What Is a Foreclosure and How Does it Work?

It can be hard to pass up a good deal, especially when it’s on a large purchase like a home. That’s why many home buyers turn to foreclosed homes in hopes of getting more space in a better area and with a much lower price tag.

Foreclosure purchases thrived in 2009-2010 when a recession-battered housing market hit its peak foreclosure rate. During that time, more than five million homes went into foreclosure and home buyers could often purchase them at more than half off the original price in many areas across the U.S.

Now that the market is in better health, foreclosed homes are on the decline, with 624,753 properties filing for foreclosure in 2018, according to the ATTOM Data Solutions 2018 Foreclosure Market Report. With less of these homes available at a higher value than before, the foreclosure market may be slowing down. But foreclosed homes are still priced much lower than the average American home for sale, and there is still an opportunity to find that great deal for the person who knows how to navigate the foreclosure market.

Before you purchase a foreclosed home, it’s important to understand what foreclosure is, why people enter into foreclosure and what to consider when buying a foreclosed home.

What Is Foreclosure?

Foreclosure happens when a borrower fails to pay their mortgage payments and the lender or mortgage investor must repossess the home. Foreclosure can also happen when the homeowner fails to pay their property taxes or homeowners association fees.

When it comes to understanding foreclosure, there are three terms to know.

• Foreclosure: the legal process in which a lender or mortgage investor takes back unpaid property
• Home in foreclosure: a property going through the foreclosure process
• Foreclosed home or REO: a property that has gone through the foreclosure process and is now owned by the lender or bank, also known as a real estate owned property (REO)

During foreclosure, the mortgage lender may seize the property and sell it to recoup the money it lost from the mortgage default. The lender is allowed to take back the home because a mortgage is a secured loan. That means the borrower guarantees repayment by providing collateral. If they can’t pay back the loan with money, they use the collateral instead. In the case of a mortgage, the home is used as collateral and, upon signing closing documents, the borrower recognizes that the lender has the right to foreclose on the home if they default on the loan. This is also known as putting a lien on the title of the home. Once the mortgage is paid off, this lien on the title of the home is removed.

At the time of getting their mortgage, people are typically in a position to successfully make payments on their loan. And most lenders ensure this by verifying income, reviewing credit history, and putting a limit on the borrower’s debt-to-income ratio (DTI). But despite all of these assurances, things don’t always go as expected – in life or in the economy.

Why Do Homeowners Go into Foreclosure?

Few people enter into a loan agreement expecting to default on it. However, there are a number of reasons a homeowner may fail to make their payments.

Unforeseen Circumstances

Many times, a person facing foreclosure has experienced a life event that changed their financial circumstances. Because of this, they can no longer afford their monthly payment. Examples of such events include:

• Getting fired, being laid off, or quitting a job
• Taking on excessive debt
• Experiencing a medical emergency
• Incurring a large, unexpected expense
• Losing part or all of their income due to divorce or death
• Experiencing an increase in living expenses
• Relocating before selling the home
• Experiencing distress from a natural disaster

Increased Mortgage Payments

It isn’t just a hardship that causes homeowners to go into foreclosure. It could be something as simple as an increase in their mortgage payment. For example, those with an adjustable rate mortgage may have an increase in interest, which will raise their mortgage payment. Or, if there is an escrow shortage due to a rise in property taxes or insurance premiums, the escrow payment will increase. And since property taxes and homeowners insurance are typically paid through the monthly mortgage payment, the monthly payment will rise as well.

These instances are not uncommon with mortgages and they depend on the terms of the mortgage. However, homeowners who don’t understand their mortgage terms may be caught off guard and unprepared for even the slightest change.

Underwater Mortgage

While most homeowners go into foreclosure because they cannot make their mortgage payment, some enter into foreclosure because they intentionally miss their payments. This often happens when their home is underwater and they no longer have any financial motivation to continue to pay their mortgage.

When a home is underwater, the amount owed on the mortgage is more than the home is worth. When they no longer have equity, some homeowners see no reason to continue making their payments. Instead, they “walk away” from the home, leaving the lender to deal with it.

How Do Foreclosures Work?

There are two types of foreclosures. A judicial foreclosure involves going through a court and allows the homeowner to contest the foreclosure. A non-judicial foreclosure does not require court action. The type of foreclosure and the process it uses will differ from state to state. Whatever the type of foreclosure and whatever the state, the process generally involves five stages.

Stage 1: Missed Payments

No matter the reason a homeowner goes into foreclosure, the process begins the same way: missed payments. Once the homeowner begins missing payments, they are no longer upholding their responsibilities of the loan and the lender can come to collect. What many homeowners don’t realize is the foreclosure process can be expensive for the lender, so it will want to avoid foreclosure, too, if possible. In most cases, lenders are willing to work with the homeowner to restructure the loan and lower or delay payments. If the homeowner needs additional assistance, they may find it through:

• Foreclosure mediation
• HUD-certified financial counseling
• Government mortgage relief programs
• Home loan modification programs

If you are a Quicken Loans®client and need assistance, please call our customer service number at (800) 508-0944, so we can go over your options to help you get back on track.

