The term “foreclosure” is generally a process both borrowers and lenders want to avoid. However, it can and does happen. In fact, lenders repossessed 42,854 properties last year through foreclosures, a year-over-over increase of 67 percent, according to U.S. News. Also, the most recent COVID-19 foreclosure moratorium expired at the end of 2021, leaving many homeowners newly vulnerable.
All this means is that it is only smart for homeowners and real estate investors to understand what foreclosure means and what their options might be.
In real estate, foreclosure is a process that starts when the borrower fails to make mortgage payments according to originally established terms, and typically ends with the lender repossessing and attempting to sell the property.
Lenders are legally permitted to seize the property because it is collateral for the mortgage loan, which is a secured loan.
The two types of foreclosures are judicial and nonjudicial, and each state determines which one takes place there. Judicial foreclosures, which can occur in all states, are currently required in some 22 states. Here, the lender typically files a suit with the judicial system, after which the borrower has a time certain to respond and pay or face foreclosure.
Nonjudicial foreclosures, meanwhile, are generally less time-consuming than judicial foreclosures. These generally take place when one’s promissory note is linked to a trust or deed, or the mortgage has a power of sale clause. Such a clause permits the lender to, following a warning and waiting period, auction the home off with no court involvement.
If there is a deed of trust involved, the title company (trustee) is also allowed to, without a court order, seize the property and sell it upon any default.
While the process for foreclosure differs from state to state – public notices, homeowner options, and the process and timeline for selling the property – all states share the same general steps, including:
The Early Stages
A mortgage loan must be at least one payment late before the early stages of the process of foreclosure is triggered. The first nonpayment usually prompts a “missed payment” notice, followed by a “demand letter” that ramps up the seriousness of the situation, but still gives the owner time to arrange to bring the account up to date.
The Loan is Referred to Counsel
The foreclosure process usually officially begins after 90 days with the loan servicer referring the loan to the foreclosure attorneys. Depending on the state involved, counsel files its first papers, which could be a notice of default or a complaint.
At this point, the borrower still has about 30 days to settle the payments, reinstate the loan, and avoid foreclosure. This may be through loss mitigation – when borrowers and lenders work together to craft a plan to avoid foreclosure.
Foreclosure is Established
Depending on the state, a judicial or nonjudicial foreclosure is filed (as covered earlier). A nonjudicial foreclosure is less complex and takes less time.
Once foreclosure has officially begun, the servicer will likely issue a “notice to quit” document or similar directive to vacate the premises, depending on the state. If the property’s residents do not vacate the premises, they can have a lawsuit filed against them.
If the foreclosure is approved, and it is judicial, the property is auctioned by the local sheriff to the highest bidder to try to get back the amount the bank is owed. Or the bank – now property owner – sells the collateral through traditional channels.
If it is a nonjudicial foreclosure – also known as power of sale – the process will likely be relatively faster since no courts are involved. The only exception is if the homeowner sues the lender.
The length of time foreclosure takes varies by state due to differing foreclosure timelines and laws, but properties nationally that foreclosed between April-June in 2021 spent an average of 922 days going through the process, up 685 days from the second quarter of the year before.
Hawaii, New York, and Indiana led the states in 2Q 2021 with the longest average number of days. For the same period, Wyoming, Arkansas, and Tennessee were the states with the shortest average times to foreclose.
In all likelihood, even a borrower who has missed a payment, or maybe two, may still be able to avoid a foreclosure.
Options could include:
The rub is that the homeowner must, in signing the deed in lieu, voluntarily relinquish their property deed to the lender. While the home will be lost, the borrower will be released from anything owed on the mortgage and escape the damage that a foreclosure can do to one’s credit. A deed in lieu will also unfavorably impact one’s credit report, but usually not to the same extent.
Note that the lender may turn down a deed in lieu of foreclosure if the house is in poor shape or the property carries other liens or tax judgements. Sometimes, the lender will deny a deed in lieu if it thinks it can recoup more lost money by using foreclosure.
Yes, a foreclosure is a serious occurrence and does have consequences. For the buyer, the foreclosure will show up on their credit report within a month or two and stay there for seven years. This could prevent the borrower from buying again or even renting, at least for several years, or longer. The foreclosure is dropped from a credit report after seven years.
On the other hand, if a lender seizes a property that does not sell, at least right away, they usually assume ownership of that property and may add it to an always-accumulating portfolio of what are called real estate owned (REO) properties – foreclosed properties.
Such properties are generally popular with real estate investors since the lender – usually a bank – sometimes must sell them for less than their market value. They usually can be found on banks’ websites.
No investment is risk-free, and that includes real estate. Still, the asset class remains a generally popular investment. Not only can adding real estate to one’s portfolio guard against inflation, but it can reduce overall volatility. Other possible benefits include leverage, cash flow, income streams and tax favorability.
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Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
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In some cases, this risk can be greater than that of traditional investments.
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The hope is that investors and homebuyers will never face foreclosure – the possibility of losing their property. However, a major part of avoiding the process is learning what foreclosure is in the first place — and the many possible options available to borrowers experiencing financial difficulties causing them to miss mortgage payments.. The key is to reach out to the bank or lender as early as possible.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.