Foreclosures

Foreclosure means a lender is looking to take possession of a home when the borrower – the homeowner – isn’t making payments on the mortgage loan used to buy it. It’s one of the biggest financial crises a person can face, but those facing foreclosure may not realize lenders don’t like it either, and will do what they can to help a borrower avoid it.

Borrowers who work with their lender may be able to keep their home, or at least emerge from foreclosure with finances relatively intact.

Lenders are required by federal law to work with a borrower who’s falling behind and provide options that help.

“One of the biggest mistakes a homeowner can make is to ignore their financial challenges and avoid engaging with their servicer,” said Tom Goyda, Wells Fargo senior vice president, consumer lending communications. Wells Fargo, the second largest mortgage lender in the U.S., like other mortgage servicers, “are here to help homeowners keep their homes and avoid foreclosure when they encounter financial difficulties,” he said.

A mortgage is a contract that requires the borrower to make monthly payments, usually for a term of  15 or 30 years. If the borrower gets behind on payments, the lender can take the house back.

Six out of 10 U.S. homeowners in a survey said they wish they understood their mortgage and its terms better. The same percentage said they are not aware of what mortgage lenders can do to help them through a financial crisis that could lead to foreclosure.

Understanding foreclosure and how it works is key to avoid losing your home.

Why Do Homes Go into Foreclosure?

When a person buys a home, the bank that lends the money for it undertakes a rigorous process to make sure the borrower can afford to pay. About 70% of mortgages last for 30 years, and unforeseen circumstances can cause someone’s financial situation to change dramatically.

Many homeowners found that out during the COVID-19 pandemic. Loss of a job or reduction in income led more homeowners to fall three months or more behind on mortgage payments than had since 2010, the height of the Great Recession. By June 2021, 15 months into the pandemic, 1.9 million Americans were still three months or more behind on mortgage payments. But it doesn’t take a global pandemic to dramatically change financial circumstances.

Major reasons for foreclosures are:

• Job loss or reduction in income
• Debt, particularly credit card debt
• Medical emergency or illness resulting in a lot of medical debt
• Divorce, or death of a spouse or partner who contributed income
• An unexpected big expense
• Moving without being able to sell the home
• Natural disaster

How Do Foreclosures Work?

There are three kinds of foreclosure: judicial, non-judicial and strict. A judicial foreclosure is a court proceeding that kicks in when the lender files a lawsuit against the borrower. The proceeding results in the property being sold or auctioned. A nonjudicial foreclosure happens outside of the court system, when the lender lets the borrower know the home will be sold if they don’t catch up on payments, and borrowers get a window to do that, usually 30 days. If they can’t, the property is sold. A strict foreclosure, which is not allowed in a majority of states, is also a court proceeding, but the lender takes the property with no auction or sale

In a judicial foreclosure, creditors adhere to the Fair Debt Collection Practices Act, which has requirements about how and when to inform a borrower about the proceedings. The U.S. Supreme Court ruled in 2019 that nonjudicial foreclosures don’t have to follow the FDCPA. The court didn’t mention judicial foreclosures, and most lenders follow the rules. Aside from the FDCPA, federal law forged after the mortgage crisis that caused the 2008-10 Great Recession requires lenders to work with borrowers who are having trouble making mortgage payments.

Foreclosures often result from a loan default when the borrower stops making payments.

While the foreclosure process can vary by state, the general steps are:

1. Missed Payments – The borrower misses payments, usually for three months in a row. Lenders contact borrowers after each missed payment to let them know they’re in default and offer them a chance to catch up.
2. Public Notice – A notice of foreclosure, or notice of default, is posted with the county clerk in the county where the property is, and the lender declares its intent to sell the property. This kicks off the foreclosure process.
3. Foreclosure – The length of time varies depending on the state, but usually 120 days to nine months. If borrowers need extra time, they can challenge the process in court to slow down or stop the foreclosure.
4. Auction – Once the foreclosure is complete, the house is sold at auction, with the bank keeping the proceeds.
5. Post-foreclosure – Once the house is sold, or the bank takes possession, the borrower who was foreclosed upon is evicted. They must move out. How much time they’re given depends on the state they live in.

How do Foreclosures Relate to Debt?

Some people find themselves facing foreclosure because of mounting debt that makes it hard to make mortgage payments.

A foreclosure can add to financial problems, particularly if your state allows a deficiency judgment, which means the borrower owes the difference between what is owed on the foreclosed property and the amount it eventually sells for at an auction.

