Foreclosures

Foreclosure is the legal and professional proceeding in which a Mortgagee (lender; beneficiary), or other lien -holder, usually other lenders, obtain a court order to terminate the mortgagor (borrower; trustor) equitable title and foreclose on the property that has been in default or has not been complying with the term and conditions of mortgage document and note. Usually a lender obtains a security interest from a borrower who mortgages or pledges an asset like a house to secure the loan. If the borrower defaults and the lender tries to repossess the property, courts of foreclosure can grant the borrower the equitable right of redemption if the borrower repays the debt. While this equitable right exists, the lender cannot be sure that it can successfully repossess the property, thus the lender seeks to foreclose the equitable right of redemption. Other lien-holders can also foreclose the owner's right of redemption for other debts, such as for overdue taxes, unpaid contractors' bills or overdue HOA dues or assessments.

The foreclosure process as applied to residential mortgage loans is a bank or other secured creditor selling or repossessing a parcel of real property after the owner has failed to comply with an agreement between the lender and borrower called a "mortgage" or "deed of trust". Commonly, the violation of the mortgage is a default in payment of a promissory note, secured by a lien on the property.  When the process is complete, the lender can sell the property and keep the proceeds to pay off its mortgage and any legal costs, and it is typically said that "the lender has foreclosed its mortgage or lien".  If the promissory note was made with a recourse clause then if the sale does not bring enough to pay the existing balance of principal and fees the mortgagee can file a claim for a deficiency judgment.

Types of foreclosure
The mortgage holder can usually initiate foreclosure at a time specified in the mortgage documents, typically some period of time after a default condition occurs.  Within the United States and many other countries, several types of foreclosure exist.  Two of them –namely, by “judicial sale” and by “power of sale” – are widely used, but other modes of foreclosure are also possible in a few states.

Foreclosure by judicial sale, more commonly known as Judicial Foreclosure or Foreclosure by Court order, is available in every state and required in many, involves the sale of the mortgaged property under the supervision of a court, with the proceeds going first to satisfy the mortgage; then other lien holders; and, finally, the mortgagor/borrower if any proceeds are left. As with all other legal actions, all parties must be notified of the foreclosure, but notification requirements vary significantly from state to state.  A judicial decision is announced after pleadings at a (usually short) hearing in a State or Local court.  In some fairly rare instances, foreclosures are filed in Federal courts.

Foreclosure by power of sale, which is also allowed by many states if a “power of sale clause” is included in the mortgage or if a Deed of trust was used instead of a mortgage. In some states so-called mortgages are actually deeds of trust. This process involves the sale of the property by the mortgage holder without court supervision. It is generally more expedient than foreclosure by judicial sale.  As in judicial sale, the mortgage holder and other lien holders are respectively first and second claimants to the proceeds from the sale.

Other types of foreclosure are considered minor because of their limited availability.  Under strict foreclosure, which is available in a few states, suit is brought by the mortgagee and if successful, a court orders the defaulted mortgagor to pay the mortgage within a specified period of time.  Should the mortgagor fail to do so, the mortgage holder gains the title to the property with no obligation to sell it. This type of foreclosure is generally available only when the value of the property is less than the debt.  Historically, strict foreclosure was the original method of foreclosure.

Acceleration
The concept of acceleration is used to determine the amount owed under foreclosure. Acceleration allows the mortgage holder to declare the entire debt of a defaulted mortgagor due and payable, when a term in the mortgage has been broken.  If a mortgage is taken, and monthly payments are required, the mortgage holder (mortgagee) can demand the mortgagor (borrower) make good on the entire loan, if the mortgagor fails to make one or more of those payments.

Lenders may also accelerate a loan if terms are there is a transfer clause, obligating mortgagor to notify the lender of any transfer, whether; a lease-option, lease-hold of 3 years or more, land contracts, agreement for deed, transfer of title or interest in the property.

The vast majority (but not all) of mortgages today have acceleration clauses.  The holder of a mortgage without this clause has only two options: either to wait until all of the payments come due or convince a court to compel a sale of some parts of the property in lieu of the past due payments. Alternatively, the court may order the property sold subject to the mortgage, with the proceeds from the sale going to the payments owed the mortgage holder.

Process
The process of foreclosure can be rapid or lengthy and varies from state to state. Other options such as refinancing, a short sale (real estat), alternate financing, temporary arrangements with the lender, or even bankruptcy may present homeowners with ways to avoid foreclosure.

In the United States, there are two types of foreclosure in most common law states.  Using a "deed in lieu of foreclosure," or "strict foreclosure", the note-holder claims the title and possession of the property back in full satisfaction of a debt, usually on contract.  In the proceeding simply known as foreclosure (or, perhaps, distinguished as "judicial foreclosure"), the property is subject to auction by the county sheriff or some other officer of the court.  Many states require this sort of proceeding in some or all cases of foreclosure, in order to protect any equity the debtor may have in the property, in case the value of the debt being foreclosed on is substantially less than the market value of the immovable property.  In this foreclosure, the sheriff then issues a deed to the winning bidder at auction.  Banks and other institutional lenders may bid in the amount of the owed debt at the sale but there are a number of other factors that may influence the bid, and if no other buyers step forward the lender receives title to the immovable property in return.

