When a borrower fails to meet its loan obligations, the lender may try to foreclose on the property securing the loan. “Foreclosure” is just the series of steps a lender has to take in order to force the sale of such property and use the sale proceeds to recover its unpaid debt.
This is simple enough in theory. However, except for professionals who deal with foreclosures on a regular basis, few understand the many steps involved in the process. Given the complexity, and the fact that these steps can vary from state to state, residential or commercial property, and even depending upon the terms of agreements between individual borrowers and lenders, it isn’t surprising the process may be a bit of a mystery.
Nonetheless, since compliance with the foreclosure process can greatly impact the length, cost and outcome of these actions, a solid understanding of the foreclosure process is critical.
In this article we’ll take a deep dive into the foreclosure process, step by step.
Foreclosure Rules Vary from State to State
First of all, as with most real estate laws, foreclosure rights and procedures are different in each state. These differences can be minor variations in things such as how many times a lender must publish notice of a foreclosure sale, or the number of days a borrower has to respond to a lawsuit.
They can also, however, vary significantly in terms of borrower and lender rights. For example, a borrower may or may not have the right of redemption, which is the ability to recover their property following a foreclosure sale by (i) paying the sale price, interest and other costs to the winning bidder or (ii) if the redemption happens before the sale, by paying the lender its outstanding debt and other costs.
Since these differences can vary so much between states, let’s take a quick look at the most significant differences between states before diving into the foreclosure process itself.
Judicial vs. Non Judicial Foreclosure
Those states which use a mortgage to evidence a lender’s security interest in property utilize a judicial foreclosure process. Judicial foreclosure requires a lender to file a lawsuit with the courts and prove they are entitled foreclose under state law and the loan documents. However, where the mortgage includes a “power of sale clause” authorizing a lender to sell the property upon default by the borrower, these states will allow the lender to use a non-judicial foreclosure.
Those states using a deed of trust utilize the non-judicial foreclosure process. This process doesn’t involve a court’s approval, but rather is conducted by a trustee for the lender and governed by state law and loan documents. In those states which use both mortgages and deeds of trust, a non-judicial foreclosure is generally available to those mortgages that include a power of sale clause.
Where a power of sale clause sets out a procedure for the foreclosure, that procedure will be followed unless it doesn’t comply with the minimum state law requirements. Because the non-judicial method is typically faster and less expensive, most lenders opt for it over the judicial method.
Because foreclosures result in the loss of property, including people’s homes, strict compliance with procedural items, such as the method and form various notices must take, is required. Accordingly, knowing when, where and what form notices must take (as well as all other procedural requirements) is critical to a successful foreclosure. While there may be some similarities, the procedural requirements for a foreclosure can vary widely from state to state.
Time to Complete the Process
Depending on the state, foreclosures can occur as quickly as 30 days, and up to seven months (or longer).
Right of Redemption
Some states grant a borrower a right of redemption, and others do not. Generally redemption is not available in non-judicial foreclosures unless the deed of trust grants the right. Even where they are given, there is a great deal of variation among the states as to the period in which a borrower must exercise or lose its right to redeem (generally between six months and a year). Further, state laws may condition the right of redemption, or modify the time period in which it can be exercised, on different factors, such as:
- Requiring the borrower to redeem the property before the foreclosure sale
- The percentage of the unpaid loan amount at the time of foreclosure judgment
- Whether the property has been abandoned
- Whether the borrower relinquished possession to the new owner (the winning bidder at the foreclosure sale) following demand
- Whether the borrower lost its source of income following foreclosure
- In what year the mortgage was granted
- Whether a lender gets a deficiency judgment
- Whether the lender was the foreclosing buyer
- The type of property (e.g., agricultural), and
- The terms of the mortgage or deed of trust
Where the proceeds from the foreclosure sale aren’t enough to pay the borrower’s unpaid debt, the lender may be able to obtain a deficiency judgment against the borrower for the difference. Some states permit them, and some do not. Generally such judgments are not available where a deed of trust was used. Again, however, even where a deficiency judgment is permitted, the states can differ on their application, such as the time period in which it must occur and conditions on its availability (e.g., a borrower may be able to avoid a deficiency judgment if it agrees to a sale of the property prior to foreclosure).
