Anatomy of a Foreclosure: How Foreclosure Works

Foreclosure activity in the U.S. totaled 676,535 properties in 2017, down to a 12-year low. Foreclosure activity includes default notices, auction sale notices, and bank repossessions.  Many of those seeking foreclosure assistance ask how foreclosure works. If you are seeking to avoid foreclosure in Washington DC, Maryland, or Virginia, you must educate yourself quickly and act. Many foreclosures are not typical, however, and do not follow the same timeline. But in a typical foreclosure, here is how foreclosure works.

Preforeclosure

If you fail to pay your mortgage for 30 days past the due date, the lender will likely enter you into their preforeclosure database. Most lenders, however, wait until you are at least 60 to 90 days delinquent before they initiate any formal action. The foreclosure process is expensive and cumbersome for mortgage lenders. Most lenders hope during preforeclosure that the borrower will cure the default without further prompting.

How quickly your lender will move to foreclose on your property generally depends upon the amount of equity in your home. Your lender will move very quickly if there is significant equity in the home. If your lender calculates that a foreclosure auction will cover its loan, then foreclosure will commence rapidly. But your the lender can (and will) take much longer if your home is under water. That is, mortgage companies take longer to foreclose if you owe more on the mortgage than the home is worth.

Notice of default

To initiate a foreclosure action, the lender issues a notice of default at least 30 days before they begin with the procedure to sell the defaulter’s home. To be valid, the notice must state that the borrower has breached the deed of trust and that the lender has the right to sell the property as a result. The bank typically mails the notice to the borrower’s address or posts to the door. Alternatively, your lender may personally serve you with the notice of default, although this is less common.

After a second 30 day period has passed, the lender must serve a further notice on the borrower. This “trustee sale notice” or “auction notice” must specify the place, date, and time of the foreclosure auction. The trustee sale notice will state the amount of your unpaid mortgage balance, plus accrued interest, contractual penalties, and cost of the foreclosure. The notice will also give the name and address of the trustee conducting the auction on behalf of the lender.

Foreclosure auction

Once the substitute trustee sets an auction date, the borrower has two options.

First, you can catch up the entire mortgage delinquency and fee balance (the “arrearage”)  within at least 11 days prior to the foreclosure auction. Or second, you can file for Chapter 13 bankruptcy protection. Chapter 13 allows you to repay your mortgage arrearage over a period of three to five years.

Foreclosure auctions are typically held at the courthouse or the offices of the substitute trustee. If there is any equity in the property, prospective purchasers will bid on the property. The winner must make a cash down payment on the spot. In many cases, however, the amount owed on the property is more than the property is worth. In those cases, the first mortgage holder may be willing to accept bids below what is owed on the first mortgage.

Deficiency judgment

If the property sells for more than the total all of the liens (mortgages and otherwise) and costs against the property, the former homeowner will be paid the difference. Obviously, this does not happen very often. After all, if there was equity in the home prior to the foreclosure, the borrower would have simply sold the home prior to the foreclosure.

In the majority of cases, the property will sell for far less than is owed on the first mortgage. At that point, the lender has two options: obtain a deficiency judgment or issue a 1099 for forgiven debt. The lender’s determination of which option to pursue depends upon the borrower’s last-reported income.

If the borrower has other assets (usually real property) or very high income, the lender will obtain a deficiency judgment, which will be a collectible debt against the former borrower. Once obtained, the lender can legally pursue collection efforts against the foreclosed-upon homeowner, including liening and garnishment. If the former homeowner’s income and assets are determined to be too low to pursue collection efforts, the lender can simply write off the debt and report to the IRS a 1099 statement of forgiven debt. The borrower will be liable for the the amount of the “forgiven” debt as taxable income for the year of the foreclosure.

Now that you know how foreclosure works, explore your options

Virginia, Maryland and the District of Columbia have the property market-stabilizing effects of our local federal government. Thus valuations and income levels are to a large degree inoculated to national trends. The above timeline is typical, but other scenarios are possible, especially for commercial property owners or second homes.

If you are facing foreclosure in the DMV, get advice on how to proceed in a manner best suited to your situation. Act quickly once you receive a notice of default. Call (202) 448-5136 to speak with a foreclosure attorney familiar with local foreclosure procedures.