Foreclosure is the legal and professional proceeding in which a
mortgagee, or other lien holder, usually a lender, obtains a court
ordered termination of a mortgagor's equitable right of redemption.
Usually a lender obtains a security interest from a borrower who
mortgages or pledges an asset like a house to secure the loan. If the
borrower defaults and the lender tries to repossess the property, courts
of equity can grant the borrower the equitable right of redemption if
the borrower repays the debt. While this equitable right exists, the
lender cannot be sure that it can successfully repossess the property,
thus the lender seeks to foreclose the equitable right of redemption.
Other lien holders can also foreclose the owner's right of redemption
for other debts, such as for overdue taxes, unpaid contractors' bills or
overdue homeowners' association dues or assessments.
The foreclosure process as applied to residential mortgage loans is a
bank or other secured creditor selling or repossessing a parcel of real
property (immovable property) after the owner has failed to comply with
an agreement between the lender and borrower called a "mortgage" or
"deed of trust". Commonly, the violation of the mortgage is a default in
payment of a promissory note, secured by a lien on the property. When
the process is complete, the lender can sell the property and keep the
proceeds to pay off its mortgage and any legal costs, and it is
typically said that "the lender has foreclosed its mortgage or lien". If
the promissory note was made with a recourse clause then if the sale
does not bring enough to pay the existing balance of principal and fees
the mortgagee can file a claim for a deficiency judgment.
Types of foreclosure
The mortgage holder can usually initiate foreclosure at a time specified
in the mortgage documents, typically some period of time after a default
condition occurs. Within the United States, Canada and many other
countries, several types of foreclosure exist. Two of them – namely, by
judicial sale and by power of sale – are widely used, but other modes of
foreclosure are also possible in a few states.
Foreclosure by judicial sale, more commonly known as Judicial
Foreclosure, is available in every state and required in many, involves
the sale of the mortgaged property under the supervision of a court,
with the proceeds going first to satisfy the mortgage; then other lien
holders; and, finally, the mortgagor/borrower if any proceeds are left.
As with all other legal actions, all parties must be notified of the
foreclosure, but notification requirements vary significantly from state
to state. A judicial decision is announced after pleadings at a (usually
short) hearing in a state or local court. In some fairly rare instances,
foreclosures are filed in Federal courts.
Foreclosure by power of sale, which is also allowed by many states if a
power of sale clause is included in the mortgage or if a Deed of trust
was used instead of a mortgage. In some states so-called mortgages are
actually deeds of trust. This process involves the sale of the property
by the mortgage holder without court supervision. It is generally more
expedient than foreclosure by judicial sale. As in judicial sale, the
mortgage holder and other lien holders are respectively first and second
claimants to the proceeds from the sale.
Other types of foreclosure are considered minor because of their limited
availability. Under strict foreclosure, which is available in a few
states including Connecticut, New Hampshire and Vermont, suit is brought
by the mortgagee and if successful, a court orders the defaulted
mortgagor to pay the mortgage within a specified period of time. Should
the mortgagor fail to do so, the mortgage holder gains the title to the
property with no obligation to sell it. This type of foreclosure is
generally available only when the value of the property is less than the
debt ("under water"). Historically, strict foreclosure was the original
method of foreclosure.
Acceleration
The concept of acceleration is used to determine the amount owed under
foreclosure. Acceleration allows the mortgage holder to declare the
entire debt of a defaulted mortgagor due and payable, when a term in the
mortgage has been broken. If a mortgage is taken, for instance, on a
$100,000 property and monthly payments are required, the mortgage holder
can demand the mortgagor make good on the entire $100,000 if the
mortgagor fails to make one or more of those payments. The mortgage
holder will also include any unpaid property taxes and delinquent
payments in this amount, so if the borrower does not have significant
equity they will owe more than the original amount of the mortgage.
Lenders may also accelerate a loan if there is a transfer clause,
obligating the mortgagor to notify the lender of any transfer, whether;
a lease-option, lease-hold of 3 years or more, land contracts, agreement
for deed, transfer of title or interest in the property.
The vast majority (but not all) of mortgages today have acceleration
clauses. The holder of a mortgage without this clause has only two
options: either to wait until all of the payments come due or convince a
court to compel a sale of some parts of the property in lieu of the past
due payments. Alternatively, the court may order the property sold
subject to the mortgage, with the proceeds from the sale going to the
payments owed the mortgage holder.
