What is Pre-Foreclosure?
Pre-foreclosure is the period starting when the mortgage lender notifies the borrower of their intent to foreclose — and typically ending when the lender has taken possession of the property.
Pre-foreclosure is the beginning of the process that ends in foreclosure and an owner’s loss of a house or other property. The lender first sends a notice (usually called a default notice or notice of default) stating their intent to foreclose once the homeowner is several months behind on payments. Once the clock starts, the process toward foreclosure continues unless the debt is paid quickly or the lender and borrower agree on a solution. During pre-foreclosure, the bank may offer settlement options to avoid foreclosure. In general, the process can take nearly a year (there is no set time), but it can be considerably shorter.
Imagine John and Jane Doe take out a mortgage to buy a home. A few years later, they run into financial difficulty due to some unexpected medical bills and fall behind in payments. Several months later, they receive a default notice from the bank telling them how far behind in payments they are and warning foreclosure will be the result — This notice is the start of pre-foreclosure. John and Jane call the bank and negotiate a loan modification (change in loan terms) to allow smaller payments over a longer length of time to avoid foreclosure.
Pre-foreclosure is like a smoke alarm…
A smoke alarm sounds a warning that something is wrong. It could be a big fire, a little fire, or just smoke, but you have to investigate and respond to prevent further damage. If you can’t stop the fire, the house may burn down (enter foreclosure).
Regulations may vary from state to state. However, the pre-foreclosure process follows general steps and can be completed in under six months (although it often takes longer). 1. Payments become late. 2. The lender contacts the borrower to notify them a payment is late and outlines fees and remedies. 3. Late payments continue until the lender's threshold is reached, usually several consecutive months. 4. The lender sends a notice of default advising the borrower of intent to foreclose, and that pre-foreclosure is beginning. The default notice usually includes a point of contact for the borrower and a list of possible solutions. Larger lenders may employ a law firm for point of contact. 5. The borrower has limited time to respond to the default notice, negotiate with the lender, submit a loss mitigation application (a form detailing the borrower's request to attempt to solve the debt through an option offered by the lender), and try to solve the default situation. 6. If no agreement is reached, or no loss mitigation application is received, the final foreclosure process often begins with a notice of eviction, a public sale at auction, and eviction of the borrowers (or their tenants) from the property. At that point, the home is considered foreclosed.
Several options exist for stopping a pre-foreclosure, but an agreement with your lender is necessary once the pre-foreclosure process begins. Be sure to read the pre-foreclosure/default notice carefully to ensure you follow lender guidelines.
For most lenders, filing the loss mitigation application is the first step. Standard options offered by the lender or the government to help prevent final foreclosure include short sales, deed in lieu of foreclosure, and loan modifications.
A short sale is an agreed-on solution where the borrower sells the home for a portion of what is owed on the mortgage (often considerably less than market value), and the lender accepts that as full payment.
If you just want to walk away from the property, deed in lieu of foreclosure is an option. If offered by the lender, the homeowner signs the deed of the home over to the lender. In exchange, the lender cancels the remainder of the loan.
Loan modification means changes to the loan terms to make it easier for the borrower to keep up payments.
A short sale, although popular as a way out of pre-foreclosure, may result in a hefty tax bill. In some cases, the amount between the short sale and the mortgage amount is considered income for tax purposes.
That means if your mortgage was for $250,000 and the short sale was $200,000, the remaining $50,000 might be taxable income. The amount of gain on the short sale is calculated on the loan balance, not the market value of the home.
A loan modification means what it sounds like — a change (adjustment) to the terms of a loan. Many lenders offer loan modifications as a way to attempt to avoid pre-foreclosure before loan payments are actually in arrears. Options vary by lender and borrower qualifications.
Common changes include length of loan, interest-only payments instead of principal plus interest payments for a limited time, temporary payment suspension, and interest rate reductions. However, an application for a loan modification does not stop the clock on pre-foreclosure, and a home can be foreclosed on while you are waiting on a loan modification decision.
