How Does Foreclosure Work?

Get an overview of how mortgages work, steps in a foreclosure, and what happens after a foreclosure.

When you take out a loan from a bank or mortgage company to buy a home, you'll most likely sign many documents, including a mortgage (or deed of trust) and promissory note. In this paperwork, you'll promise to make the payments according to the payment schedule.

But if you fail to make payments, the lender can go through a legal process called "foreclosure" to sell your home to a new owner. Some states require the process to go through court (judicial foreclosures). In other states, the foreclosing party (the "lender") can use out-of-court procedures (nonjudicial foreclosures). Or it may opt to use the court system to foreclose.

The lender will apply the proceeds from the foreclosure sale to your outstanding debt.

What Is a Mortgage and How Do Mortgages Work?

Because buying a home involves a large sum of money, it's common for a buyer to finance the purchase with a loan (often called a "mortgage") rather than coming up with all the cash upfront. The main parties to the transaction are the borrower and the lender.

The borrower is the person who borrows money and pledges the property as security to the lender for the loan. The borrower is sometimes called the "mortgagor." The lender, or "mortgagee," provides the loan.

What Are the Main Documents That Make Up a Mortgage Loan?

The borrower usually signs several documents as part of the loan transaction, including a promissory note and a mortgage (or deed of trust or a similar instrument).

  • Promissory notes. A "promissory note" is a document that contains a borrower's promise to repay the amount borrowed and the terms for repayment, like the interest rate. But the note doesn't set out any consequences of non-payment other than late charges—that's the function of the mortgage or deed of trust.
  • Mortgages. Even though people typically refer to a home loan as a "mortgage," a mortgage is actually the contract that secures the loan. It gives the lender the right to foreclose if the borrower doesn't make the loan payments.
  • Deeds of trust. In states that don't use mortgages to secure the loan, the borrower signs a different security instrument, frequently called a "deed of trust."
  • Other security instruments. And a few states use other documents for secured transactions, like a security deed.

When the lender records the mortgage, deed of trust, or other security instrument in the land records, it creates a lien on the home. If the borrower breaches the loan contract, like failing to make payments, the lender can foreclose the property.

Servicers and Investors

A "servicer" manages the loan account. In some cases, the loan owner is also the servicer. Other times, the loan owner sells the servicing rights to a third party. That company then handles the loan account; it processes monthly payments and oversees collection activities if the borrower doesn't make the payments.

Many times, after originating the loan, the original lender won't keep it. Instead, the lender sells the loan to bring in more money to keep lending to new borrowers. Promissory notes and mortgages/deeds of trust are transferable.

When a loan changes hands, the promissory note is endorsed (signed over) to the new owner. The seller documents the transfer by recording an assignment in the land records. The new owner is called an "investor." Lenders typically sell the loans they originate to other banks or investors on the secondary mortgage market.

Preforeclosure Notices and Requirements

Most standard mortgages and deeds of trust require the lender to send a "breach" letter before starting a foreclosure. The letter ordinarily gives the borrower 30 days to catch up on the overdue amounts to avoid losing the property.

Some states also have a law requiring the lender or servicer to send some kind of notice before a foreclosure starts. While the type and content of these notices vary from state to state, they usually serve the same purpose as a breach letter—they tell the borrower to get current, or a foreclosure will start. Preforeclosure notices also often provide information about loss mitigation options (ways to avoid foreclosure), like loan modifications and short sales.

Federal Foreclosure Laws

Federal mortgage servicing laws also provide preforeclosure protections to homeowners, including:

  • The servicer has to try to contact you to discuss loss mitigation options no later than 36 days after you miss a payment and again within 36 days after each missed payment, even if the servicer previously contacted you. (12 C.F.R. § 1024.39.)
  • The servicer has to send you a written notice no later than the 45th day after a missed payment—and once every 180 days after that for as long as the loan is delinquent—to tell you about loss mitigation options. (12 C.F.R. § 1024.39.)
  • In most cases, the foreclosure can't officially start until you're more than 120 days delinquent. (12 C.F.R. § 1024.41).

What Happens During a Foreclosure?

Again, state law determines foreclosure procedures. Generally, the process will be judicial or nonjudicial.

What Is a Judicial Foreclosure?

Approximately half of the states require the lender to file a lawsuit in court to foreclose. You'll be served a copy of the suit (called a "complaint" or "petition"), along with a summons, telling you about the foreclosure. If you don't file an answer with the court, the lender will ask the court for, and probably get, a default judgment, which will allow it to hold a foreclosure sale.

However, if you respond to the lawsuit, the case will go through litigation. To protect your rights, you have to respond to the suit within the time afforded by your state, raising any defenses, affirmative defenses, and counterclaims in your answer.

