Foreclosure
Foreclosure is a legal process through which a lender seeks to recover the balance owed on a defaulted mortgage by taking ownership of the property used as collateral. Default occurs after a borrower misses a mortgage payment, with the process typically initiated by the lender after three to six months of missed payments. The specific procedures for foreclosure can differ significantly across states in the U.S. There are two principal types of foreclosure: judicial, which involves court proceedings, and nonjudicial, which allows the lender to auction the property without court intervention. Various programs have been developed, especially after economic crises like the 2008 housing market crash, to assist homeowners facing foreclosure, offering options such as loan modifications and refinancing assistance. The impact of foreclosure extends beyond individual homeowners, affecting property values and community dynamics, often leading to long-lasting economic and social consequences for those involved. Additionally, recent governmental initiatives, like the Homeowners Assistance Fund, aim to provide relief to those experiencing financial hardship, especially during challenging times such as the COVID-19 pandemic.
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Subject Terms
Foreclosure
Foreclosure is the legal process through which a lender recoups the amount owed by a borrower who has defaulted on a mortgage. Defaulting is simply the failure to pay a debt; a borrower is considered to be in default after one missed mortgage payment. In a foreclosure, the lender recovers the debt by taking ownership of the asset the borrower used as collateral for the mortgage, which is the real estate that the mortgage was used to purchase. In the United States, the specific process involved in a foreclosure varies from state to state.
Following the US economic crisis of 2008, home foreclosures became widespread. Contributing factors included increasingly relaxed lending practices and a rise in the number of high-risk mortgages, such as subprime mortgages and adjustable-rate mortgages. In response to the crisis, the US government developed various programs to aid struggling mortgage holders and help them keep their homes. These programs offer guidance on loan modification and refinancing, among other topics.
Background
Modern foreclosure law stems from English common law, which dictated that when a prospective property owner borrowed money to purchase property, the lender would hold the title and all rights to the property until the borrower paid back the loan. The process was unforgiving to borrowers, who would lose their equity in the property. All income earned from the property during this time went to the lender instead.
While US mortgage law is based on this system, it developed in such a way as to help protect the borrower’s equity. By the nineteenth century, many states had begun to require that foreclosed property be sold to the public rather than held by the lender. The payment received from these sales would be applied to the outstanding amount of the loan, with any additional money being returned to the borrower. At first, the public sales of foreclosed property fell under the jurisdiction of the courts, but over time, some states allowed lenders or trustees to conduct the sales. Trustees are third parties who work with the borrower and the lender during the foreclosure process.
Throughout most of the twentieth century, US housing prices were stable; however, in 1997, they began to increase dramatically. This increase was due in part to high-risk mortgage loans and lending practices, sometimes referred to as "predatory lending." Examples of such high-risk loans include subprime mortgages, in which a mortgage is sold to somebody with poor credit and a significant risk of default, and adjustable-rate mortgages (ARMs), in which the interest rate is fixed only for a short time, after which it may be periodically adjusted depending on the market. These mortgages required little to no down payment, resulting in higher monthly payments and more accumulated interest.
Housing prices peaked in 2005 and early 2006, followed by a precipitous drop. As prices continued to fall and interest rates rose, holders of subprime mortgages and ARMs began to default on their loans in record numbers. According to the CoreLogic National Foreclosure Report, between September 2008 and January 2014, 4.9 million foreclosures were completed in the United States. From 2021 to 2024, after the COVID-19 pandemic, interest rates rose five percentage points before they began to drop slightly. A housing shortage caused a sharp spike in the cost of homes. The foreclosure rate rose in 2022 and 2023, although it was much lower than it was in 2008 and 2009.
Overview
Foreclosure laws and processes vary by state. The foreclosure process typically begins after three to six months of defaulted payments on a mortgage loan. The lender generally initiates the foreclosure process by filing a public default notice, referred to as "notice of default" or a "lis pendens" (from the Latin for "dispute pending"). This notice, which is usually sent to the borrower via mail, includes information about the property and the amount owed and serves to notify the borrower that he or she is in default and in danger of foreclosure. The notice of default is generally followed by a foreclosure notice, which means that the lender has begun foreclosure proceedings and scheduled a public auction of the property. The foreclosure notice is generally printed in local newspapers or in the county’s legal newspaper.
