What is Foreclosure?
The lifecycle of a home can begin with a shiny new mortgage, but sometimes ends with foreclosure. Foreclosure is a process by which the bank can take back your home to cover mortgage payments that you missed. When you purchase a house with a mortgage, technically the bank owns the house as collateral while you pay off the mortgage. If you make payments on time month after month, no problem. If you miss a payment and the bank is no longer getting the money it was promised, it can use your house to secure the rest of the money that it is owed.
In this post, we’re going to explore the foreclosure process from brand new mortgage to final trustees sale. We’ll also talk about things you can do during the foreclosure process to save your house.
What is a Mortgage?
There’s no foreclosure without a mortgage. When most people buy houses, they cannot pay the entire cost of the house at the same time out of savings. If you’re looking to buy a $500,000 house, you probably won’t hand over $500,000 in cash free and clear. You’ll pay the seller $500,000 in cash—but the cash comes from a loan that you’ve taken out from the bank. You’ll then have to pay the bank back through a mortgage.
Down Payment (Loan to Value)
Most mortgages require you to make a down payment, maybe 3-6% of the value of the home. In our $500,000 example, if your down payment was 3%, that means that you’d end up paying $15,000 down to the bank when you take out the mortgage. This covers the amount of the loan that you aren’t approved for, which is also known as the LTV (loan to value) of the home. If you’re approved for 97% loan to value, which is pretty standard for first-time home buyers, then you’d pay 3% down.
Term and Monthly Payments
After the down payment, mortgages put you on the hook for a variety of monthly payments. This is where the possibility of foreclosure will enter the equation later, if you’re unable to make your monthly payment! Mortgages come in terms from 15 years to 30 years, and the total remaining cost of the loan is averaged out over monthly payments during the term of the loan.
For example, let’s say that you’re buying a $500,000 house. You pay $500,000 for the house, but you make a down payment of 3% to bring the total balance down to $485,000. Let’s say that your interest rate is 3.92% and you get a mortgage for 30 years. This means that you’ll be making 360 payments over the lifetime of the loan, and plus interest, your monthly payment would be $2,293 a month!
Over the life of the loan, you’d pay a total of $825,535. And now you can see why lenders really do love mortgages—they stand to make over $300k by loaning you just $500k. On the other hand, if you could afford to take out a 15-year mortgage instead of a 30-year mortgage, you’d pay $3,568 a month. But you’d save a total of nearly $200,000 over the life of the loan!
Interest and APR
You’ll normally see two numbers on the mortgage cost, the interest and the APR. The interest is always lower than the APR, and is simply the amount of money that you owe for borrowing the total amount of the house. The APR includes the interest rate and other fees for the mortgage. So always look at the APR (annual percentage rate) as a more accurate representation of the cost of the mortgage.
APRs may sit anywhere between 2.5% and 5%, just depending on the market and the term that you’re trying to get approved for. 30-year fixed mortgages generally cost a lot, while 15-year mortgages are much more affordable.
Foreclosure: Missing a Monthly Payment
Once you’ve bought the house, you’re on the hook to the bank for the full amount of the mortgage. In our example, your monthly payment is $2,293. As long as you meet that monthly payment without interruption for the full 30 years, or 360 payments, you’re totally fine. But if you come up short in any month, the lender’s foreclosure process can be set in motion.
Most lenders won’t move when you’ve missed a single payment. You’ll have to make it up and you should be in communication with the lender, but you won’t get foreclosed on. But if you’re behind on payments for 3-6 months, most lenders will set the foreclosure process in motion.
The Foreclosure Process in California
The vast majority of foreclosures in California go through the nonjudicial foreclosure process. It’s quicker, easier, and less complicated for both lenders and borrowers.
Missed a Payment
The foreclosure process legally cannot begin until there is a payment on the mortgage missed. Depending on the policies of the lender in question, you may get a reminder and a grace period after you’ve missed a payment. You should get off with just a late fee. If you’re able to make it up the next month, or even in the next couple months, you should be fine. Usually the missed payment won’t turn into the foreclosure process until 90 days after you’ve missed a payment and have failed to bring your balance up to current.
Notice of Default
After 90 days where your loan balance is behind, most lenders will begin to move forward with a notice of default. The notice of default can be filed after 120 days, according to the Consumer Finance Protection Bureau. Once the official notice is filed, they must notify you that you’re in default within 10 days of filing the notice.
