The FDCPA restricts the way collectors can contact debtors, along with the time of day and number of contacts that can be made. Violators can be sued by the debtor for damages and attorney fees, meaning if you win in court the lender or debt collector pays for your lawyer.

Let’s take a look at the five main steps in foreclosure:

1. Missed Payments

When a homeowner misses payments, a lender’s sensors go off. Once the borrower stops living up to the terms of the mortgage contract, the lender can take steps to collect. In most situations, the homeowner must be at least 120 days delinquent before a lender can proceed with foreclosure.

Keep in mind, though, that banks and lenders don’t want to foreclose. They can’t always sell post-foreclosure property for a profit, so their incentive is to make it work with the original borrower. In many cases, lenders will work with borrowers to find a way to make the original mortgage work.

2. Public Notice

If the situation is not fixable and the homeowner does not work to resolve the issue, the lender issues a public notice, a written notification to the homeowner that the lender will pursue legal action on the debt. Homeowners must respond to this notice in 20-30 days, depending on the state. Do not ignore a foreclosure notice. It is vital to respond because it is a step toward possibly keeping the home.

3. Foreclosure

This phase begins once the public notice is filed. The home now is in the early stages of repossession, and the homeowner has 90 days to avoid being foreclosed and evicted. Among the actions the homeowner can take: Pay the balance due; sell the property and use the equity in the home to pay the loan; sell the property at a loss; or simply sign the deed to the lender in lieu of foreclosure.

4. Auction

Once the lender has possession of the home, it can put it up for auction. This foreclosure sale makes your house available to anyone who wants to buy it. It is done by bid. The buyer usually must pay cash or make a hefty down payment right away.

5. Post-Foreclosure

The home is now sold, so the homeowner has to vacate the premises. The new owner could rent the home to you, but it’s unlikely that will happen because you’ve already shown you can’t keep up with mortgage payments. If the home is not sold by auction, the bank owns it and it is called a Real Estate-Owned Property (REO). The bank then must pay for upkeep and property taxes. This usually leads to the bank trying to sell the REO.

How Long Does Foreclosure Take?

A nonjudicial process can take 2-3 months; judicial foreclosures can last several months and perhaps to as many as 18 months.

Judicial foreclosures are the most common type of foreclosure. This process is allowed in every state and required in some. A judicial action requires a lender to file a lawsuit in court. The borrower has up to 30 days to respond, and it’s important to do so because no response could lead to an immediate decision in favor of the lender. Responding means the case is heard in court, and that could lead to a settlement that avoids foreclosure. However, if the borrower’s financial situation is dire, the court also could allow the lender to foreclose.

The states that primarily use judicial foreclosure are Connecticut, Delaware, Florida, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Nebraska, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma (if the borrower asks), Pennsylvania, South Carolina, South Dakota (if the borrower asks), Vermont, Virginia, Washington, D.C., and Wisconsin

Nonjudicial foreclosure usually happens when a home purchase has a power of sale clause, which gives the lender the right to sell the property if the homeowner defaults. It also can be used if there is a promissory note – a legally binding document in which you agree to repay the loan – attached to the property.

Nonjudicial foreclosures are done out of court, and official notice is required. The borrower then has time to respond.

One of the only benefits of nonjudicial: The homeowner will not have a delinquency judgment on their record.

Both processes vary depending on the laws in each state and the specific circumstances of each situation. In Ohio, for example, judicial foreclosure can take 6-18 months. In Florida, the judicial process takes six-to-seven months. In California, nonjudicial foreclosures are the most common.

Foreclosure’s Effect on Your Credit

Foreclosure has a very damaging effect on your credit score for seven years, but there are opportunities to regain a lender’s trust.

How many points you lose depends on where the credit score was when your home was foreclosed. If it was above 700, you can anticipate a drop of 100 to maybe as many as 160 points. If it were below 600, the drop would be closer to 75-100 points.

In either case, the result is that likely you fall into the “poor” category for credit scores, and you will be fighting to overcome it. Foreclosure stays on your credit report for seven years and it can’t be removed at any point before then.

Along the way, however, you could help your credit standing by making on-time payments to all creditors. It may take a few years, but the on-time payments improve your score, while the negative impact of foreclosure gradually wears off.

