A foreclosure is generally about as pleasant as a root canal. For both parties. Don’t think your lender wants to foreclose. Lenders almost never want to go through the expense and hassle of going through the entire foreclosure process. But the lender also has a responsibility to its investors to protect their position as best it can, and so foreclosures happen.
So what’s going to happen once you receive notice of a foreclosure? It varies. Here are the possible outcomes:
1. You pay the mortgage and keep the house.
This is the happiest of all possible outcomes. The lender is satisfied, and you get to keep your home. Once you pay the note, the foreclosure becomes null and void. Occasionally, people can raise enough cash to pay off the note. But in most cases, people pay off the note by refinancing, one way or another.
Hopefully, if you refinance, you will be able to do it via another bank loan or mortgage company loan at a reasonable interest rate. In some cases, people have paid off their notes with personal loans or high-interest credit card debt, by hocking their cars, or any combination of the above.
Be cautious about replacing a mortgage debt you can’t pay with even higher interest debt you can’t pay: You could wind up in bankruptcy, despite your best efforts.
2. You pay the mortgage by selling your house.
If you can’t refinance, and you can’t pay off the loan with other assets, the next best thing may be to sell the house yourself. If you can satisfy the loan with the proceeds from selling the home, all is well. For the moment, anyway. If you don’t buy another house soon, and you actually profited from the transaction, you could be hit with a capital gains tax liability. True, if you lived in the house for three of the previous five years (special rules may apply for active duty military), you get a $250,000 capital gains tax exclusion on the sale of a personal residence. Twice that for married couples.
If it’s an investment property, on the other hand, you’re under the gun, and the clock is ticking.
You have until the moment the lender auctions off the home to sell it yourself. However, if you owe more on the mortgage than the home is worth, you will either need to make up the difference in cash, or get the bank to agree to take a lower amount in a short sale.
3. The bank auctions the home.
Different states have different specific procedures. But generally, whoever made the highest bid and comes up with the cash will get the deed to the property – and all the rights and privileges attaching thereto. You may be able to make a deal with the buyer to stay on as a renter or work out a rent-to-own arrangement.
If you were on the cusp of being able to arrange financing to pay off the loan and just didn’t quite manage it in time, you may even be able to purchase the home from the new owner outright – though the new owner will likely expect a tidy profit for his or her trouble!
Tip: Some states provide for a redemption period. This is a period of time, ranging from a few days to as long as a month, in which you can still get your home back, if you can come up with the necessary cash. Speak with your own foreclosure law attorney to find the applicable laws in your state.
4. The bank takes over the property.
Sometimes a lender will go ahead and take over the property outright, choosing to manage the property itself. This happens if there are no reasonable bidders for the property, or if the lender is confident that they can eventually get a better recovery by biding their time and waiting.
Meanwhile, unless the home was a residential property, or the loan was a non-recourse loan (meaning the loan is secured only by the underlying property itself, and the lender has no right to file suit to recover any unsatisfied balance), the borrower remains on the hook for the difference between the loan balance and the fair market value of the property.
If the lender actually seizes the property, you can eventually expect the sheriff to come and evict you and your belongings and the locks to get changed. In some cases, though, you may be able to stay on as a renter, as described above. (This is one advantage to using a small, locally owned and operated bank as your lender: You can sometimes strike a better deal with a senior loan officer, or even a bank president, with the authority to approve your proposal, than you can with a low-ranking drone in your bank’s foreclosure department.
By filing bankruptcy, you can legally bring all foreclosure proceedings to a halt. In some areas, this can take months or years. Meanwhile, you can save as much as you can, and perhaps free up enough cash flow during the process to pay off your mortgage, or at least get current on it. State laws vary a great deal. Chapter 7 bankruptcy – the full discharge of debt – typically requires you to sell off almost everything you have, frequently including your home, as part of the bankruptcy process. Generally, you won’t be able to qualify for Chapter 7 anyway, unless you meet the income requirements for your area. Typically, to stave off bankruptcy, at least temporarily, you will file under Chapter 13.
Bankruptcy doesn’t eliminate a foreclosure all by itself. But it can buy time to help you bring things to a more favorable conclusion for you, or at least give you some breathing space while the long bankruptcy process plays itself out.
Can I Throw Away My Foreclosure Paperwork?
It’s going to be awhile before you want to throw that stuff away, tempting though it may be. Especially if you don’t live in a non-recourse state. You can look up your state’s specific laws on the HUD website. If your state allows mortgage lenders to pursue you even after the foreclosure for the unpaid amount on your mortgage, they may get a judgment for the difference – and you could be on the hook, subject to collection actions, for as long as 20 years, depending on the law in your state.
If you filed a bankruptcy, keep your papers around for at least 10 years after a Chapter 7, or seven years after a Chapter 13.
If you had debt forgiven on an investment property, there will be tax consequences to that as well. You’ll get a 1099 for any debt the lender has to write off, which is generally taxable as income to you. Keep your documents for at least six years after you file your taxes for that year.
So Now What?
So let’s say you can already read the tea leaves, and you know you aren’t going to be able to keep your home. It’s time to batten down the hatches, say experts.
First, you will need to solve the immediate problem of finding a new place to live. With a recent foreclosure on your record, many landlords will shy away, or require a higher security deposit from you to compensate them for their risk.
If you’re sending every spare penny into the bank in a hopeless attempt to stave off the inevitable, you may want to rethink that strategy. Keep enough in hand in cash to pay all your move-in costs for the new place.
Tip: Consider the “cash for keys” program. If you have an FHA loan, there are programs available that will give you cash – up to $20,000 in some limited circumstances – to move out and leave the property in good condition. Everyone wins: You have something in “starting-over money,” and the lender gets prompt access to a property they can quickly sell or rent.
Cash & Carry
Once a foreclosure goes on your credit record, it could cause an unpleasant chain reaction. For example, you could see banks close your credit card accounts to new charges, or jack up your rate. Why? Once you have gone through a foreclosure, lenders put you in a different risk category. They see a high correlation between people who go through foreclosure and who default on other debts.
What’s more, that foreclosure is going to hang around on your credit report like a backache: It will take seven years for it to scroll off your credit report, according to the Fair Isaac Corporation, the company behind your credit score. If you declared bankruptcy to delay foreclosure, you could have that bankruptcy on your record for up to 10 years. However, the good news is that the effects of a foreclosure on your credit score gradually fade with time, and it will gradually get easier for you to get credit, including car loans, credit cards, and even a new mortgage.
Note: Not all foreclosures are equal. You can buy again in a few years if you default because of a layoff. But if you do a “strategic default” and simply walk away from your mortgage, don’t expect anyone to give you a mortgage again with that on your record. At least, not without a substantial down payment of up to 30 percent, according to Jay Brinkman, the chief economist for the Mortgage Bankers Association.
Professional Consequences After Foreclosure or Bankruptcy
If your job requires you to hold a top secret security clearance, get out in front of it. Promptly notify your supervisor of your foreclosure situation. In some cases, bankruptcy and foreclosure can contribute to a decision by federal officials to revoke your clearance – which can jeopardize your career. But being up front about it will look much better to adjudicating officials than trying to conceal your financial issues. There is less stigma to foreclosure and bankruptcy than there used to be, and so foreclosure is less of a factor in security clearance revocations than it was a few years ago. However, it can still be a problem. If your career depends on your security clearance, be very conservative with your finances, and do what you can to avoid foreclosure or bankruptcy in the first place.