Summary of State Variations in The Foreclosure Process
The above categories outlines the most significant differences between states. To get specific and detailed differences you can browse the Foreclosure Laws website. Because of these many variations, and because this article is only for informational purposes, and not legal advice, if you have any specific foreclosure issues, you should consult with an attorney.
The Foreclosure Process
Now that we’ve covered some of the major differences between states, let’s next walk through the foreclosure process, step by step.
Default by Borrower
The foreclosure process begins when a borrower defaults on its loan, whether by failing to make timely payments or meet its other obligations under the loan documents (e.g., failing to maintain property insurance). Evidence of the default is the linchpin of a lender being able to establish it has the right to foreclose.
Notice of Default
Following default, the lender sends a notice to the borrower that includes a description of the default and the time period in which the default must be cured. For example, if the default is a failure to timely pay loan amounts, the notice will state the amount due and when it must be paid. If the default is not cured before this period expires, the lender may begin the foreclosure process.
Under certain circumstances, typically for commercial properties where the loan documents permit, the notice of default may also include a demand that the borrower sends the lender all rents from the property it currently has, and those rents it collects through the foreclosure process which aren’t used for certain property expenses approved by the lender.
Though not an actual part of the foreclosure process, in an effort to avoid the time, cost and other negative consequences of a foreclosure, following the default notice the parties may attempt a workout, or a restructuring of the loan terms, to avoid further defaults. Common workouts include forbearance, loan modification, a repayment plan, deed in lieu of foreclosure or short sale.
If the borrower fails to cure the default before the period stated in the notice, the lender demands an acceleration of the loan. Acceleration means the amount due is no longer the missed payments, but rather the total amount of unpaid debt. The right to demand acceleration is granted in the loan documents, and the time required between the default notice and acceleration demand varies.
Lender Files Complaint / Trustee Issues Notice of Default
The next step depends on whether or not the state is a judicial foreclosure state or a non-judicial foreclosure state. Let’s walk through both scenarios.
Judicial Foreclosure: Complaint
In a judicial foreclosure action, if the borrower is unresponsive to the demand and acceleration letter, and no workout has been negotiated, the lender will begin the foreclosure lawsuit by:
- Filing a complaint or petition for foreclosure with the courts,
- Issuing summons to the borrower and all interested parties notifying them of the suit and stating the time period in which they must contest the foreclosure, and
- Recording in the county records a lis pendens (this is done to give notice to the public, subsequent lien holders, and potential purchasers of the foreclosure).
The suit is filed in the county where the property is located, and asks the court for a judgment of foreclosure, an order for sale of the property, and in some cases a deficiency judgment.
The complaint will name the borrower and all other interested parties. These can include, for example, guarantors to the loan, holders of second mortgages or other liens junior to the lender’s mortgage, or the IRS if a tax lien encumbers the property. The lender must notify each defendant separately by summons according to form, method and timing under state law.
The complaint sets forth the lender’s argument that it is entitled to the relief it seeks. Typically a complaint will include the mortgage, all loan documents, state the default and amount due, and identify the property. Some states require the lender to file an affidavit of fact with the complaint, which affidavit attests to the amounts due, the amount of the unpaid principal balance, unpaid interest due, late fees, attorney fees, and other costs. Further, a person with personal knowledge of the affidavit’s contents must sign it. This means that no automated signatures are permitted.
In some states, where the foreclosure is on commercial property, the complaint may also include a request that the court issue an order requiring the borrower to deposit all rents from the property into the court or other depository. Generally, in order to protect the value of the property securing the loan during the pendency of the foreclosure action, the court may use these rents to pay expenses relating to the operation of the property and make payments on the loan.
Non-Judicial Foreclosure: Notice of Default
In a non-judicial foreclosure, a third party referred to as the “trustee” handles the foreclosure instead of a court. The trustee, named in the deed of trust, is a neutral third party who owes a fiduciary duty to both lender and borrower.