Process
The process of foreclosure can be rapid or lengthy
and varies from state to state. Other options such as
refinancing, a short sale, alternate financing,
temporary arrangements with the lender, or even
bankruptcy may present homeowners with ways to avoid
foreclosure. Websites which can connect individual
borrowers and homeowners to lenders are increasingly
offered as mechanisms to bypass traditional lenders
while meeting payment obligations for mortgage
providers.
In the United States, there are two types of
foreclosure in most common law states. Using a "deed in
lieu of foreclosure," or "strict foreclosure", the
noteholder claims the title and possession of the
property back in full satisfaction of a debt, usually on
contract. In the proceeding simply known as foreclosure
(or, perhaps, distinguished as "judicial foreclosure"),
the property is subject to auction by the county sheriff
or some other officer of the court. Many states require
this sort of proceeding in some or all cases of
foreclosure to protect any equity the debtor may have in
the property, in case the value of the debt being
foreclosed on is substantially less than the market
value of the immovable property (this also discourages
strategic foreclosure). In this foreclosure, the sheriff
then issues a deed to the winning bidder at auction.
Banks and other institutional lenders may bid in the
amount of the owed debt at the sale but there are a
number of other factors that may influence the bid, and
if no other buyers step forward the lender receives
title to the immovable property in return.
Other states have adopted non-judicial foreclosure
procedures in which the mortgagee, or more commonly the
mortgagee's servicer's attorney or designated agent,
gives the debtor a notice of default and the mortgagee's
intent to sell the immovable property in a form
prescribed by state statute. This type of foreclosure is
commonly referred to as "statutory" or "non-judicial"
foreclosure, as opposed to "judicial". With this
"power-of-sale" type of foreclosure, if the debtor fails
to cure the default, or use other lawful means (such as
filing for bankruptcy, which temporarily stays the
foreclosure) to stop the sale, the mortgagee or its
representative conduct a public auction in a similar
manner to the sheriff's auction. The highest bidder at
the auction becomes the owner of the immovable property,
free and clear of interest of the former owner, but
possibly encumbered by liens superior to the foreclosed
mortgage (e.g., a senior mortgage or unpaid property
taxes). Further legal action, such as an eviction may be
necessary to obtain possession of the premises.
Defenses - The Constitutional Issue of Due
Process has affected the ability of lenders to foreclose
property. In Ohio, the Federal District Court has
dismissed numerous foreclosure actions by lenders
because of the inability of the alleged lender to prove
that they are the real party in interest. In Colorado,
on June 19, 2008, a District Court Judge dismissed a
foreclosure action because of failure of the alleged
lender to prove they were the real party in interest.
"Strict foreclosure" is an equitable right available
in some states. The strict foreclosure period arises
after the foreclosure sale has taken place and is
available to the foreclosure sale purchaser. The
foreclosure sale purchaser must petition a court for a
decree that cuts off any junior lien holder's rights to
redeem the senior debt. If the junior lien holder fails
to do so within the judicially established time frame,
his lien is canceled and the purchaser's title is
cleared. This effect is the same as the strict
foreclosure that occurred at common law in England's
courts of equity as a response to the development of the
equity of redemption.
In most jurisdictions it is customary for the
foreclosing lender to obtain a title search of the
immovable property and to notify all other persons who
may have liens on the property, whether by judgment, by
contract, or by statute or other law, so that they may
appear and assert their interest in the foreclosure
litigation. In all US jurisdictions a lender who
conducts a foreclosure sale of immovable property which
is the subject of a federal tax lien must give 25 days'
notice of the sale to the Internal Revenue Service:
failure to give notice to the IRS results in the lien
remaining attached to the immovable property after the
sale. Therefore, it is imperative the lender search
local Federal Tax Liens so if parties involved in the
foreclosure have a federal tax lien filed against them,
the proper notice to the IRS is given. A detailed
explanation by the IRS of the Federal Tax Lien process
can be foundThe US congress passed, and President Bush
signed into law, a temporary change to the tax code. For
the period Jan. 1, 2007, through Dec. 31, 2009,
homeowners do not have to pay tax on canceled debt.
Contesting a foreclosure
Because the right of redemption is an equitable right, foreclosure is an
action in equity. To keep the right of redemption, the debtor can ask an
equity court for an injunction. If repossession is imminent the debtor
must seek a temporary restraining order. However, the debtor may have to
post a bond in the amount of the debt. This protects the creditor if the
attempt to stop foreclosure is simply an attempt to escape the debt.
