Foreclosure is a legal process initiated after a homeowner fails to pay the mortgage.

What is foreclosure?

When a borrower takes out a secured loan, he is required to put up collateral. In the case of a home loan, the property or house is the collateral. This asset is security for repayment of the loan and serves to protect the lender in case the borrower defaults.

Foreclosure occurs when a borrower fails to uphold his or her repayment obligations as stipulated in the mortgage contract. As a result, the borrower defaults and the lender seizes the property to sell it in an auction or through a realtor, as an attempt to recover the money owed to them. The entire foreclosure process can take about 480 to 700 days.

How does foreclosure work?

Stage 1: Missing your monthly mortgage payments

The first step of foreclosure is when the homeowner or borrower misses his or her mortgage payments. At this time, the loan becomes delinquent. Few borrowers miss payments voluntarily. They may have lost their job, are suddenly unable to work because of medical reasons, or stop paying because of a change in life circumstances, because of a divorce.

Stage 2: Lender records a public notice

After three to six months of missed payments, the lender will file a public notice with the County Recorder’s Office. This record means that the borrower has defaulted on the loan.

You will then receive a Notice of Default or NOD. This official notice declares that the borrower is in danger of foreclosure and potentially losing the rights to the property.

Stage 3: Pre-foreclosure

During this grace period, the borrower can work out an arrangement with the lender. Foreclosure is an expensive process, and most lenders will try to work with you to avoid it.

Depending on local regulations, you will have 30 to 120 days to either pay the outstanding amount owed or work with your lender to make a short sale. A short sale is when you sell your house for less than your current mortgage balance. The bank is “shorted” because they have agreed to consider your loan paid in full at a discounted payoff.

A short sale has a smaller negative impact on your credit score than a foreclosure.

Stage 4: Auction

If there has not been resolution yet, then the lender will seize the property and set a date to sell it at a foreclosure auction. A lender may use a representative, known as a trustee, to sell the property. A foreclosure auction is sometimes known as a Trustee Sale.

When the date is set, the Notice of Trustee’s Sale or NTS is recorded with the County Recorder’s Office. The borrower will be notified. In some states, the borrower has the right of redemption. In other words, if he can come up with the outstanding amount, he can stop the foreclosure process.

On the date of the auction, the home is sold to the highest bidder for a cash payment.

Stage 5: Post-auction

If the property is not purchased at the foreclosure auction, the property remains with the lender. This is known as a bank-owned property or an REO (real estate owned) property.

Bank-owned properties are usually listed by a local real estate agent or on the open market.

Impact on the Borrower

A foreclosure negatively affects your credit score and can remain on your credit report for seven years. Additionally, after a foreclosure, you are restricted from buying another home for some time.