Foreclosure Process

As long as people have taken out loans to buy real estate, there has also been foreclosure activity.

A vast majority of loans are paid off according to plan. But there are always exceptions where borrowers fail to pay, causing them to lose their property through foreclosure. And that's been pretty much throughout modern real estate history.

Foreclosure activity levels tend to rise and fall in step with broader economic trends. Activity can vary from region to region. At any given time, the number of foreclosures by state may vary widely from one state to another. A number of different factors influence the volume of foreclosed homes, but let's start by considering how foreclosures come about in the first place.

It starts with a loan

Let's start at the beginning of the home owner cycle. Most people cannot afford to pay the price for a traditional house-for-sale with their own available cash. To buy a house, in most cases, they need to borrow money to cover the purchase (usually less a down-payment).

Money is available to borrow from banks, mortgage companies, and other lending organizations. Home loans, or mortgages, are issued by the lenders based on the home buyer's ability and promise to repay the loan over time. But there's a catch: if the buyer cannot continue to pay off their loan, the lender can take legal actions to take the property back from the home owner. This is the foreclosure process.

Foreclosure defined

What exactly does "foreclosure" mean? Let's look at a few flavors of definitions, as posted in various online dictionaries of language, real estate and legal terms.

One definition of foreclosure is very literal, based on historic French and Latin word routes: 'to shut out'. And it still holds true. People experiencing foreclosures are shut out of their house when the lender takes back ownership. Another more formal definition offers:  'the legal proceeding that bars or removes a mortgagor's equity of redemption in a mortgaged property.' Or a more friendly, layman's version says: 'the proceeding in which the financer of a mortgage acts to regain a property due to the borrower having defaulted on loan payments, when the loan is guaranteed by the ownership of the property.'

Types of mortgages

Loans gone bad are the root of the foreclosure process. What kind of loans are involved? There are several types. Knowing these can help gain understanding of the reasons for foreclosures.

Home loans can be thought of in two classes of two: fixed rate or variable rate and conforming or non-confirming loans.

  • Fixed-rate mortgages keep the interest rate charged the same over time. The borrower's monthly mortgage payment does not change through the life of the loan. Economic or interest rate changes in the open market will not influence a fixed rate mortgage. For example, a 7%, 30-year loan charges a steady 7% interest rate over a 30-year payment plan.

    Sudden changes in employment, health or other financial status of a homeowner with a fixed mortgage may cause difficulty in repayment, leading to the home becoming a foreclosure listing.

  • Variable-rate mortgages are also known as Adjustable Rate Mortgages, or ARM's. The interest charged in these loans is usually tied to a specific economic index to measure the changes in market interest rates. And the mortgage is regularly adjusted to reflect these changes. For example, if a loan is a 5/1 ARM at 3%, the first 5 years of the loan will be charged at 3% interest, but after that period, the interest rate is subject to change up or down.

    ARM's usually adjust to higher interest rates after an introductory low rate period. This can result in a significant increase in the monthly payment due. This can put borrowers into difficulty if they did not plan on having more money available for the new monthly payments. If new rates or terms cannot be made, the homeowner is at risk of falling behind and sending the home into foreclosure.

Conforming or non-conforming loans are usually determined by and refer to the dollar amount loaned.

  • Conforming loans are a smaller amount, where non-conforming are higher (historically over $700,000). The amounts can vary over time depending on the current status of the banking and real estate markets.

    Non-conforming loans may also be written for borrowers with poor credit histories or on property types that are considered non-standard.

  • Non-conforming, sub-prime loans are some of the riskiest mortgages for lenders to issue. As such, it is not uncommon to see sub-prime loans default and enter the foreclosure process.