A debtor may also challenge the validity of the debt in a claim against
the bank to stop the foreclosure and sue for damages. In a foreclosure
proceeding, the lender bears the burden of proving that there was a
valid debt.
One note-worthy court case questions the legality of the foreclosure
practice. In the case First National Bank of Montgomery vs Jerome Daly
Jerome Daly claimed that the bank didn't offer a legal form of
consideration because the money loaned to him was created upon signing
of the loan contract. Daly won, and the result was that he didn't have
to repay the loan, and the bank couldn't repossess his property.
Foreclosure auction
When the entity (in the US, typically a county sheriff or designee)
auctions a foreclosed property the noteholder may set the starting price
as the remaining balance on the mortgage loan. However, there are a
number of issues that affect how pricing for properties is considered,
including bankruptcy rulings. In a weak market the foreclosing party may
set the starting price at a lower amount if it believes the real estate
securing the loan is worth less than the remaining principal of the
loan.
In the case where the remaining mortgage balance is higher than the
actual home value the foreclosing party is unlikely to attract auction
bids at this price level. A house that went through a foreclosure
auction and failed to attract any acceptable bids may remain the
property of the owner of the mortgage. That inventory is called REO
(real estate owned). In these situations the owner/servicer tries to
sell it through standard real estate channels.
Further borrower's obligations
The mortgagor may be required to pay for Private Mortgage Insurance, or
PMI, for as long as the principal of his primary mortgage is above 80%
of the value of his property. In most situations, insurance requirements
are sufficient to guarantee that the lender gets some pre-defined
percentage of the loan value back, either from foreclosure auction
proceeds or from PMI or a combination thereof.
Nevertheless, in an illiquid real estate market or following a
significant drop in real estate prices, it may happen that the property
being foreclosed is sold for less than the remaining balance on the
primary mortgage loan, and there may be no insurance to cover the loss.
In this case, the court overseeing the foreclosure process may enter a
deficiency judgment against the mortgagor. Deficiency judgments can be
used to place a lien on the borrower's other property that obligates the
mortgagor to repay the difference. It gives lender a legal right to
collect the remainder of debt out of mortgagor's other assets (if any).
There are exceptions to this rule, however. If the mortgage is a
non-recourse debt (which is often the case with owner-occupied
residential mortgages in the U.S.), lender may not go after borrower's
assets to recoup his losses. Lender's ability to pursue deficiency
judgment may be restricted by state laws. In California and some other
states, original mortgages (the ones taken out at the time of purchase)
are typically non-recourse loans; however, refinanced loans and home
equity lines of credit aren't.
If the lender chooses not to pursue deficiency judgment—or can't because
the mortgage is non-recourse—and writes off the loss, the borrower may
have to pay income taxes on the un-repaid amount if it can be considered
"forgiven debt." However, recent changes in tax laws may change the way
these amounts are reported.
Any liens resulting from other loans taken out against the property
being foreclosed (second mortgages, HELOCs) are "wiped out" by
foreclosure, but the borrower is still obligated to pay those loans off
if they are not paid out of the foreclosure auction's proceeds.
Renegotiation alternative
In the wake of the United States housing bubble and the subsequent
subprime mortgage crisis there has been increased interest in
renegotiation or modification of the mortgage loans rather than
foreclosure, and some commentators have speculated that the crisis was
exacerbated by the "unwillingness of lenders to renegotiate
mortgages".[5] Several policies, including the U.S. Treasury sponsored
Hope Now initiative and the 2009 "Making Home Affordable" plan have
offered incentives to renegotiate mortgages. Renegotiations can include
lowering the principal due or temporarily reducing the interest rate. A
2009 study by Federal Reserve economists found that even using a broad
definition of renegotiation, only 3% of "seriously delinquent borrowers"
received a modification. The leading theory attributes the lack of
renegotiation to securitization and a large number of claimants with
security interest in the mortgage. There is some support behind this
theory, but an analysis of the data found that renegotiation rates were
similar among insecurities and securitized mortgages. The authors of the
analysis argue that banks don't typically renegotiate because they
expect to make more money with a foreclosure, as renegotiation imposes
"self-cure" and "re-default" risks.
Finances