Pre-foreclosure means the time between loan default and the loss of the home. During pre-foreclosure, the borrower has opportunities to catch up and fix the late payments/default.
Actual foreclosure occurs when the bank takes possession of the property and sells it. Once the home is foreclosed on, the borrower can only get the house back by redeeming it during a redemption period after the auction.
The redemption period (often six to 12 months) allows the borrower to pay in full the amount of the foreclosure sale plus fees and interest to take back the home before the sale to the auction purchaser becomes final.
A loan servicer is a company that carries out the day-to-day management of your loan. Loan servicers typically handle customer service, statements, the escrow account, payments from escrow to cover insurance and property taxes, and sometimes foreclosure. Your lender might hire an outside loan servicer or handle those functions itself. The loan servicer acts as the first point of contact for borrowers.
To find your loan servicer, check your mortgage statement or look on the payment coupon booklet cover. Alternately, the private company MERS (Mortgage Electronic Registration Systems, Inc.) runs a database searchable by 18-digit Mortgage Identification Number (MIN), Property address/Borrower Details, and FHA/VA/MI Certificate.
Sometimes borrowers may list a pre-foreclosure property for sale with a real estate agent, or already have it up for sale when it goes into pre-foreclosure. Homes under pre-foreclosure must be disclosed as under pre-foreclosure as the sale listing doesn't stop the pre-foreclosure process.
If the lender and borrower have agreed to a short sale, the pre-foreclosure process will be on hold for a particular duration to hopefully give the home time to sell, and the property will be labeled as a short sale on the real estate listing.
Buying a home as a short sale often offers lower costs to a buyer as the seller wants to get out from under the loan. As they say in real estate, the seller is motivated to sell. Because the bank has agreed to the sale, there are no worries that the home could be foreclosed on before completing the purchase.
If a pre-foreclosure home is for sale without a short sale agreement, the motivation to sell quickly at a potentially low price still exists, but so does risk. Foreclosure might complete before the sale finishes, resulting in deposit losses for the buyer. Also, in some cases, the seller might have the right to rescind the transaction (negate the sale) if they felt they were taken advantage of during the sale.
The advantages of a pre-foreclosure are few. Pre-foreclosure has more downsides than upsides. The risk of losing the home and further credit rating damage are significant downsides to pre-foreclosures. However, the advantage is that it provides options to save your home when in financial trouble.
Lenders are often more willing to offer alternatives to regular payments during pre-foreclosure because the bank doesn't want to go through the hassle of foreclosing on you. Remedying the debt in pre-foreclosure also offers the chance to avoid deficiency proceedings that could happen if the foreclosure went through — Where a lender sues to recover the difference between the foreclosure auction proceeds and the mortgage balance.
Pre-foreclosures can affect your credit scores in some cases, depending on what remedies you attempt and whether the foreclosure completes. Pre-foreclosure itself does not change it as much as a final foreclosure. Nor does pre-foreclosure affect your credit the same way bankruptcy does.
As soon as you recognize you might not make your full mortgage payment on time, it would be best if you began work to avoid a pre-foreclosure. Debt consolidation, refinancing, reducing spending, and obtaining additional income through another job are all possible first steps in trying to avoid getting behind on your mortgage.
However, if there is no way to prevent problems with your mortgage payment, contact your lender before the first payment is late. Most lenders and their loan servicers have programs in place to work with borrowers before the loan moves to default. Some of the possible options include short sales, interest reductions, and temporary interest-only payments.
The United States government also offers programs to help avoid pre-foreclosure and foreclosure. The Making Home Affordable Modification Program (HAMP), Home Affordable Refinance Program (HARP), the HOPE for Homeowners (H4H) program, the Home Affordable Unemployment Program (UP), and Second Lien Modification Program (2MP), each offer possible ways to avoid getting behind on your mortgage.
Some states also offer assistance to homeowners in financial difficulty. For example, Michigan offers help with delinquent mortgage and property tax up to $30,000 in some cases.
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