Foreclosure: Definition, Process, Downside, and Ways To Avoid

What Is Foreclosure?

Foreclosure is the legal process by which a lender attempts to recover the amount owed on a defaulted loan by taking ownership of the mortgaged property and selling it. Typically, default is triggered when a borrower misses a specific number of monthly payments, but it can also happen when the borrower fails to meet other terms in the mortgage document.

Understanding Foreclosure

The foreclosure process derives its legal basis from a mortgage or deed of trust contract, which gives the lender the right to use a property as collateral in case the borrower fails to uphold the terms of the mortgage document. Although the process varies by state, the foreclosure process generally begins when a borrower defaults or misses at least one mortgage payment. The lender then sends a missed-payment notice that indicates that month’s payment hasn’t been received.

If the borrower misses two payments, the lender sends a demand letter. This is more serious than a missed payment notice, but the lender still may be willing to make arrangements for the borrower to catch up on the missed payments.

The lender sends a notice of default after 90 days of missed payments. The loan is handed over to the lender’s foreclosure department, and the borrower typically has another 30 days to settle the payments and reinstate the loan (this is called the reinstatement period). At the end of the reinstatement period, the lender will begin to foreclose if the homeowner has not made up the missed payments.

The Foreclosure Process Varies by State

Each state has laws that govern foreclosures, including the notices that a lender must post publicly, the homeowner’s options for bringing the loan current and avoiding foreclosure, and the timeline and process for selling the property.

A foreclosure—the actual act of a lender seizing a property—is typically the final step after a lengthy pre-foreclosure process. Before foreclosure, the lender may offer several alternatives to avoid foreclosure, many of which can mediate a foreclosure’s negative consequences for both the buyer and the seller.

In 22 states—including Florida, Illinois, and New York—judicial foreclosure is the norm. This is where the lender must go through the courts to get permission to foreclose by proving the borrower is delinquent. If the foreclosure is approved, the local sheriff auctions the property to the highest bidder to try to recoup what the bank is owed, or the bank becomes the owner and sells the property through the traditional route to recoup its losses.

The other 28 states—including Arizona, California, Georgia, and Texas—primarily use nonjudicial foreclosure, also called power of sale. This type of foreclosure tends to be faster than a judicial foreclosure, and it does not go through the courts unless the homeowner sues the lender.

How Long Does Foreclosure Take?

Properties foreclosed in the second quarter of 2021 had spent an average of 922 days in the foreclosure process, according to the U.S. Foreclosure Market Report from ATTOM Data Solutions, a property data provider. This is down slightly from the previous quarter’s average of 930 days, and up 34.5%, from 685 days, in the second quarter of 2020.

The average number of days varies by state because of differing laws and foreclosure timelines. The states with the longest average number of days for properties foreclosed in the second quarter of 2021 were:

• Hawaii (3,068 days)
• New York (1,822 days)
• Indiana (1,617 days)

States with the shortest average times to foreclose during the same period were:

• Wyoming (173 days)
• Arkansas (253 days)
• Tennessee (270 days)

The graph below shows the quarterly average days to foreclosure since the first quarter of 2007.

Can You Avoid Foreclosure?

Even if a borrower has missed a payment or two, there still may be ways to avoid foreclosure. Some alternatives include:

• Reinstatement—During the reinstatement period, the borrower can pay back what they owe (including missed payments, interest, and any penalties) before a specific date to get back on track with the mortgage.
• Short refinance—In a short refinance, the new loan amount is less than the outstanding balance, and the lender may forgive the difference to help the borrower avoid foreclosure.
• Special forbearance—If the borrower has a temporary financial hardship, such as medical bills or a decrease in income, then the lender may agree to reduce or suspend payments for a set amount of time.

Consequences of Foreclosure

If a property fails to sell at a foreclosure auction, or if it otherwise never went through one, then lenders—often banks—typically take ownership of the property and may add it to an accumulated portfolio of foreclosed properties, also called real estate owned (REO).

Foreclosed properties are typically easily accessible on banks’ websites. Such properties can be attractive to real estate investors, because in some cases, banks sell them at a discount to their market value, which, in turn, negatively affects the lender.

For the borrower, a foreclosure appears on a credit report within a month or two, and it stays there for seven years from the date of the first missed payment. After seven years, the foreclosure is deleted from the borrower’s credit report.