If the lender wins the case, the judge will enter a judgment, allowing the lender to sell the property. This process, called a "judicial foreclosure," usually takes at least several months and as long as a few years in some places.

What Is a Nonjudicial Foreclosure?

In a nonjudicial foreclosure, the lender usually has to provide notice about the foreclosure in one or more of the following ways:

  • through the mail
  • by publishing sale information in a newspaper, or
  • by posting a notice on the property.

Typically, the lender must also record a notice in the county records. Nonjudicial foreclosures generally take much less time than judicial ones, taking only a few weeks or months to complete. You must file a lawsuit if you have one or more defenses and want to fight a nonjudicial foreclosure.

What Is Foreclosure Mediation?

Some states, counties, and cities give homeowners the right to participate in foreclosure mediation. Attending foreclosure mediation doesn't guarantee that you'll be able to keep your home. But it does boost your chances of stopping the foreclosure process.

And even if you can't work out a foreclosure avoidance option, you'll probably at least buy yourself some extra time to live in the home without making any payments.

How Foreclosure Mediation Works

Mediation consists of one or more meetings with the foreclosing lender or the lender's representative, such as the loan servicer, and a neutral mediator to try to find an alternative other than foreclosure.

During mediation, the parties discuss the borrower's financial situation and consider different options to prevent a foreclosure, like by completing a loan modification, short sale, deed in lieu of foreclosure, repayment plan, or something else.

Foreclosure procedures are usually put on hold while you participate in mediation.

Where Is Foreclosure Mediation Available?

Many courts and state legislatures have implemented foreclosure mediation programs for residential homeowners. Mediation programs came about in three ways: through new state laws, judicial orders, or administrative orders from local courts.

So, foreclosure mediation isn't available everywhere. Statewide programs exist in some places; in others, mediation is available only in specific counties or particular cities. Other localities don't offer foreclosure mediation at all.

If you're already in foreclosure and mediation is available, you'll probably get a notice about its availability along with the foreclosure paperwork. Otherwise, you can talk to a lawyer to find out if foreclosure mediation is available in your area or review your state's statutes to see if the legislature passed a foreclosure mediation law. However, keep in mind that your state's laws won't mention any judicial or administrative orders about foreclosure mediation programs.

Foreclosure Mediation Process

If your state, county, or city offers a foreclosure mediation program, your lender must follow the program guidelines. Mediation processes vary widely from place to place, but the procedures usually begin when the lender starts a foreclosure.

When foreclosure mediation is available, homeowners typically get the following information along with notice of the foreclosure:

  • materials about the mediation program
  • details on how to opt into the program if enrollment isn't automatic, and
  • contact information for HUD-approved housing counselors and low-cost legal services available in the state.

Some programs require the lender to participate if the homeowner opts into the program. Other programs require participation, even if the homeowner doesn't request it.

Should I Go to Foreclosure Mediation?

If your state, county, or city offers foreclosure mediation, you should strongly consider participating. While foreclosure mediation programs don't make the lender give you a loss mitigation option, according to one study, people who participate in mediation are almost twice as likely to prevent a foreclosure as those who didn't.

If nothing else, you might get some extra time to stay in the home because foreclosure typically stops during the mediation. During this time, you can save some money because you'll be living in the property payment-free.

How Foreclosure Sales Work

The foreclosure process ends with a foreclosure sale with both judicial and nonjudicial foreclosures. The sale is typically an auction where the public and foreclosing lender may bid on the property.

The lender normally makes a bid on the property using what's called a "credit bid" rather than bidding cash. (The lender gets a credit up to the amount of the borrower's debt.)

The highest bidder at the sale becomes the new owner of the property.

What Happens After a Foreclosure

Depending on state law, you might be able to remain in the property, even after the sale, until the redemption period expires or some other action, like sale ratification, happens.

You'll be evicted if you don't move after the foreclosure sale or the extra time expires. In some cases, the lender includes an eviction as part of a judicial foreclosure. Other times, the lender has to file an eviction lawsuit to evict. A separate eviction lawsuit is typically required after a nonjudicial foreclosure.

Deficiency Judgments Following Foreclosures

If the foreclosure sale doesn't bring in enough money to fully repay what you owe the lender, the difference between the sale price and the total debt is called a "deficiency."

In some states, the foreclosing lender can get a personal judgment, called a "deficiency judgment," against you for the deficiency amount. Other states prohibit deficiency judgments under certain circumstances.

Talk to a Lawyer

While this article provides a general picture of foreclosure processes, laws differ among states. To get specific information about your state's foreclosure procedures, how they apply to your particular situation, and your legal rights, consider talking to a local foreclosure lawyer.

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