Foreclosure is a term every homeowner should know. Learn more about it.

What is foreclosure?

Foreclosure is when a lender sells the asset used as collateral in a loan to recover money owed to them from the borrower. When a borrower takes out a loan, such as a mortgage, he may be asked to put up collateral to protect his lender in case he defaults. If the borrower defaults, the lender takes control of the property and sells it in a foreclosure.

Deeper definition

If a homeowner thinks she won’t be able to continue making payments, she may be able to sell the home in a short sale instead of defaulting, or refinancing the mortgage to make payments more manageable. Both of these options aren’t great for her credit, but neither is as bad as foreclosure.

If the borrower defaults, the lender has the option of foreclosing on the property to recoup its losses. Being simply delinquent won’t result in foreclosure, but it does warn the lending institution that a borrower is close to default.

In the case of a mortgage, lenders must follow all state foreclosure laws regarding the notices they must send to the homeowner, including offering the homeowner options to avoid foreclosure like transferring rights to the home in a deed in lieu of foreclosure agreement. Laws and requirements vary from state to state, but many lenders must get permission from the court to foreclose on a property.

Once the foreclosure receives approval, the foreclosed property is sold in an auction or through a realtor. Depending on whether the foreclosure has to go through the judicial system, the foreclosure process can take anywhere from 480 to 700 days. For that reason, lenders often prefer to work with the borrower instead of having to hold on to a property and potentially lose money on it.

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Foreclosure example

Luigi has been delinquent on his mortgage payments for his mansion. He missed one last month and thinks he’ll miss another next month. His lender, a local bank, sends him a notice telling him that he’ll be in default if he misses one more, and that it may foreclose on his mansion. Luigi contacts his bank about his options. The bank, knowing that Luigi’s mansion could be difficult to sell on the market, offers to refinance his loan to make his payments easier. Luigi avoids foreclosure and gets to stay in his home.

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