Foreclosure
Encyclopedia
Redemption value
Redemption value is the price at which the issuing company may choose to repurchase a security before its maturity date.A bond is purchased at a discount if its redemption value exceeds its purchase price. It is purchased at a premium if its purchase price exceeds its redemption value....
, either by court order
Court order
A court order is an official proclamation by a judge that defines the legal relationships between the parties to a hearing, a trial, an appeal or other court proceedings. Such ruling requires or authorizes the carrying out of certain steps by one or more parties to a case...
or by operation of law (after following a specific statutory procedure). Usually a lender obtains a security interest
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
from a borrower who mortgages or pledges an asset like a house to secure the loan. If the borrower defaults
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
and the lender tries to repossess
Repossession
Repossession is generally used to refer to a financial institution taking back an object that was either used as collateral or rented or leased in a transaction. Repossession is a "self-help" type of action in which the party having right of ownership of the property in question takes the property...
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, it is a cloud on title
Cloud on title
The term cloud on title refers to any irregularity in the chain of title of property that would give a reasonable person pause before accepting a conveyance of title...
and the lender cannot be sure that (s)he can successfully repossess the property. Therefore, through the process of foreclosure, the lender seeks to foreclose the equitable right of redemption and take both legal and equitable title to the property in fee simple
Fee simple
In English law, a fee simple is an estate in land, a form of freehold ownership. It is the most common way that real estate is owned in common law countries, and is ordinarily the most complete ownership interest that can be had in real property short of allodial title, which is often reserved...
. 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
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
or other secured
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
selling or repossessing a parcel of real property
Real property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...
(immovable property
Immovable property
Immovable property is an immovable object, an item of property that cannot be moved without destroying or altering it - property that is fixed to the Earth, such as land or a house. In the United States it is also commercially and legally known as real estate and in Britain as 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
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
in payment of a promissory note
Promissory note
A promissory note is a negotiable instrument, wherein one party makes an unconditional promise in writing to pay a determinate sum of money to the other , either at a fixed or determinable future time or on demand of the payee, under specific terms.Referred to as a note payable in accounting, or...
, secured by a lien
Lien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
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
Lien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
". 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 mortgageholder 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. In the U.S., 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, which 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. Under this system, the lender initiates foreclosure by filing a lawsuit
Lawsuit
A lawsuit or "suit in law" is a civil action brought in a court of law in which a plaintiff, a party who claims to have incurred loss as a result of a defendant's actions, demands a legal or equitable remedy. The defendant is required to respond to the plaintiff's complaint...
against the borrower. 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 the exchange of pleadings at a (usually short) hearing in a state or local court. In some rather rare instances, foreclosures are filed in federal courts.
Foreclosure by power of sale, also known as nonjudicial foreclosure, is authorized by many states if a power of sale clause is included in the mortgage or if a deed of trust with such a clause was used, instead of an actual mortgage. In some states, like California
California
California is a state located on the West Coast of the United States. It is by far the most populous U.S. state, and the third-largest by land area...
, nearly all so-called mortgages are actually deeds of trust. This process involves the sale of the property by the mortgage holder without court supervision (as elaborated upon below). This process is generally much faster and cheaper 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 refinancingRefinancing
Refinancing may refer to the replacement of an existing debt obligation with a debt obligation under different terms. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic factors such as, inherent risk, projected risk, political...
, a short sale
Short sale (real estate)
A short sale is a sale of real estate in which the proceeds from selling the property will fall short of the balance of debts secured by liens against the property and the property owner cannot afford to repay the liens' full amounts, whereby the lien holders agree to release their lien on the real...
, alternate financing, temporary arrangements with the lender, or even bankruptcy
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
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.
Strict foreclosure/judicial foreclosure
In the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, there are two types of foreclosure in most common law
Common law
Common law is law developed by judges through decisions of courts and similar tribunals rather than through legislative statutes or executive branch action...
states. Using a "deed in lieu of foreclosure
Deed in lieu of foreclosure
A Deed in lieu of foreclosure is a deed instrument in which a mortgagor conveys all interest in a real property to the mortgagee to satisfy a loan that is in default and avoid foreclosure proceedings....
," or "strict foreclosure", the noteholder claims the title
Title (property)
Title is a legal term for a bundle of rights in a piece of property in which a party may own either a legal interest or an equitable interest. The rights in the bundle may be separated and held by different parties. It may also refer to a formal document that serves as evidence of ownership...
