Foreclosure Overview & Foreclosure Process

What is Foreclosure?

Foreclosure is a process that allows a lender to recover the amount owed on a defaulted loan by selling or taking ownership (repossession) of the property securing the loan. The foreclosure process begins when a borrower/owner defaults on loan payments (usually mortgage payments) and the lender files a public default notice, called a Notice of Default or Lis Pendens. The foreclosure process can end one of four ways:

1.      The borrower/owner reinstates the loan by paying off the default amount during a grace period determined by state law. This grace period is also known as pre-foreclosure.

2.      The borrower/owner sells the property to a third party during the pre-foreclosure period. The sale allows the borrower/owner to pay off the loan and avoid having a foreclosure on his or her credit history.

3.      A third party buys the property at a public auction at the end of the pre-foreclosure period.

4.      The lender takes ownership of the property, usually with the intent to re-sell it on the open market. The lender can take ownership either through an agreement with the borrower/owner during pre-foreclosure, via a short sale foreclosure or by buying back the property at the public auction. Properties repossessed by the lender are also known as bank-owned or REO properties (Real Estate Owned by the lender).

Auction (NTS, NFS):

If the loan is not reinstated by the end of the pre-foreclosure period, potential buyers can bid on the property at a public auction. Buyers often are required to pay in cash at the auction and may not have much time to research the title and condition of the property beforehand; however, a public auction often offers some of the best bargains and avoids the unpredictability of dealing directly with the borrower/owner.

Bank-owned (REO):

If the lender takes ownership of the property, either through an agreement with the owner during pre-foreclosure or at the public auction, the lender will usually want to re-sell the property to recover the unpaid loan amount. The lender will then typically clear the title and perform needed maintenance and repair; however, the potential bargain for these REO homes is typically less than a pre-foreclosure or auction property. Bank foreclosures can become government foreclosures if the loan is backed by a government agency such as the Department of Housing and Urban Development (HUD) or the Department of Veterans Affairs (VA). In that case the government agency would be responsible for selling the property.

Property Condition:

Banks always want to sell a property in "as is" condition. Most will provide a Section 1 pest certification, but not unless you include it in your offer and negotiate the point. They will allow you to get all the inspections you want (at your expense), but they may not agree to do any repairs.

Your offer should include an inspection contingency period that allows you to terminate the sale if the inspections reveal unanticipated damages that the bank will not correct.

Even though you agreed to “as is," always give the bank another opportunity to make repairs or give you a credit after you’ve completed your inspections. Sometimes they’ll re-negotiate to save the transaction instead of putting the property back on the market, but don’t take it for granted.

Banks do not want to see a lot of proprietary disclosures; they are exempt from the California Seller’s Transfer Disclosure Statement (TDS-14). If there are real estate agents involved, either representing you or the bank, those agents are required to provide you their disclosure statements.

Most banks will not provide financing on their REOs but it doesn’t hurt to ask. Especially if the property has extensive damage and you are purchasing it "as is."

Making an Offer:

Before making an offer, have your agent contact the listing agent and ask the following:

Are there any inspection reports?

What work has the bank agreed to?

Is there a special "as is" form?

How long does it take the bank to accept an offer?

How does your agent deliver the offer?

Offers are usually FAXED to the bank. The listing agent needs your originals. There is no formal presentation. Keep in mind: nothing happens evenings and weekends (banks are closed).

Since there is no face-to-face presentation to the bank, provide the listing agent with a pre-qualification or better yet, a pre-approval letter and buyer biography. Make your offer easy to accept.

What is a Short Sale?

A short sale happens when the lender is shorted on a mortgage, meaning the lender accepts less than the total amount that is due. If your mortgage is $100,000, but your home is worth, say, $90,000, you are $10,000 short, not including costs to close the sale such as real estate commissions, recording fees, and/or title and escrow charges.

Sometimes, to avoid going through the costs of foreclosure, a lender will sanction a short sale by letting a buyer purchase the home for less than the mortgage balance while the home is in pre-foreclosure stage. A pre-foreclosure stage is one of the three stages of foreclosures.

Here are sample steps of a short sale:

·         Seller signs a listing agreement with a real estate agent subject to selling as a short sale with third-party (lender) approval.

·         The agent finds a buyer who makes an offer for less than the amount of the mortgage.

·         Seller accepts the buyer's purchase offer.

·         Seller's lender accepts the buyer's purchase offer.

·         Transaction closes when the buyer delivers the funds, the lender releases the lien and the seller delivers the deed.

Qualifications for a Short Sale

·         The Home's Market Value Has Dropped.

Hard comparable sales must substantiate that the home is worth less than the unpaid balance due the lender. This unpaid balance may include a prepayment penalty.

·         The Mortgage is in or Near Default Status.

It used to be that lenders would not consider a short sale if the payments were current, but that is no longer the case. Realizing that other factors contribute to a potential default, many lenders are eager to head off future problems at the pass.

·         The Seller Has Fallen on Hard Times.

The seller must submit a letter of hardship that explains why the seller can not pay the difference due upon sale, including why the seller has or will stop making the monthly payments.

A few examples that do NOT constitute a hardship are:

1.      Bad purchase decisions. Blowing your paycheck on a home theater system with surround sound does not qualify as a hardship.

2.      Unhappy with the neighbors. Even if every home on your block has turned into pot growing houses, that will not qualify as a hardship.

3.      Buying another home. The lender will not care if you have decided the home is no longer suitable for you or your family.

4.      Pregnancy. Increasing the size of your family or starting a family is not considered a hardship.

5.      Moving into an apartment. If you decide to move out of your home, that is a lifestyle decision and not a very good reason to abandon your home.

Examples of hardship are:

6.        Unemployment

7.        Divorce

8.        Medical emergency / sudden illness

9.        Bankruptcy

10.    Death

·         The Seller Has No Assets

The lender will probably want to see a copy of the seller's tax returns and / or a financial statement. If the lender discovers assets, the lender may not grant the short sale because the lender will feel that the seller has the ability to pay the shorted difference. Sellers with assets may still be granted a short sale but could be required to pay back the shortfall.

For example, if the seller has cash in a savings account, owns other real estate, stocks, bonds or even IRA accounts, the lender will most likely determine that the seller has assets. However, the lender might discount the amount the seller is required to pay back.

Short Sale Consequences

A short sale is dependent on a buyer making an offer to purchase. If you do not receive an offer, you will not qualify for a short sale. So even if you meet all the other criteria, it is possible that no one will buy your home. It is also dependent on the lender accepting the buyer's offer. If the lender rejects the offer, a short sale will not take place.

·         Tax Consequences

If the lender agrees to the short sale, the lender may possess the right to issue you a 1099 for the shorted difference, due to a provision in the IRS code about debt forgiveness. Many situations are exempt from debt forgiveness, according to the Mortgage Forgiveness Debt Relief Act of 2007.

You should speak to a real estate lawyer and a tax accountant to determine the amount of short sale tax consequences, and whether you can afford to pay those taxes, if any.

·         Blemished Credit Report