In the midst of the 2008 financial crisis, the unprecedented number of foreclosures overwhelmed the news cycle. But what is this powerful financial force that seemed to single-handedly bring down the housing market? What does it mean for homeowners, banks, and homebuyers? Here we explain what a foreclosure is and how it can change the real estate market.
What is a Foreclosure?
A foreclosure is the process where a homeowner's rights to their property are forfeited due to their failure to pay the mortgage. This can be a lengthy process as the actual timline from the first missed payment to the sale of the property will depend upon the bank as well as on the individual real estate market.
The homeowner is not actually a homeowner until they have paid off the mortgage in its entirety. Until then, the homeowner is actually identified as a borrower. The mortgage that a person signs when they buy a home actually places a lien on the property, meaning that the property belongs to another entity until the mortgage is paid off complete. This makes the loan more secure from the bank's perspective with the home acting as the collateral.
When payment is not made, the collateral can lawfully be seized, which ultimately results in a foreclosure. Understanding how it can happen and what takes place on the real estate market can help to identify the length of time it takes.
How Does it Happen?
A foreclosure is not something that happens overnight. It all begins with the failure to make mortgage payments in a timely fashion. There may be financial hardships due to unemployment, death, divorce, or even medical problems. Ultimately, a foreclosure happens because the repayment terms of the loan cannot be met.
After approximately three to six months of payments being missed, the lender will file a public notice with the County Recorder's Office. This is to identify that the borrower is in default on their mortgage. This may be referred to as a Notice of Default (or NOD) in some states.
The borrower will then get the notice and then immediately go into a grace period identified as pre-foreclosure. There may be an option to pay the outstanding amount or to go into a short sale. If the default is paid off during the pre-foreclosure phase, the foreclosure stops and the borrower is able to avoid eviction and the sale of their home.
Foreclosures in the Real Estate Market
When there are foreclosures, there are a few different options in terms of how it will hit the real estate market. The first and most common is that of a foreclosure auction. The home is sold to the highest bidder and the payment is done in cash. These homes are typically sold at well below the market price as the bank is motivated to get the property off their books. If a third party doesn't buy the property by the end of the auction, the lender will take ownership. It then becomes a bank-owned property, which is most commonly listed by a local real estate agent on the local multiple listing service (or MLS).
Foreclosures on the market can be a great way to get an affordable house. However, if there is an unusually high number of foreclosures in a particular market, it can be difficult for people who are selling their homes in the traditional way because it drives the value of the homes down considerably.