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 lender must sue the defaulting borrower in state court. Upon final judgment (usually summary judgment
Summary judgment
In law, a summary judgment is a determination made by a court without a full trial. Such a judgment may be issued as to the merits of an entire case, or of specific issues in that case....
) in the lender's favor, the property is subject to auction
Auction
An auction is a process of buying and selling goods or services by offering them up for bid, taking bids, and then selling the item to the highest bidder...
by the county sheriff
Sheriff
A sheriff is in principle a legal official with responsibility for a county. In practice, the specific combination of legal, political, and ceremonial duties of a sheriff varies greatly from country to country....
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
Ownership equity
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
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 real property (this also discourages strategic foreclosure
Strategic default
A strategic default is the decision by a borrower to stop making payments on a debt despite having the financial ability to make the payments....
). 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 real property in return.
Nonjudicial foreclosure
Historically, the vast majority of judicial foreclosures have been unopposed, since most defaulting borrowers have no money with which to hire counsel. Therefore, the U.S. financial services industry has lobbied since the mid-19th century for faster foreclosure procedures that would not clog up state courts with uncontested cases, and would lower the cost of credit (because it must always have the cost of recovering collateral built-in). Lenders have also argued that taking foreclosures out of the courts is actually kinder and less traumatic to defaulting borrowers, as it avoids the in terroremIn terrorem
In terrorem, Latin for "in [order to] frighten," is a legal term used to describe a warning, usually one given in hope of compelling someone to act without resorting to a lawsuit or criminal prosecution...
effects of being sued.
In response, a slight majority of U.S. states have adopted nonjudicial foreclosure procedures in which the mortgagee (or more commonly the mortgagee's servicer's attorney, designated agent, or trustee) gives the debtor a notice of default (NOD) and the mortgagee's intent to sell the real property in a form prescribed by state statute
Statute
A statute is a formal written enactment of a legislative authority that governs a state, city, or county. Typically, statutes command or prohibit something, or declare policy. The word is often used to distinguish law made by legislative bodies from case law, decided by courts, and regulations...
; the NOD in some states must also be recorded against the property. This type of foreclosure is commonly referred to as "statutory" or "nonjudicial" foreclosure, as opposed to "judicial", because the mortgagee does not need to file an actual lawsuit to initiate the foreclosure. A few states impose additional procedural requirements such as having documents stamped by a court clerk; Colorado requires the use of a county "public trustee," a government official, rather than a private trustee specializing in carrying out foreclosures. However, in most states, the only government official involved in a nonjudicial foreclosure is the county recorder, who merely records any pre-sale notices and the trustee's deed upon sale.
In 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
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
to temporarily stay the foreclosure) to stop the sale, the mortgagee or its representative conduct a public auction
Public auction
A public auction is an auction held on behalf of a government in which the property to be auctioned is either property owned by the government, or property which is sold under the authority of a court of law or a government agency with similar authority....
in a manner similar to the sheriff's auction. Notably, the lender itself can bid for the property at the auction, and is the only bidder that can make a "credit bid" (a bid based on the outstanding debt itself) while all other bidders must be able to immediately present the auctioneer with cash or a cash equivalent like a cashier's check
Cashier's check
A cashier's check is a check guaranteed by a bank. They are treated as guaranteed funds and are usually cleared the next day. It is the customer's right to request "next-day availability" when depositing a cashier's check in person...
.
The highest bidder at the auction becomes the owner of the real 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
Eviction
How you doing???? Eviction is the removal of a tenant from rental property by the landlord. Depending on the laws of the jurisdiction, eviction may also be known as unlawful detainer, summary possession, summary dispossess, forcible detainer, ejectment, and repossession, among other terms...
, may be necessary to obtain possession of the premises if the former occupant fails to voluntarily vacate.
Defenses
In some states, particularly those where only judicial foreclosure is available, the constitutional issue of due processDue process
Due process is the legal code that the state must venerate all of the legal rights that are owed to a person under the principle. Due process balances the power of the state law of the land and thus protects individual persons from it...
has affected the ability of some lenders to foreclose. In Ohio, the federal district court for the Northern District of Ohio 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 June 2008, a Colorado district court judge also dismissed a foreclosure action because of failure of the alleged lender to prove they were the real party in interest.