Other states have adopted non-judicial foreclosure procedures in which the mortgagee, or more commonly the mortgagee's servicer's attorney or designated agent, gives the debtor a notice of default and the mortgagee's intent to sell the immovable property in a form prescribed by state statute. This type of foreclosure is commonly referred to as "statutory" or "non-judicial" foreclosure, as opposed to "judicial". With this "power-of-sale" type of foreclosure, if the debtor fails to cure the default, or use other lawful means (such as filing for bankruptcy which provides a temporary automatic stay to the foreclosure proceeding) to stop the sale, the mortgagee or its representative will conduct a public auction in a similar manner as the sheriff's auction described above.  The highest bidder at the auction becomes the owner of the immovable property free and clear of any interest of the former owner but the property may be encumbered by any liens superior to the mortgage being foreclosed (e.g. a senior mortgage, unpaid property taxes etc). Further legal action, such as an eviction may be necessary to obtain possession of the premises.

In most jurisdictions it is customary for the foreclosing lender to obtain a title search of the immovable property and to notify all other persons who may have liens on the property, whether by judgment, by contract, or by statute or other law, so that they may appear and assert their interest in the foreclosure litigation.  In all US jurisdictions a lender who conducts a foreclosure sale of immovable property which is the subject of a federal tax lien must give 25 days' notice of the sale to the Internal Revenue Service (IRS).   Failure to give notice to the IRS will result in the lien remaining attached to the immovable property after the sale. Therefore, it is imperative that the lender obtain a search of the local Federal Tax Liens so that if the persons or companies involved in the foreclosure have a federal tax lien filed against them, the proper notice to the IRS will be given.

A temporary change to the tax code provided tax relief for homeowners. For the period Jan. 1, 2007, through Dec. 31, 2009, homeowners will not have to pay tax on any debt that is cancelled.

Contesting a Foreclosure
Because the right of redemption is an equitable right, foreclosure is an action in equity.  In order to keep the right of redemption the debtor can ask an equity court for an injunction.  If repossession is imminent the debtor would need to seek a temporary restraining order.  However, the debtor may have to post a bond in the amount of the debt. This would protect the creditor if the attempt to stop foreclosure were a naked attempt to cheat the lender and skip on the debt.

A debtor may also challenge the validity of the debt in a claim against the bank in order to stop the foreclosure and sue for damages.  In a foreclosure proceeding, the lender bears the burden of proving that there was a valid debt.

Foreclosure auction
When the entity (in the US, typically a county sheriff or designee) auctions a foreclosed property the note-holder may set the starting price as the remaining balance on the mortgage loan.  However, there are a number of issues that affect how pricing for properties is considered, including bankruptcy rulings.  In a weak market the foreclosing party may set the starting price at a lower amount if it believes the real estate securing the loan is worth less than the remaining principal of the loan.

In the case where the remaining mortgage balance is higher than the actual home value the foreclosing party is unlikely to attract auction bids at this price level.  A house that went through a foreclosure auction and failed to attract any acceptable bids may remain the property of the owner of the mortgage.  That inventory is called REO (real estate owned). In these situations the owner/servicer will try to sell it through standard real estate channels.

Further borrower's obligations
The mortgagor may be required to pay for Private Mortgage Insurance (PMI), for as long as the principal of his primary mortgage is above 80% of the value of his property.  In most situations, insurance requirements are sufficient to guarantee that the lender will get some pre-defined percentage of the loan value back, either from foreclosure auction proceeds or from PMI or a combination thereof.

Nevertheless, in an illiquid real estate market or following a significant drop in real estate prices, it may happen that the property being foreclosed is sold for less than the remaining balance on the primary mortgage loan, and there may be no insurance to cover the loss. In this case, the court overseeing the foreclosure process may enter a deficiency judgment against the mortgagor.  Deficiency judgments can be used to place a lien on the borrower's other property that obligates the mortgagor to repay the difference. It gives lender a legal right to collect the remainder of debt out of mortgagor's other assets (if any).

There are exceptions to this rule, however. If the mortgage is a non-recourse debt (which is often the case with owner-occupied residential mortgages in the U.S.), lender may not go after borrower's assets to recoup his losses.  Lender's ability to pursue deficiency judgment may be restricted by state laws.  In California and some other states, original mortgages (the ones taken out at the time of purchase) whichis purchase loans are typically non-recourse loans; however, refinanced loans and home equity lines of credit aren't.

If the lender chooses not to pursue deficiency judgment—or can't because the mortgage is non-recourse—and writes off the loss, the borrower may have to pay income taxes on the unrepaid amount if it can be considered "forgiven debt." However, recent changes in tax laws may change the way these amounts are reported.

Any liens resulting from other loans taken out against the property being foreclosed (second mortgages, HELOCs) are "wiped out" by foreclosure, but the borrower is still obligated to pay those loans off if they are not paid out of the foreclosure auction's proceeds.