By the time a foreclosure is removed from your credit report, you could regain all of your previous standing.

Avoiding Foreclosure

The easiest way to avoid foreclosure is to make mortgage payments on time. The second easiest way is to communicate with your lender that you’re having financial problems. Banks and lenders will work with you if there are serious issues affecting your ability to pay.

Foreclosure is a legal, time-consuming, and expensive process that typically benefits nobody. A lender would much rather work with a borrower to come up with a solution and avoid the process. Don’t ignore the situation and hope the bank does not notice it. Communicate with the bank or lender and try to work out a solution.

If you’re at risk of foreclosure the first thing you can do is to go through foreclosure prevention counseling. It’s free and will help determine your options.

Among the potential solutions that could be pursued:

• Loan modification: A lender may recognize that but for unfortunate circumstances, you would be making timely payments. So the lender could seek to modify the loan with a lower interest rate or by extending the loan terms, which may allow the homeowner to afford payments.
• Forbearance: A lender with belief in the homeowner, offers to pause payments for a time, or offers reduced payments for a time period. This signals good faith, that the lender believes once the borrower is back on his or her feet, payments will resume.
• Repayment plans: The lender agrees on a plan that will increase monthly payments and allow the homeowner to catch up on what is owed.
• Refinancing: The borrower obtains a new loan that pays off the mortgage and includes a lower interest rate, which reduces the monthly payment. A refinance probably costs the lender less than it would to foreclose.
• Chapter 13 bankruptcy: Filing Chapter 13 means setting up a payment plan for debt over 3-5 years. This gives the homeowner that amount of time to catch up on missed payments.

There are ways to stop foreclosure or avoid it even after the process has started. One is a short sale, in which the homeowner sells the property for less than remains on the mortgage. The proceeds go to the lender, who can forgive the difference or seek a deficiency judgment. The less the deficiency, the less likely the lender will take that court action. The benefit of a short sale: You get out of the mortgage, and the credit score is not affected as much as it is with a foreclosure.

Another option is to pursue a deed in lieu of foreclosure. The borrower basically gives the property to the bank and the bank waives the right to foreclose.

Hillard says that if foreclosure is a serious concern, the best option is a regular sale. This simply means selling the house for more than what is owed on the mortgage. This can happen if there is enough equity in the home. In a regular sale, the homeowner pays the lender what is owed and keeps the rest, with no foreclosure. The key: Complete the sale before foreclosure is filed.

“For anyone who has equity in the home, I would say sell it prior to the foreclosure case being filed,” Hillard said. “Once it’s filed, they won’t be able to refinance because Fannie Mae and Freddie Mac guidelines won’t allow lenders to make a loan modification to get you out of it. Once it’s started, most people are screwed.

“If you can’t write the check or borrow the money to catch up on missed payments, then go ahead and sell it and let the bank know. That is very important. Communicate with the bank that you are selling the property.”

Consequences of Foreclosure

The consequences of foreclosure for a homeowner are significant. Not only does the credit score drop, foreclosure stays on the credit report for seven years, which will make it more difficult to borrow money in the future.

In addition, the home owner has to leave his or her residence and find a new one. The mental toll weighs heavy, but the financial loss of the down payment and the home is significant.

Recovery from foreclosure has challenges and takes time, but there are steps that can help. The borrower could rebuild credit by keeping careful watch on his or her credit report, and by making sure he or she makes timely payment on bills going forward. Applying for and using a secured credit card also can help, though it requires the borrower to make a deposit that will equal the credit card limit.

Anyone facing financial challenges or misfortune that has them worried about making mortgage payments would be wise to consider talking to a nonprofit credit counselor. These counseling sessions will help by assessing income and expenses, and the best ways to solve the challenge.

Credit counseling is free and can be done by phone. The counselor is required by law to offer the best solution for your situation. A debt management program, for example, could reduce credit card interest and monthly payment rates to a more affordable level.

All the consequences stress the importance of trying to do whatever possible to avoid foreclosure and doing so in the most emotion-less way possible. Losing a home in foreclosure is a serious matter, so doing everything to avoid the situation before it gets to that point is vital.