In contrast, in six federal judicial circuits
United States courts of appeals
The United States courts of appeals are the intermediate appellate courts of the United States federal court system...
and the majority of nonjudicial foreclosure states (like California), due process has already been judicially determined to be a frivolous defense. The entire point of nonjudicial foreclosure is that there is no state actor
State actor
In United States law, a state actor is a person who is acting on behalf of a governmental body, and is therefore subject to regulation under the United States Bill of Rights, including the First, Fifth and Fourteenth Amendments, which prohibit the federal and state governments from violating...
(i.e., a court) involved. The constitutional right of due process protects people only from violations of their civil rights by state actors, not private actors. A further rationale is that under the principle of freedom of contract
Freedom of contract
Freedom of contract is the freedom of individuals and corporations to form contracts without government restrictions. This is opposed to government restrictions such as minimum wage, competition law, or price fixing...
, if debtors wish to enjoy the additional protection of the formalities of judicial foreclosure, it is their burden to find a lender willing to provide a loan secured by a traditional conventional mortgage instead of a deed of trust with a power of sale. The difficulty in finding such a lender in nonjudicial foreclosure states is not the state's problem. Courts have also rejected as frivolous the argument that the mere legislative act of authorizing the nonjudicial foreclosure process thereby transforms the process itself into state action.
In turn, since there is no right to due process in nonjudicial foreclosure, it has been held that it is irrelevant whether the borrower had actual notice of the foreclosure, as long as the foreclosure trustee performed the tasks prescribed by statute in an attempt to give notice.
Equitable foreclosure
"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 object 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.Title search and tax lien issues
In most jurisdictions it is customary for the foreclosing lender to obtain a title searchTitle search
A title search is a process that is performed primarily to determine the answer to three questions:*Does the seller have a saleable interest in the property?...
of the real property and to notify all other persons who may have lien
Lien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
s on the property, whether by judgment, by contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
, or by statute
Statute
A statute is a formal written enactment of a legislative authority that governs a state, city, or county. Typically, statutes command or prohibit something, or declare policy. The word is often used to distinguish law made by legislative bodies from case law, decided by courts, and regulations...
or other law, so that they may appear and assert their interest in the foreclosure litigation. This is accomplished through the filing of a lis pendens
Lis pendens
Lis pendens is Latin for "suit pending." This may refer to any pending lawsuit or to a specific situation with a public notice of litigation that has been recorded in the same location where the title of real property has been recorded...
as part of the lawsuit and recordation of it in order to provide public notice of the pendency of the foreclosure action. In all U.S. jurisdictions a lender who conducts a foreclosure sale of real property which is the subject of a federal tax lien must give 25 days' notice of the sale to the Internal Revenue Service
Internal Revenue Service
The Internal Revenue Service is the revenue service of the United States federal government. The agency is a bureau of the Department of the Treasury, and is under the immediate direction of the Commissioner of Internal Revenue...
: failure to give notice to the IRS results in the lien remaining attached to the real 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 found.
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 may be able to petition the 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 also bears the burden of proving they have standing to foreclose.
Several U.S. states, including California, Georgia, and Texas impose a "tender" condition precedent upon borrowers seeking to challenge a wrongful foreclosure, which is rooted in the maxim of equity
Maxims of equity
The maxims of equity evolved, in Latin and eventually translated into English, as the principles applied by courts of equity in deciding cases before them.Among the traditional maxims are:-Equity regards done what ought to be done:...
that "he who seeks equity must first do equity," as well as the common law rule that the party seeking rescission
Rescission
In contract law, rescission has been defined as the unmaking of a contract between parties. Rescission is the unwinding of a transaction. This is done to bring the parties, as far as possible, back to the position in which they were before they entered into a contract .-In court:Rescission is an...
of a contract must first return all benefits received under the contract.
In other words, to challenge an allegedly wrongful foreclosure, the borrower must make legal tender
Legal tender
Legal tender is a medium of payment allowed by law or recognized by a legal system to be valid for meeting a financial obligation. Paper currency is a common form of legal tender in many countries....
of the entire remaining balance of the debt prior to the foreclosure sale. California has one of the strictest forms of this rule, in that the funds must be received by the lender before the sale. One tender attempt was held inadequate when the check arrived via FedEx
FedEx
FedEx Corporation , originally known as FDX Corporation, is a logistics services company, based in the United States with headquarters in Memphis, Tennessee...
on a Monday, three days after the foreclosure sale had already occurred on Friday.