Stage 2: Public Notice

Once the homeowner misses 3 –6 months’ worth of payments, the lender will give a public notice to the County Recorder’s Office or file a lawsuit with the court. Also called a Notice of Default (NOD), or lis pendens(suit pending), the public notice is a written notification to the homeowner that the lender will pursue legal action if the debt is not paid.

Stage 3: Pre-Foreclosure

Once the lender records the public notice, the pre-foreclosure stage begins and the home enters the early stages of repossession. At this point, the homeowner typically has 90 days to take action. If they want to avoid foreclosure and avoid eviction, they have a few options:

• Reverse the default by paying the outstanding balance
• Sell the property in a short sale before it goes to foreclosure
• Sign the deed over to the lender through a deed in lieu of foreclosure

A short sale is a voluntary sale of the home before foreclosure. It is called a short sale because the sale price usually comes up “short” of the balance owed. When that happens, all of the proceeds from the sale go to the lender and the sale cannot happen unless the lender approves it. A short sale is usually preferable for both the homeowner and the lender. It will be less damaging to the homeowner’s credit and ability to obtain another mortgage in the future. For the lender, a short sale will help recover as much of the loan balance as possible while avoiding the cost of a foreclosure. And, if the property sells for the amount owed, both parties benefit even more. The lender is able to recoup all of its money and the homeowner is able to avoid the credit hit. If the sale price is more than what is owed, the homeowner will get to keep whatever money is left after the mortgage is paid off.

Another way for both parties to avoid foreclosure is with a deed in lieu of foreclosure. In this transaction, the homeowner voluntarily signs the deed over to the lender or bank and is released of all mortgage obligations. Again, by avoiding foreclosure, the homeowner’s credit and mortgage eligibility may take less of a hit. The lender may benefit by avoiding the costs and additional time involved in the foreclosure process. However, it may only approve a deed in lieu of foreclosure if the homeowner cannot sell the home in a short sale and there are no other liens on the property. Even then, the lender may not accept this offer.

If the homeowner cannot sell the home in a short sale, make up the late payments, or pursue a deed in lieu of foreclosure, the home will then go to public auction.

Stage 4: Auction

When the time comes, the mortgage investor or its representative, the trustee, will put the home up for auction. Also known as a trustee sale, the auction is open to the public and will often take place on the steps of the county courthouse, in a conference room or convention center, or even online. Before the auction, a Notice of Trustee’s Sale (NTS) will notify the homeowner and the public of the auction and provide such information as a date, time and location.

Since the mortgage investor, terms of the loan, and specific state guidelines control the policies of the auction, every auction will be different. However, you can expect similar processes and requirements.

At the auction, the minimum bid is normally set at the balance owed on the loan, and the foreclosed home is sold to the highest bidder. That person must pay cash for the full amount or a significant deposit immediately. Though the highest bidder is the winner of the auction, they may not necessarily win ownership of the home. In some states, the previous homeowner has a “right of redemption” that allows them to buy their home back even after it is sold at auction. Typically, they will need to pay the sale price or full loan balance, plus any interest and costs the bank incurred during the process. Depending on the state laws and the method of foreclosure, a homeowner’s right of redemption could be valid up to the time the court clerk files the certificate of sale, or as long as 1 year after the sale. 

Stage 5: Post-Foreclosure

If the home was purchased at auction, the previous homeowner must move out of the home, and the new homeowner can do with the home as they please. Some people move into the home as their permanent residence while others rent out or sell the home and make a profit.

Oftentimes, the home does not sell at auction because the mortgage investor does not approve any bids or the pool of buyers who can pay cash is limited. When this happens, the foreclosed home becomes a bank-owned property, also referred to as a real estate owned property (REO). As stated before, an REO is not the same thing as a home in foreclosure. A home in foreclosure is going through the process of being repossessed by the bank, while an REO is a home that has already been repossessed by the bank. In an REO, the bank is the sole owner of the property.

As the owner of the property, the bank must pay property taxes on the home. Add that to the costs incurred during the foreclosure process and the money lost during default, and it’s easy to see why the bank will want to get rid of the REO home as soon as possible. However, a motivated seller doesn’t always mean the home will sell for dirt cheap. Keep this in mind when buying a home in any stage of the foreclosure process.

Buying a Home in Foreclosure or an REO Property

When buying a home in foreclosure or an REO property, it can be easy to get your hopes up about finding the perfect home for a steal. After all, that’s one of the main reasons you’re looking into purchasing this type of home. But the property may not be perfect and the process isn’t always easy. It’s best to know what to expect and what to be cautious of up front.

