Definition, Process, Ways to Avoid

Definition, Process, Ways to Avoid

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  • Foreclosure is when a mortgage lender reposesses your home because you defaulted on your loan.
  • The exact details of a foreclosure process will vary based on your state and the lender.
  • There are options to avoid foreclosure if you act quickly and stay in communication with the lender.

The thought of losing your home is scary. But if you are no longer able to keep up with your monthly mortgage payments, the lender will likely pursue foreclosure.

Although foreclosure is a financial situation that no one wants to face, it’s useful to understand the details of this legal process.

What is foreclosure?

Foreclosure involves a mortgage lender taking possession of your home because you have defaulted on your loan. Usually, this is caused by missing several monthly payments. However, the lender can foreclose on a home if the borrower doesn’t meet any of the other conditions outlined in the mortgage documents.

Levon Galstyan, an accounting consultant at Oak View Law Groupsays some of the common reasons homeowners find themselves in this position include unexpectedly high costs, increased interest rates, loss of employment, medical emergencies that trigger more debt, and natural catastrophes.

From the lender’s perspective, foreclosure is necessary to recoup their financial losses. After taking possession of the home, most lenders will sell it to recoup the borrower’s unpaid balance.

Unfortunately for the former homeowner, a foreclosure will show up as a negative mark on their credit report for seven years.

The foreclosure process

The details of the foreclosure process vary from state to state. A borrower is technically in default 30 days after missing a payment. Typically, lenders start the foreclosure process between three and six months after the first missed payment.

Once the borrower is in default, the lender indicates its intention to foreclose on the loan by issuing a notice of default. At that point, you’ll enter the preforeclosure stage.

“To delay or stop the foreclosure, borrowers can challenge the process and file a petition if they need more time,” Galstyan says.

Depending on the situation, the lender may be willing to work out a new payment arrangement. However, doing so involves communicating your financial situation to the lender or mortgage servicer. If it decides to move forward with foreclosure, the “duration varies by state and often ranges from 120 days to nine months,” Galstyan says.

Throughout the foreclosure process, it’s imperative for homeowners to carefully read any notices sent by the lender.

“Be sure to attend any court hearings you are summoned to and utilize the services of your local courts’ legal aid department to get free advice and guidance,” says Bill Samuel, owner of Blue Ladder Developmenta Chicago-based home-buying company.

Types of foreclosure

Foreclosures fall into a few different categories. Here’s a closer look at each:

  • Judicial foreclosure: A judicial foreclosure involves the lender filing a lawsuit in a local court. If your lender is pursuing judicial foreclosure, you’ll receive a letter in the mail requesting past-due payments. After that, you’ll have 30 days to submit the money or the home will be sold at an auction conducted by the local court or sheriff.
  • Power of sale foreclosure: If the mortgage has a power of sale clause, the lender can pursue a power of sale foreclosure. After a default on the loan, the lender will send a letter demanding payment. If you don’t catch up within a defined period of time, the mortgage company can auction off the property without going through the local court system.
  • Strict foreclosure: With strict foreclosure, the lender files a lawsuit after the homeowner has defaulted on the loan. If you can’t catch up on payments within a specific window of time, the lender will reclaim ownership of the property.

Can I refinance in foreclosure?

If you’re struggling to pay your mortgage and want to avoid foreclosure, you may be wondering if lowering your payment through a refinance is an option. It may be, but you’ll generally have to start the process before foreclosure begins. With a delinquent mortgage, it can be difficult to get approval from any new lender.

Does foreclosure affect my credit?

Since a foreclosure will remain on your credit report for seven years, it can have a lasting effect on your credit score.

With a low credit score, your ability to borrow money in the future is hampered. For example, if you want to finance a vehicle in the next couple of years, you’ll likely face higher interest rates and limited borrowing power.

In the years following a foreclosure, your homebuying options are also limited. With conventional loans, you’ll need to wait seven years after a foreclosure to obtain a new home loan. If you’re seeking a government-backed mortgage, you might not have to wait as long. But in any case, a foreclosure will impact your home-buying options for years to come.

7 ways to avoid foreclosure

If you are facing foreclosure, it’s a stressful and uncomfortable situation. But there are actions you can take to prevent it.

1. Stay in touch with your lender

Lenders typically won’t offer a helping hand unless you ask for it. Staying open with your lender about your financial situation could lead to a solution.

2. Ask for forbearance

Forbearance is a temporary pause or reduction in your monthly payments. Some lenders are willing to provide this temporary reprieve to avoid foreclosure.

3. Ask for a loan modification

If your monthly payment is simply too high, ask your lender about a loan modification, which is a permanent change to your loan terms. A longer repayment period or lower interest rate could result in a more manageable monthly payment.

4. Refinance

For homeowners worried about their ability to make future mortgage payments, consider refinancing with the goal of a lower monthly payment. You will likely need to get current on your payments before qualifying for a refinance.

5. Sell the house

If you can sell the home for more than you owe, you can use the proceeds from the sale to pay off your debt.

6. Pursue a dirty shorts

A short sale involves selling your home for less than you owe. This option involves securing lender approval before signing on the dotted line.

7. Deed in place of foreclosure

If you can’t sell your home, then handing over the deed to the lender may release you from your debt.

The bottom line

Foreclosure is a process that no one wants to go through, with ramifications that can impact your finances for years to come. If you need help navigating the process, seek out a HUD-approved housing counselor in your state.

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