What is a Foreclosure?

Foreclosure is like your parents taking away your car privileges because you didn’t live up to the arrangement to keep the vehicle gassed and clean...

Maybe your part-time job reduced your hours, so you no longer had enough money to care for the car. Whatever the case, you didn’t meet your obligation. Your parents felt they had no choice but to enforce the agreement and take back full control of the car. In a similar way, when a homeowner doesn’t make mortgage payments, the bank takes control of the home.

A foreclosure occurs when a property owner fails to make the necessary mortgage payments, and a lending institution exercises its right to take control of the property. The lender then usually attempts to recover some of its lost money by reselling the property to new owners.

The laws determining when the foreclosure process can begin differ from state to state as do the rules governing what can be done regarding the property and the mortgage’s outstanding balance.

In the mid-2000s, new regulations allowed lending institutions in the U.S. to issue new forms of mortgages to homebuyers who did not qualify for traditional mortgages. Those new mortgages were easy to obtain but difficult to maintain. In time, homeowners could no longer afford to make their monthly payments. Lenders then foreclosed on the properties, seizing a large number of houses nationwide.

There is no national foreclosure process — the procedure is different from state to state. Nevertheless, when speaking of foreclosure proceedings in general terms, you can see the following similarities across the country:

• The homeowner fails to make agreed-upon mortgage payments to the lender of the loan.
• The lender records a notice of default after the state’s mandated waiting period for the homeowner to have the chance to bring the account current.
• The mortgage lender files notice of intent to sell the property if the homeowner has still not satisfied the terms of the mortgage loan.
• The property is made available at public auction with the sale going to the highest bidder.
• If the property doesn’t sell at auction, the lender becomes the owner, and the house is now referred to as real estate owned property (REO).

Whether the property sells at auction or not, it’s usually during this stage, depending upon state laws, that the former homeowner is evicted.

There are several consequences to foreclosure.

Loss of a home: Losing a place to stay can be traumatic. It can force you to make huge changes, including where you work and where your kids attend school. Renting can even become a challenge since some landlords shy away from potential tenants with a foreclosure in their recent past. If the foreclosed property wasn’t your primary residence, you might have another place to live, but you should still expect to see an effect on your credit report.

A hit to your credit score: Damage to your credit score is unavoidable during a foreclosure. According to a FICO study, a FICO score of 680 fell to 570-595 after a foreclosure. A score of 720 took an even greater tumble to 570-590. An excellent score of 780 suffered the most damage, crashing to 620-640. Unfortunately, your foreclosure will affect your chances of getting a loan for other major purchases, such as a car or even obtaining a new credit card for quite a while. A foreclosure can remain on your credit report for up to seven years. You can also expect the interest rates available on loans in the near future to be less favorable than the ones you received before the foreclosure.

A deficiency judgment: Getting rid of the house may not get rid of all your money problems. If you live in a state where the lender can sue you for money still owed on the mortgage, you could be named in what’s called a deficiency judgment. The lender is seeking to recover the difference in the balance of the mortgage and the amount earned at the foreclosure sale. The tactics used against you may vary but could include garnishing your wages until the judgment is satisfied.

The key to whether you still owe money after a foreclosure is related to how much money you still owe on the house and in which state the home is located.

If your foreclosed house sells for at least the same as the amount remaining on the mortgage, all is well. However, if the house sells for less, the bank could try to force you to pay the difference. There could also be additional fees added. The legal method the bank uses to try to obtain the rest of its money is called a deficiency judgment.

Let’s say a couple owes $250,000 on their mortgage when they’re forced out by foreclosure. The bank sells the home for $220,000. The bank then files a deficiency judgment seeking the balance of $30,000 from the former homeowners. (For simplicity, the example doesn’t include any additional fees.)

At this point, the former homeowners have lost their property because they didn’t have the money to make their mortgage payments and are now faced with a demand that’s bigger than the monthly mortgage requirement that they couldn’t meet. Some people in this situation have felt that they had no choice but to file for bankruptcy in a last-ditch effort to shield what remaining assets they have.

Not everyone who has lost a home to foreclosure faces such a dire situation — Some live in a state that limits lenders from seeking deficiency judgments. In those states, the lender still has the right to seize the property and sell it. But the lender doesn’t have the unrestricted right to require the former homeowner to pay any deficiency. Various states have some of the following restrictions to protect the previous homeowner from deficiency judgments:

• Not liable if the foreclosure was not handled through the court system
• Not liable if the home rests on land of less than two and a half acres and is either a single one-family or single two-family dwelling
• Not liable for more than the difference between the foreclosure sale price and the home’s fair market value
• Not liable if the structure sits on less than 40 acres and has three or fewer units
• Not liable if you contacted the lender by letter 10 or more days ahead of the date of the foreclosure sale and stated that you both live in the house and choose to opt out of a deficiency judgment
• Not liable if the property has no more than four units and is a residence for you or a close family member

Online resources can help you research the foreclosure laws in your state.

A careful shopper can usually locate a foreclosed home that’s worth its asking price. However, that shopper is typically a sharp-eyed veteran real estate investor. The story can be quite different for a first-time investor or home buyer. Why?

Some foreclosure properties, especially those at the public auction stage, can be in excellent condition, but others can be neglected homes. If the previous owner couldn’t afford to make mortgage payments, it’s likely that the owner also couldn’t afford to make needed repairs. Also, foreclosed homes can remain empty for a long time after the owner has been evicted.

It’s doubtful that the bank will do much doing that time to keep the property attractive. The most you can typically expect is an occasional cutting of the grass to comply with local housing ordinances. A house left alone can also become the target of thieves who steal copper wiring and plumbing along with window air conditioner units.

An experienced investor could look at all the problems the house has and still see the potential for profit. But the investor likely has far deeper pockets than someone who wants to purchase the property to live there. For example, if there is notable termite damage, the investor probably has the patience and the financial means to make the repairs. That may not be the case with someone looking to move into their first home. Potential new homeowners have to ask themselves if they can afford to pay for a house that may need extensive repairs before it becomes livable.

If you’re convinced that you have what it takes to purchase a foreclosure home, do your homework. Learn the specific laws governing foreclosed property in your state. Be careful about trying to apply the advice of people who buy houses in other states. Your laws may be similar but not the same. That discrepancy could mean the difference between success and failure.

Yes, you can get a mortgage on a foreclosed home.

If your financial status is solid, you intend to live in the home, and the house is in excellent condition, you should have little trouble receiving a traditional mortgage from your preferred lender, even for a foreclosed home.

If your credit is not stellar, you might apply for a Section 203(k) insured FHA loan. Apply through a lender approved by the FHA. Not only might the FHA give you a loan if your credit rating is low, but it will also include in the loan the cost of rehabilitating a neglected home. If the repairs are not significant, you could file for a Limited 203(k).

The rehabilitation costs for Section 203(k) have to be a minimum of $5,000. Another requirement is that the value of the home has to be within the FHA mortgage limit for the property’s location.

Some of the improvements allowed with Section 203(k) financing include:

• Reconstruction
• Removal of health hazards
• Replacing plumbing
• Landscaping
• Making the home accessible for those with disabilities
• Improving the home’s energy use

You can begin your search for a foreclosed property on the website of your choice. A few likely places to look at include the websites of the following:

• Banks
• Credit Unions
• U.S. Department of Housing and Urban Development (HUD)
• Federal National Mortgage Association (Fannie Mae)
• Federal Home Loan Association (Freddie Mac)