At least one textbook has attacked the paradox inherent in the tender rule—namely, if the borrower actually had enough cash to promptly pay the entire balance, they would have already paid it off and the lender would not be trying to foreclose upon them in the first place—but it continues to be the law in the aforementioned states.
Occasionally, borrowers have raised enough cash at the last minute (usually through desperate fire sale
Fire sale
A fire sale is the sale of goods at extremely discounted prices, typically when the seller faces bankruptcy or other impending distress. The term may originally have been based on the sale of goods at a heavy discount due to fire damage...
s of other unencumbered assets) to offer good tender and have thereby avoided foreclosure or at least preserved their rights to challenge the foreclosure process. Courts have been unsympathetic to attempts by such borrowers to recover fire sale losses from foreclosing lenders.
One noteworthy but legally meaningless court case questions the legality of the foreclosure practice is sometimes cited as proof of various claims regarding lending. In the case First National Bank of Montgomery vs Jerome Daly
First National Bank of Montgomery vs Jerome Daly
First National Bank of Montgomery v. Jerome Daly, Dec. 9, 1968 , also known as the Credit River Case, was a case tried before a Justice of the Peace in Minnesota in 1968...
Jerome Daly claimed that the bank didn't offer a legal form of consideration
Consideration
Consideration is the central concept in the common law of contracts and is required, in most cases, for a contract to be enforceable. Consideration is the price one pays for another's promise. It can take a number of forms: money, property, a promise, the doing of an act, or even refraining from...
because the money loaned to him was created upon signing of the loan contract. The myth reports that Daly won, and the result was that he didn't have to repay the loan, and the bank couldn't repossess his property. In fact, the "ruling" (widely referred to as the "Credit River Decision") was ruled a nullity by the courts.
In a recent New York case, the Court rejected a lender's attempt to foreclose on summary judgment because the lender failed to submit proper affidavits and papers in support of its foreclosure action and also, the papers and affidavits that were submitted were not prepared in the ordinary course of business. .
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
Real estate owned or REO is a class of property owned by a lender typically a bank, government agency, or government loan insurer, after an unsuccessful sale at a foreclosure auction. A foreclosing beneficiary will typically set the opening bid at a foreclosure auction for at least the outstanding...
(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
Deficiency judgment
A deficiency judgment is an unsecured money judgment against a borrower whose mortgage foreclosure sale did not produce sufficient funds to pay the underlying promissory note, or loan, in full. The availability of a deficiency judgment depends on whether the lender has a recourse or nonrecourse...
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 unrepaid 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 mortgage
Second mortgage
A second mortgage typically refers to a secured loan that is subordinate to another loan against the same property.In real estate, a property can have multiple loans or liens against it. The loan which is registered with county or city registry first is called the first mortgage or first position...
s, HELOC
HELOC
A home equity line of credit is a loan in which the lender agrees to lend a maximum amount within an agreed period , where the collateral is the borrower's equity in his/her house...
s) 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 bubbleUnited States housing bubble
The United States housing bubble is an economic bubble affecting many parts of the United States housing market in over half of American states. Housing prices peaked in early 2006, started to decline in 2006 and 2007, and may not yet have hit bottom as of 2011. On December 30, 2008 the...
and the subsequent subprime mortgage crisis
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
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". 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
Securitization
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or Collateralized mortgage obligation , to...
and a large number of claimants with security interest
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
in the mortgage. There is some support behind this theory, but an analysis of the data found that renegotiation rates were similar among unsecuritized 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 "redefault" risks.
