The foreclosure process
The foreclosure process is not as mysterious as it seems. Due to federal and state laws, lenders must follow a specific process to foreclose on a property. Understanding the process will help you find investment opportunities.
First, you’ll need to understand when a lender is allowed to foreclose on a mortgage. The process begins with the mortgage itself. A mortgage creates five covenants:
1. The owner agrees to pay the principal of the mortgage debt
2. The owner will insure the building against fire or damage to help protect the bank’s interest in the property.
3. The building or house cannot be demolished or removed without the consent of the bank
4. The entirety of the principal will be payable in the event of non-payment of the principal, interest, taxes or assessments.
5. The bank will consent to the appointment of a receiver in case of foreclosure
The first three items are agreements that the owner must adhere to. If those agreements are breached, the bank must follow numbers 4 and 5. (Why the word “must”? Because banks are really “trusted officers”: they are not lending their own money, they are lending money that belongs to Depositors have no right to take risks with other people’s money, so they must comply with these agreements).
The last two agreements give the bank the means to foreclose on a mortgage. One provides for the appointment of a trustee, usually an attorney, who carries out the sale of the property. The other allows the bank to speed up payments and ask for the entire balance. If the bank’s lawyers take a landlord to court, they want all the money, and if it can’t be paid, they want a judgment against the landlord. Simply put: they want out of the deal because the owner has not fulfilled his obligations.
It is important to note that until a judgment is obtained, the homeowner is not actually under threat of foreclosure. Once the judgment is obtained, the owner can be evicted from the property immediately.
Once a judgment has been passed against the owner, a time is set for the public sale of the property at auction. If the owner can’t collect the full judgment amount before the sale… that’s it – no more delays, no more compromises – the sale will go through. Often these sales take place in the courthouse, and in many cases, they actually take place on the courthouse steps.
The court then appoints a trustee, again, usually an attorney, to carry out the sale of the owner’s property. Real property generally cannot be transferred without both parties to the purchase agreement signing the deed of transfer. Since the homeowner is unlikely to voluntarily relinquish his home, the trustee has the legal authority to sign a valid deed transferring ownership to a new buyer.
Let’s briefly look at the stages of foreclosure. To keep it simple, we’ll pretend you’re a homeowner facing financial hardship.
If you are late on a payment, you are typically sent a letter documenting the late payment and requesting immediate payment of the overdue amount. Once you are several times behind in payments, the bank’s lawyer will send you a letter. Receiving a letter from the lawyer means that you are in trouble; You have not just made an oversight that the bank wants to correct, but you are now considered a serious “problem debtor.” When you hear from the lawyer, it means that the bank has committed resources (time and money) for you to pay on time, so they are serious.
If you cannot reach an agreement with the lawyer, you will receive a summons. (The lawyer has very little reason to negotiate, so usually the only “agreement” he will be able to reach is that he will make your loan payments on time… starting immediately.) After the “service,” which is the process by which the summons is physically presented to you, the attorney will also file the papers with the county courthouse. All other people with claims against the property (called “secondary” liabilities), such as second mortgages, judgments, or other liens, receive the documents so they have the right to try to protect their interests as well. (It is important to note that if the enforcing party is negligent in notifying minor lien holders, those creditors have a valid claim for repayment against the property’s eventual new owner. That is why purchasing title insurance when purchasing foreclosed properties is absolutely essential: you protect yourself against subsequent claims you were unaware of (after all, you don’t want to have to be held responsible for the foreclosure party’s lack of attention to detail).
To enforce money judgments you have to be personally served. That’s one of the reasons foreclosure actions can take so long: the homeowner must be located and the summons must be physically served. Often the owners will not want to be served and will go out of their way to avoid the server. Each jurisdiction has different laws and regulations, but generally speaking, if a person cannot be located and all reasonable efforts have been made to find them, a publication procedure is established. This usually consists of a public notice printed in the classified section of the local newspaper.
Most jurisdictions also require public notice whether or not the owner has been notified. This allows parties with a legitimate claim to come forward to protect their interests.
After the listing process is complete, the foreclosure action will proceed. If you can’t reach an agreement with the bank’s lawyer and you can’t get the funds to repay the loan, your property will be sold at a foreclosure auction and you will be evicted from the property, if you haven’t already left.
The foreclosure process is extremely painful for the homeowner. Legal proceedings can take months to complete. Homeowners are subject to pressure from banks and lawyers, public notice that their home is in foreclosure, and the realization that they will soon lose it.