At this point, you’re currently considered in default of your mortgage. If you can pay the full balance that you’re behind on, then you can get out of default. Returning to our beautiful $500,000 home, let’s say that we’ve come up $1,000 short in 3 consecutive months. We’re now $3,000 behind on the mortgage, and probably owe some additional interest and fees, so let’s just say we owe $3,500. If you are unable to pay the $3,500 after receiving the notice of default, then the home will continue to be in default. Additionally, our balance will go up every time that another monthly payment is due. Our monthly payments were around $2,300, so the default increases by that amount every time another monthly payment is due.
When you receive a notice of default, you get an additional 90 days to cure the default and bring the loan back to current. Because you’ve probably already waited a few months before the notice of default is given, you probably have at least a half a year to bring your mortgage back to current. It can be tough, however, because the missed payments and interest can easily add up. Plus fees and processing, you can easily find yourself buried under the missed payments. But if you can get your finances in order and bring the payment current before the 90 days are up, you can avoid foreclosure.
Notice of Trustee Sale
In the nonjudicial foreclosure process, the notice of trustee sale is the final move made before your house is auctioned off and the foreclosure process is complete. The auction is the bank’s way of recovering it’s resources and the amount of money that it expected to make off the loan. Homes can be sold for less than their value at times if the bank just needs to recover a little bit less.
Once the bank has set a date for the auction, you’ll be notified in the mail. Traditionally, you have until about 5 days before the day of the auction to make payments, cure the default, and end the foreclosure process. Trustee sales must be set 21 days after the notice is given, so you may only have a couple of weeks at this point to save the house.
Once the auction goes through, the trustee sale is complete and the home is foreclosed. You no longer own the home and the money that you sunk into the mortgage is now lost.
In California, judicial foreclosure is actually quite rare, because nonjudicial foreclosures are usually easier. The only reason that a bank would take you through judicial foreclosure is if they are trying to recover the deficiency of the home. For example, if the property value of our $500,000 example house goes down to $400,000 and you’ve only paid the bank $50,000 in mortgage payments, then you might have a deficiency of $50,000. In nonjudicial foreclosure, there’s nothing a bank could do to recover that money. But in judicial foreclosure in California, if the house is not your primary residence, the bank could recover the $50,000 through a deficiency agreement. Again, the reason that banks in California don’t often pursue judicial foreclosure is because they cannot collect deficiency on a primary residence.
Nobody wants to enter foreclosure. At the time that you bought it, the $500,000 house with the $2,300 payment might have been perfectly reasonable. Most mortgages target about 31% or less of the income of a buyer. But life happens, and a lost job, medical emergency, divorce, or extenuating circumstance can suddenly make a quite reasonable payment impossible to make or bring current.
If you struggle to make payments on a house and are in the middle of the foreclosure process, you have a few options. In California, you have until right before the trustees sale to save your house. Usually that gives you at least 6-8 months after the first missed payment to pursue one of these options:
Forbearance Plans and Loan Modifications
The best way to prevent foreclosure while remaining in your house is to find a forbearance plan or loan modification that allows you to make payments. It’s critical that you remain in good communication with your lender here. They are unlikely to work with someone who doesn’t respond to their communications, or who didn’t seem aware of what was happening to the mortgage.
Forbearance plans and loan modifications allow you to get your payments back on track. Usually you can apply and get approved for a modification only if you experienced a financial hardship that has fundamentally changed your ability to pay the mortgage. You won’t be approved if you could still make your full payments, and you also won’t be approved if you can’t make any payments at all. Loan modifications are useful for both lenders and borrowers when lenders think that a loan modification will realistically prevent a foreclosure. If they aren’t convinced that you’re going to remain above water, then they’ll simply let the foreclosure process unfold.
Short sale allows you to sell your house to pay off the remainder of the mortgage, and is a good option when the property value has remained high but you don’t think you’ll be able to meet the demands of the mortgage anymore. It allows you to sell off the house and pay the mortgage, avoiding foreclosure.
Deed in Lieu
Pretty much the same as foreclosure, but it happens a lot quicker. If you’re afraid that you won’t be able to meet the demands of the lender and there is no way to avoid foreclosure, you can negotiate a deed in lieu to willingly give up the house. The only benefit is that you save some of your credit score and can move on more quickly.
Filing for Bankruptcy
If other options are exhausted, bankruptcy can help you save your house and reduce debt that you don’t need. All unsecured debts go away and you work with your creditors to establish new payment plans for the secured debts that you owe. The big benefit of filing for bankruptcy is that it puts a freeze on the foreclosure process, so that your lender cannot proceed until bankruptcy is completed. Additionally, bankruptcy usually gives you a chance to keep your house and renegotiate your mortgage payments.