Experiences of Households Post-Foreclosure
A 2011 research paper by the Federal Reserve Board, “The Post-Foreclosure Experience of U.S. Households,” used credit reports from more than 37 million individuals between 1999 to 2010 to measure post-foreclosure behavior, especially in regard to future borrowing and housing consumption. The study found that: 1) On average 23% of people experiencing foreclosure had moved within a year of the foreclosure process starting. In the same time, a control group (not facing foreclosure) had only a 12% migration rate; 2) Only 30% of post-foreclosure borrowers moved to neighborhoods with median income at least 25% lower than their previous neighborhood; 3) The majority of post-foreclosure migrants do not end up in substantially less-desirable neighborhoods or more crowded living conditions; 4) There was no significant difference in household size between the post-foreclosure and control groups. However, only 17% of the post-foreclosure individuals had the same number and composition of household members after a foreclosure than before. By comparison, the control group maintained the same household companions in 46% of cases; and, 5) Only about 20% of post-foreclosure individuals chose to live in households where one person maintained a mortgage. Overall, the authors conclude that it is “difficult to say whether this small effect is because the shock that leads to foreclosure is not long-lasting, because the credit constraints imposed by having a foreclosure on one’s credit report are not large, or because housing services are more inelastic than other forms of consumption."Countries other than the USA
- AustraliaAustraliaAustralia , officially the Commonwealth of Australia, is a country in the Southern Hemisphere comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands in the Indian and Pacific Oceans. It is the world's sixth-largest country by total area...
and New ZealandNew ZealandNew Zealand is an island country in the south-western Pacific Ocean comprising two main landmasses and numerous smaller islands. The country is situated some east of Australia across the Tasman Sea, and roughly south of the Pacific island nations of New Caledonia, Fiji, and Tonga...
: Foreclosures are generally referred to as Mortgagee sales or Mortgagee auctions. In those cases, the bank or lender ("Mortgagee") sells under the terms of the mortgage. In both of these countries statutory reform has altered the manner in which real property dealings are conducted. What is termed a "mortgage" is a charge that is registered against the title of the property. Since in both countries, the Torrens titleTorrens titleTorrens title is a system of land title where a register of land holdings maintained by the state guarantees an indefeasible title to those included in the register...
system of land registration is used, being registered as proprietor or as a mortgagee creates an indefeasible interest (unless the acquisition of the registration was by land transfer fraud). The mortgagee therefore never holds any title documents, and there is a statutory process for initiating and conducting a mortgagee sale in the event that the mortgagor defaults. In New Zealand, the land title database is now electronic so there are no paper "title documents". - United KingdomUnited KingdomThe United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
: Foreclosure is a little used remedy which vests the property in the mortgagee with the mortgagor having no right to any surplus from the sale. Because this remedy can be harsh, courts almost never allow it. Instead, they usually grant an order for possession and an order for sale, which mitigates some of the harshness of the repossession by allowing the sale. - IrelandRepublic of IrelandIreland , described as the Republic of Ireland , is a sovereign state in Europe occupying approximately five-sixths of the island of the same name. Its capital is Dublin. Ireland, which had a population of 4.58 million in 2011, is a constitutional republic governed as a parliamentary democracy,...
: Foreclosure has been abolished by the Land and Conveyancing Reform Act 2009Land and Conveyancing Reform Act 2009 but Chapter 4 of Part 9 of the National Asset Management AgencyNational Asset Management AgencyThe National Asset Management Agency is a body created by the Government of Ireland in late 2009. It is in response to the Irish financial crisis and the deflation of the Irish property bubble....
Act 2009 provides for vesting orders that are equivalent to foreclosure but may only be used by NAMA. - SwitzerlandSwitzerlandSwitzerland name of one of the Swiss cantons. ; ; ; or ), in its full name the Swiss Confederation , is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe,Or Central Europe depending on the definition....
: Foreclosure takes place as a form of debt enforcement proceedings under Swiss insolvency lawInsolvency law of SwitzerlandThe insolvency law of Switzerland is the law governing insolvency, foreclosure, bankruptcy and debt restructuring proceedings in Switzerland. It is principally codified in the Federal Statute on Debt Enforcement and Bankruptcy of 11 April 1889 as well as in ancillary federal and cantonal laws.For...
. - People's Republic of ChinaPeople's Republic of ChinaChina , officially the People's Republic of China , is the most populous country in the world, with over 1.3 billion citizens. Located in East Asia, the country covers approximately 9.6 million square kilometres...
: Foreclosure takes place as a form of debt enforcement proceedings under strict judicial foreclosure, which is only allowed by law of guarantee and law of property right. - PhilippinesPhilippinesThe Philippines , officially known as the Republic of the Philippines , is a country in Southeast Asia in the western Pacific Ocean. To its north across the Luzon Strait lies Taiwan. West across the South China Sea sits Vietnam...