One important consideration is that the condition of a foreclosed home can be a toss-up. Typically, there are some issues with this type of home, and they can range from minor repairs to absolute deal breakers. Think about it: if the home is going through foreclosure because the person couldn’t afford their monthly payments, chances are they didn’t have the extra funds for other housing costs, including general upkeep, replacements and repairs.

There are also a few different ways to buy the home, and some methods will fit your goals better than others. How you purchase the home and who you purchase it from will depend on if you are buying a home in foreclosure or buying an REO property. Because of this, there are specific factors to consider when purchasing from the homeowner (stages 1 –3), at the auction (stage 4) or from the bank (stage 5).

Purchasing from the Homeowner

If you’re purchasing the home from the homeowner, chances are you’re doing it through a short sale. While the short sale process is similar to a traditional purchase, one key difference is that the bank, not the homeowner, must approve the offer and the terms of the purchase. That means you’ll be dealing with the bank, which is looking to recoup as much money as possible. That means you may deal with more counteroffers and negotiations than normal. The bank may also take longer to reply to an offer, sometimes weeks or months, which can stall the process.

Purchasing at the Foreclosure Auction

On the other hand, purchasing a home at a foreclosure auction may be a faster process than you want. When you buy a home at auction, you’re typically purchasing the home “as is” without an inspection or an appraisal. Because of this, you run the risk of paying more than the home is actually worth or incurring additional costs in future repairs you didn’t know about.

Depending on the structure of the auction, you may need to pay the full bid amount in cash or put down a significant cash deposit. Either way, you will need a considerable amount of money on hand to pay immediately following the auction. Do you have that much money and do you want to use it all?

When purchasing a home in a foreclosure auction, you’ll also want to consider the responsibilities you’ll incur if you become the owner of the home. If there are liens on the property, they will be transferred to you and you will be responsible for paying them. You’ll want to get title insurance to protect you from liens put on the home before you purchase it.

If you don’t do well in awkward situations, you may want to rethink buying the home at an auction. That’s because you’ll also be responsible for evicting the previous homeowner if they refuse to leave the home. This process may include serving an eviction notice, offering “cash for keys” or filing an eviction lawsuit. Make sure that is something you’re willing to take on.

Purchasing from the Bank

When you purchase a foreclosed home, or REO property, you won’t have to deal with the previous homeowner because the bank now owns the home. Typically, once the property becomes an REO, the bank will clear any liens on the property and evict the previous homeowner before selling the home, so you won’t have to.

Many banks won’t sell directly to home buyers. Instead, they use an REO agent to handle the sale of the home. This person will typically contract a local real estate agent to list the property on a Multiple Listing Service, which may include national online listing platforms and local real estate sites. HUD also hosts an REO directory for all government-backed loans as well as Fannie Mae and Freddie Mac loans.

When purchasing an REO property, you’ll want to work with an experienced agent who knows REO homes. They’ll understand the REO purchase process and specific state guidelines and know how to negotiate with the REO agent and bank. They can best calculate your offer based on any needed repairs and can tell you if you are getting a good deal or need to move on to a different home.

Just like purchasing the home in the other stages of foreclosure, you will be purchasing an REO home “as is.” That means you will be responsible for any required repairs. However, unlike purchasing a home at a foreclosure auction, you can get a home inspection and appraisal before buying an REO home.

In some cases, the bank conducts an inspection after taking back the home. If that is the case, you will want to review a copy of the inspection report. Even then, you should hire a professional to inspect the home since many of these properties sit vacant for weeks or even months after the bank takes over.

A home inspection will tell you if there are structural issues and any repairs you’ll need to fix. Depending on the results, you may want to include repairs or repair costs in your offer. However, don’t expect the bank to make the repairs or accept the offer with the costs included. While it does want to get the property off its books, the bank also doesn’t want to pour any more money into the home than it has to. Though the bank may not fix any of the problems, it’s still important to get an inspection so you know exactly what you’re getting yourself into before moving in. If you have to pay for the repairs yourself, you’ll want to figure those costs into your budget to see if you can swing it and to make sure you are still getting a good deal on the home

While many homes in foreclosure and REO homes are sold at a good price, you should still get an appraisal when you can. In fact, if you are planning on purchasing the home with a mortgage, you will be required to get an appraisal because the lender cannot loan you more money than the home is worth. Remember, the bank is trying to recover as much of its money as possible, so you’ll want to take the asking price with a grain of salt. An appraisal will give you an estimated value of the home and compare it to similar homes in the area. This will help you determine if the asking price is fair or if you are paying too much for the home itself or for the area it’s in. On the flip side, an appraisal could also reveal just how much of a deal you’re getting on the home!

Are you interested in buying a home in foreclosure or purchasing an REO property? Get mortgage approval online through Rocket Mortgage^®by Quicken Loans^® or call (800) 785-4788 to speak to one of our Home Loan Experts. They can go over your specific situation and answer any questions you may have

Have you had success with buying a foreclosure? Share your experience and tips in the comments.

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