The U.S. housing bubble burst almost ten years ago, but as people struggle to make payments on their properties, foreclosure remains an important (and misunderstood) legal process. Most home-buyers cannot afford to purchase a home outright, so they need to obtain mortgage loans. Mortgage loans are secured transactions, which means that the bank, or any other entity that makes a mortgage loan, has a security interest in the property purchased with the loan. In other words, the home becomes collateral for the mortgage loan. When you take out a mortgage, you also sign a promissory note promising your lender that you will repay the loan. Foreclosure occurs when a homeowner fails to make a monthly mortgage payment and the lender seeks to recover the amount owed. The lender then seizes the property and attempts to force the sale of the home.
Foreclosure as a Process
Foreclosure isn’t just a one-time event. Rather, it’s a process. The process to take back a home begins when a lender files a foreclosure action. The lender files this action only after the homeowner has not made a mortgage payment for at least 90 days, in most states; if the home is covered by a federal loan, then the action will not be filed for 120 days. The homeowner’s failure to make payments is considered a default on the promissory note. The lender may then initiate the foreclosure process to recover its payments. The process of recovery varies from state to state; depending on the location, the foreclosure process may take years to go through the legal system. The homeowner also has an opportunity to cure the default by paying the amount due, negotiating with the lender, or selling the property to pay off the mortgage.
The three types of foreclosure—judicial, statutory, and strict—are discussed below. Many states permit both judicial and nonjudicial foreclosure, though your state may favor one type of foreclosure over the other.
In judicial foreclosure, the lender files a lawsuit in state court and sends the homeowner a demand for payment. The court oversees the case, which can proceed like an ordinary lawsuit. The homeowner may file an answer to the suit, and if there is disagreement about the essential facts of the case, the suit may go to trial. If the homeowner cannot present a legally valid reason for not making the mortgage payments, the court will enter a judgment against the homeowner. Also, if the homeowner fails to respond to the lawsuit in the first place, the court may issue a default judgment against the homeowner. If the court finds against the homeowner, the lender sells the foreclosed property at an auction held by the court or the sheriff’s office. Many states, including New York, New Jersey, and Illinois, provide for judicial foreclosures.
Power of Sale/Statutory Foreclosure
Statutory foreclosure is permitted in those states where mortgages include a “power of sale” clause. In this type of foreclosure, a clause in the mortgage agreement gives the lender the power to demand payment and sell the property without filing a lawsuit. The specific provisions and timeline for this type of foreclosure are outlined in statutes that vary from state to state. Generally, the statutory foreclosure process is overseen by a trustee, who is chosen by the lender. In statutory foreclosure, the lender may auction off the property directly without relying on the courts or the sheriff. More than half the states, including California and Texas, permit power of sale foreclosures.
A few states permit strict foreclosure, which resembles judicial foreclosure at first glance. Like judicial foreclosure, strict foreclosure begins when the lender files a lawsuit claiming that the homeowner has defaulted. However, the court then sets a timeline for the homeowner to make payment. In strict foreclosure, the home is not auctioned but reverts directly to the lender’s possession.
Sale of the Home
The sale of the home in a foreclosure occurs at the end of the lawsuit or, in cases of statutory foreclosure, at the end of the trustee’s oversight. The sale process varies depending on the type of foreclosure allowed by state law, and the status of the mortgage. Frequently, the property is put up for auction. If the home is to be auctioned, the party responsible for carrying out the auction advertises the home to be sold. The homeowner also receives notice of the sale date. The auction then takes place at the courthouse or another site. The lender may set the opening bid (typically, the outstanding balance of the mortgage, plus any associated fees). If the home is underwater (worth less than the amount owed on the mortgage) or if other bids fail to exceed the opening bid, the lender will take title to the home. If the home is not underwater, title will pass to the high bidder.
Be aware though that the former homeowner’s obligations may not be discharged entirely by the home’s sale. Some states allow the lender to collect a “deficiency judgment.” If the home sold for less than the amount owed on the mortgage, the lender may be able to collect the difference between the foreclosure price and the mortgage amount, or between the foreclosure price and the fair market value of the home, from the former homeowner. If the sale price of the home exceeds what the former homeowner owed on the mortgage, the difference will be paid to any other creditors who hold a security interest in the home. If there are no other creditors, then any monies over and above the mortgage debt go to the homeowner.
The new owner of the home must provide a copy of the new deed to the homeowner. The new owner may file an action in landlord/tenant court to remove the former homeowner from the property. Usually, though, the new owner will work out amicable arrangements for the former homeowner to leave the home without the expense and conflict of a landlord/tenant proceeding.
Elliot Schlissel is an attorney licensed to practice in the State of New York. His law firm, with offices in Nassau County, Suffolk County and Queens County, practices in family law & divorce, criminal law, personal injury matters, bankruptcy, wills & trusts, and foreclosure defense.