Thirty-eight states allow financial institutions to pursue deficiency judgments against borrowers for this money.

If a lender does not seek a deficiency judgment, a foreclosure can relieve your financial burden. Although it is a loss when a lender takes the home you partially paid for, it can be a start to rebuild your finances.

It is a good idea to work with a financial adviser or a nonprofit credit counselor to understand what kind of debt you may incur during a foreclosure.

How to Avoid Foreclosure

The best way to avoid foreclosure is to pay your mortgage on time. If you’re in a financial situation where paying is hard, or impossible, let your lender know.

“We encourage (borrowers) to contact us as soon as possible when they think they may have trouble making their payments or after they miss a payment, so we can discuss options that may help them based on their individual circumstances,” Goyda, of Wells Fargo, said.

A foreclosure generally costs a lender $40,000-$50,000 and is time-consuming. Lenders would rather work with a borrower who’s in financial trouble.

Goyda said there are many options for homeowners, depending on their circumstances.

“Options could include a payment suspension — something many homeowners have used to help them through the COVID pandemic — modifications, and other programs that can bring their loan current and, in some cases, provide a reduced payment,” he said. “A modification allows us to adjust the loan terms — including ways to address missed payments and other charges, reducing the interest rate and extending the payment term — based on investor guidelines.

The most common options are:

• Loan modification. The lender lowers mortgage payments, usually by extending the term or lowering interest rates.
• This is the “payment suspension” Goyda mentioned. It can be either on mortgage payments or on the foreclosure. A lender allows a borrower to temporarily skip payments, though they’ll have to catch up in the future. A foreclosure can also be paused to give the borrower time to catch up.
• Similar to loan modification, it changes the term or interest rate to allow lower monthly payments, but as a new loan.
• Repayment Plan. If a borrower is behind, but their financial situation has improved, a lender may temporarily increase payments to cover the amount in arrears so the borrower can catch up.
• Chapter 13 bankruptcy. An “automatic stay” upon filing halts foreclosure proceedings. Chapter 13 involves a payment plan, usually over five years, and mortgage payments as well as past-due payments are part of it.

Homeowners facing a foreclosure may also sell their house themselves. Goyda said lenders are willing to help with the process.

“If a customer cannot afford their mortgage and no longer wants to stay in their home, we also can work with them as they attempt to sell their home,” he said. He said in many recent cases, a sale has enabled homeowners facing foreclosure to take advantage of the strong U.S. housing market, including steep price increases, that came during the COVID-19 pandemic.

The owner sells the house, and the bank takes what’s owed on the mortgage, and if there’s any left, the homeowner keeps the balance.

Another option is a short sale, where the homeowner sells the house for less than what they owe the bank, and the bank either forgives the balance or files a deficiency judgment against the owner.

The homeowner can also turn the house over to the lender and avoid the foreclosure process, called a deed in lieu of sale. The balance of the mortgage is forgiven in these cases.

What Else Should I Know?

If you are thinking about going into foreclosure, here are some things to consider:

• A foreclosure dramatically affects your credit score. Fair Isaac, the company that created FICO (credit) scores, lowers credit scores from 85 points to 160 points after a foreclosure or short sale. The amount depends on factors such as previous credit score.
• Get in touch with your lender as soon as you are aware that you are having difficulty making payments. You may be able to avoid foreclosure by negotiating a new repayment plan or mortgage loan refinancing that works better for you.
• States have different rules on how foreclosures work, including how long you can stay in the home once proceedings begin. Be sure to understand your rights in your state.
• If you restructure your home loan because of a foreclosure, you can get a tax break through the Mortgage Forgiveness Debt Relief Act. Those filing taxes can exclude income from discharging debt on a principal residence, including debt reduced through mortgage restructuring and mortgage debt relief through foreclosure.
• Foreclosure is a long process, as in years long. In mid-2021, foreclosures took an average of 930 days. Circumstances vary, depending on the economy and other factors, but since 2016, the average has fluctuated between 650 and 1,000-plus days.
• The U.S. government has resources, including the Making Home Affordable program, that helps those in financial trouble keep their home, particularly for those with FHA, VA and USDA mortgages.
• Look out for scammers hoping to profit from your misfortune. If you work with a company to help you through foreclosure, get everything in writing and understand the fees and contract.
• Those at risk of losing their home to foreclosure should consider discussing their financial situation with a counselor at a nonprofit accredited credit counseling agency. The counseling is free. A counselor can help with budgeting and options that may help avoid foreclosure.