How does foreclosure work

Around the country, home values have dropped dramatically in the past few years. Some people who bought with ‘zero down’ or even 10 percent down when lending was easy, find themselves with homes ‘underwater.’ When the property is worth less than the total mortgage amount, they’ve often had to sell in a short sale.

In the worst-case scenario, the homeowner has to walk away, and the bank forecloses.

For many of us in real estate, foreclosures were rare up until just a few years ago. With the real estate boom and bust and the financial meltdown of 2008, foreclosures have become commonplace. Has the stigma worn off? Are there similar implications today, both social and financial, that there were just five years ago? It seems as though the social stigma is wearing off, but will time will tell about the financial ones.

Foreclosure procedures and timelines vary by state. And the process can be complicated and lengthy. Lots of books have been written on the subject. But here’s how it often goes.

Filing a ‘Notice of Default’

1. After the first missed mortgage payment, you’ll most likely get a call (or letter) from the lender, informing you of the delinquency and attempting to discover why you haven’t paid. Lenders may report your delinquency to credit bureaus, which can have an immediate affect on your credit score.

2. Once you’ve missed three consecutive payments, the lender typically files a ‘Notice of Default’ with your city’s local assessor-recorder’s office (where it’s public record). You’ll get a letter saying the foreclosure process will begin unless you pay all money owed, including penalties.

By the way, at this point you’ll probably also get targeted by scammers, who know you’re vulnerable. So be wary.

Landing on the courthouse steps

3. Ninety days after filing the ‘Notice of Default,’ you still haven’t paid up. The lender can now file a ‘Notice of Intent to Sell.’ Then, 21 days later, the lender can submit your home to the county clerk for sale ‘on the courthouse steps,’ literally. They will try to sell your home to recover the amount of the loan. Many times, however, the loan amount may actually be more than market value. In this case, the home won’t sell on the courthouse steps.

4. If there’s no buyer, the lender will take back the property, hire a Realtor and attempt to sell the home on the open market, much like other homes for sale. The lender will issue a request for a broker price opinion (BPO). Much like an appraiser, this third party will give the bank an indication of what the property should sell for. Banks tend to sell the property below market value because they want it off their books.

Sold ‘as is’

5. Although you’ll find that bank owned or Real Estate Owned (REO) properties seem like a good “deal,” you don’t always get “something for nothing.” The property is usually listed as an ‘as-is sale.’ The standard seller disclosures don’t apply as the bank doesn’t have any knowledge about the home, its legal status, defects or the neighborhood. It’s ‘buyer beware’ time for those interested in purchasing the property.

The impact on your credit score

6. Your home has been foreclosed and sold. What’s next for you? A foreclosure is a huge drag on your credit score. It’s not unheard of for a credit score to drop 300 points as a result of a foreclosure.

A foreclosure isn’t fully removed from your record until after seven years. But some lenders might offer you small loans as early as two years after a foreclosure, especially if you keep up with your financial obligations during that period. You’ll pay higher interest rates, however, than someone with a good or excellent credit score.

The bottom line

Walking away from a mortgage doesn’t have quite the social stigma it once had, because in this recession, a lot more people have had to do it.

Still, letting your home get foreclosed isn’t something you want to do, if you can avoid it. A short sale is preferable and has less of a negative effect on your credit score.

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