: There are two modes of foreclosure in the Philippines. A mortgagee may foreclose either judicially or extrajudicially, as governed by Rule 68 of the 1997 Revised Rules of Civil Procedure and Act. No. 3135, respectively. A judicial foreclosure is done by filing a complaint in the Regional Trial Court of the place where the property is located. The judge renders judgment, ordering the mortgagor to pay the debt within a period of 90–120 days. If the debt is not paid within the said period, a foreclosure sale satisfies the judgment. In an extrajudicial foreclosure, the mortgagee need not initiate an action in court but may simply file an application before the Clerk of Court to secure attendance of the Sheriff who conducts the public sale. This is done pursuant to a power of sale. Note that these two modes specifically apply to real estate mortgages. Foreclosure of chattel mortgages (mortgage of movable property) are governed by Sec. 14 of Act No. 1506, which gives the mortgagee the right to sell the chattel at a public sale. It has also been held that as regards chattel mortgages, the law does not prohibit that the foreclosure sale be done privately if it is agreed upon by the parties. - South AfricaSouth AfricaThe Republic of South Africa is a country in southern Africa. Located at the southern tip of Africa, it is divided into nine provinces, with of coastline on the Atlantic and Indian oceans...
: For a developing country, there is a high rate of foreclosures in South Africa because of the privatisation of housing delivery. One of the biggest opponents of foreclosures is the Western Cape Anti-Eviction CampaignWestern Cape Anti-Eviction CampaignThe Western Cape Anti-Eviction Campaign is a non-racial popular movement made up of poor and oppressed communities in Cape Town, South Africa...
which sees foreclosures as unconstitutional and a particular burden on vulnerable poor populations.
See also
- Deed in lieu of foreclosureDeed in lieu of foreclosureA Deed in lieu of foreclosure is a deed instrument in which a mortgagor conveys all interest in a real property to the mortgagee to satisfy a loan that is in default and avoid foreclosure proceedings....
- Equity strippingEquity strippingEquity stripping, also known as equity skimming, is a type of foreclosure rescue scheme. Often considered a form of predatory lending, equity stripping became increasingly widespread in the early 2000s. In an equity stripping scheme an investor buys the property from a homeowner facing foreclosure...
- Financial crisis of 2007–2010
- ForbearanceForbearanceIn the context of a mortgage process, forbearance is a special agreement between the lender and the borrower to delay a foreclosure. The literal meaning of forbearance is “holding back.”...
- HUD auctionHUD auctionA HUD auction is a form of foreclosure auction except the original lender was a federal agency instead of a private lender. The United States Department of Housing and Urban Development , is the insurer of loans made through a variety of government programs, particularly FHA loans...
- Loss mitigationLoss mitigationLoss mitigation is used to describe a third party helping a homeowner, a division within a bank that mitigates the loss of the bank, or a firm that handles the process of negotiation between a homeowner and the homeowner's lender. Loss mitigation works to negotiate mortgage terms for the homeowner...
- RepossessionRepossessionRepossession is generally used to refer to a financial institution taking back an object that was either used as collateral or rented or leased in a transaction. Repossession is a "self-help" type of action in which the party having right of ownership of the property in question takes the property...
- Real estate trendsReal estate trendsReal estate trends is a generic term used to describe any consistent pattern or change in the general direction of the real estate industry which, over the course of time, causes a statistically noticeable change...
- Short sale (real estate)Short sale (real estate)A short sale is a sale of real estate in which the proceeds from selling the property will fall short of the balance of debts secured by liens against the property and the property owner cannot afford to repay the liens' full amounts, whereby the lien holders agree to release their lien on the real...
- Tax takingTax takingTax taking is a form of forced sale by taxation authorities in lieu of unpaid taxes.- Auction for Tax Bills :Richland County, South Carolina is a typical tax deed county. If the taxes are unpaid for five years then the tax bill will be sold at an auction...
- Tax Sales, Tax Auctions, Tax Foreclosures - Vacant property
Further reading
- Trevor Rhodes. American Foreclosure: Everything U Need to Know about Preventing and Buying. 348 pages. McGraw-HillMcGraw-HillThe McGraw-Hill Companies, Inc., is a publicly traded corporation headquartered in Rockefeller Center in New York City. Its primary areas of business are financial, education, publishing, broadcasting, and business services...
, April, 2008. ISBN 0-07-159058-7