There are two main types of foreclosures: judicial foreclosure and nonjudicial foreclosure, also called foreclosure by power of sale. A judicial foreclosure is when a lender files a lawsuit against the defaulted borrower. The borrower is notified of the legal action via mail, at which point he or she has thirty days to furnish a payment toward the loan. If a payment is not received within a certain time frame, the property proceeds to public auction, which is conducted by either a public official, such as a judge or sheriff, or somebody appointed by the court.
A nonjudicial foreclosure occurs when the mortgage in question includes a power-of-sale clause, which entitles the mortgage lender to carry out a public auction of the foreclosure property without the intervention of the legal system. In this case, the auction is conducted directly by the lender or by a lender-appointed trustee. Nonjudicial foreclosures typically proceed more quickly than judicial foreclosures.
When a foreclosed property is auctioned, the amount of the opening bid is determined by the balance of the mortgage, plus any additional fees or penalties incurred during the foreclosure process. Some states allow a redemption period after the auction, during which the property can be purchased back by the borrower for either the full remaining balance of the mortgage, plus any legal fees, taxes, and interest, or the amount of the winning bid. This redemption period can range from thirty days to two years, depending on the state.
A few states permit a third type of foreclosure, known as strict foreclosure. In a strict foreclosure, the demands on the borrower are higher than in the other types. Once the borrower defaults on payment, a court determines a time frame during which the borrower must pay the remaining balance. If the borrower does not pay within that time frame, the property is returned directly to the lender, who is not required to sell it. Strict foreclosures generally occur only when the amount owed exceeds the value of the property.
In 2009, under the administration of President Barack Obama, the US Department of the Treasury (DoT) and the Department of Housing and Urban Development (HUD) launched the Homeowner Affordability and Stability Plan, designed to help struggling mortgage holders keep their homes. A cornerstone of the plan was the Making Home Affordable (MHA) program, which offered homeowners information and assistance related to foreclosures, refinancing, short sales, and loan modifications. The Home Affordable Modification Program (HAMP) was a segment of the MHA that gave homeowners the opportunity to decrease their monthly mortgage payments. By 2015, more than 1.3 million people had taken advantage of HAMP’s services. Other MHA programs included the Home Affordable Unemployment Program (UP), designed to help unemployed homeowners maintain their mortgages, and the Home Affordable Foreclosure Alternative Program (HAFA), which helped struggling homeowners transition out of homeownership by offering assistance with short sales and relocation assistance funds, which could total $10,000.
HOPE NOW, later called HOPE, was an organization developed by HUD and the DoT in 2007, early on in the housing crisis. HOPE NOW represented a group of diverse stakeholders from the private and public sectors who sought to address and repair problems in the mortgage industry. Their goals included increasing awareness of predatory lending to at-risk borrowers and offering information to struggling mortgage holders regarding foreclosure alternatives.
Another government initiative to combat foreclosure was the National Foreclosure Mitigation Counseling (NFMC) program. Formed in 2007, the NFMC significantly increased the availability of financial counseling to struggling homeowners. In the 2012 research study "National Foreclosure Mitigation Counseling Program Evaluation: Final Report Rounds 1 and 2," Neil S. Mayer and colleagues reported that the program was successful in helping counseled homeowners avoid foreclosure. The study found that counseling homeowners on how to modify their existing mortgages was particularly effective.
The Homeowners Assistance Fund (HAF) was part of the 2021 American Rescue Plan Act. HAF provided funds to homeowners facing hardship because of COVID-19. The funds, which were distributed to states, US territories, and Native American tribes, could be used to make payments on mortgages, insurance, and utilities. The program ran until June 2024 and assisted nearly 550,000 homeowners.
The negative impact of foreclosures reaches much farther than the individual homeowners undergoing foreclosure. In their 2023 article, "The Effect of Foreclosures on Homeowners, Tenants, and Landlords," Stanford economist Rebecca Diamond and her colleagues contend that the effects of a foreclosure on a homeowner are long-lasting. According to the article, they are less likely to buy another house and more likely to default on their debts. They are more likely to divorce and move to lower-income neighborhoods. Foreclosure also affects a community, as property values drop when it occurs. This is because foreclosed homes are sold at significantly lower prices than their market value, so they affect the comparable properties in the area.
Bibliography
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