The procedure detailed in the deed of trust and loan documents will be followed so long as they meet the minimum borrower protections afforded under state law. Generally this begins with the lender notifying the trustee of the borrower’s default and how it may be cured. The trustee then issues a notice of default by:
- Sending all interested parties notice of the proceeding, the foreclosure sale and its date,
- Recording a notice of the default in the county records, and
- Publishing notice in newspapers, posting on the property, or as otherwise required in the deed of trust and state law.
As with a summons, the notice of default will tell the borrower the basis of the lender’s complaint, the date by which the borrower must either contest the foreclosure or bring the loan payments current, and the remedy sought by the lender, i.e., money judgment and sale of the property.
Appointment of Receiver
In a commercial foreclosure, and if the mortgage provides for such, a lender may ask that a receiver be appointed. A receiver is a neutral third party, paid by the lender, who essentially takes over the management of the property to ensure the borrower is not damaging the property (including by failing to make necessary repairs) or “skimming” rent (using the rent to pay non-property expenses, including loan payments).
Depending on the terms of the mortgage, receivership may be requested either by petitioning the court upon a default or as a part of the foreclosure complaint. Although the lender pays for the receiver, the receiver is responsible only to direction from court.
Once a receiver has been appointed, it will operate all aspects of the property, including such things as managing leases, entering into new leases, collecting rent, maintaining and repairing the property, paying all property expenses (e.g., insurance, taxes, etc.), and, if all parties and the court consent, selling the property and ending the foreclosure proceeding.
Borrower’s Answer and Defenses
If the borrower wants to contest the foreclosure, it must file an answer within the time period set forth in the complaint (judicial) or in the notice of default (non-judicial). The answer will include responses to all of the statements made by lender in its complaint, either accepting, denying or asserting it doesn’t have enough information to accept or deny each claim.
Additionally, in the answer the borrower may assert any defenses or counterclaims it has to the foreclosure. Common defenses and counterclaims include:
- Violations under Fair Debt Collection Practices Act (residential foreclosures only) or Truth in Lending Act
- Loan has been paid in full
- Lender miscalculated the amount due
- State law, mortgage or deed of trust procedures weren’t followed
- Deficient affidavit of fact
- Improper plaintiff or assignment (lender failed to establish it was the owner of the mortgage and loan)
- Equitable estoppel
- Statute of limitations
If the borrower doesn’t file a timely answer, the court will issue a default judgment for the lender.
In the case of a non-judicial foreclosure, where the borrower does not have the chance to make such defenses or counterclaims to a court, the borrower may consider suing the lender. It then becomes the plaintiff filing the complaint, and argues the foreclosure should be stopped or modified based on the borrower’s defenses.
While a lawsuit could be a large expense for a borrower, it is sometimes used to delay the foreclosure or encourage settlement with the lender.
Relief: Judgment of Foreclosure and Deficiency Judgment
Following the court’s consideration of the lender’s claims and borrower’s defenses and counterclaims, the court will issue a judgment either denying the foreclosure, or granting the relief sought by the lender. As noted above, lenders typically ask for a judgment of foreclosure (money judgment for principal, pre-judgment interest, reasonable expenses, and costs of the action), an order for sale of the property, and in some cases a deficiency judgment.
In those states where a deficiency judgment isn’t issued at this time, the lender will ask the court to retain jurisdiction over the action so it can consider the request for deficiency later.
While most states don’t pass title to the property until the foreclosure sale has been completed or the redemption period has expired, in two states, Vermont and Connecticut, the foreclosure judgment can include an order that title to property is immediately transferred to the lender.
As to the deficiency judgment, the lender can then start trying to collect this amount. Some methods to do so include garnishing wages, freezing bank accounts, and placing liens on the borrower’s other assets.
Notice of Sale
Following a court’s order for sale, the lender will notify the borrower of the sale date, time and place. Depending on state law and the loan documents, this notice may have to be mailed to the borrower, posted on the property, published in certain newspapers, recorded in the county records, or otherwise distributed.
Generally the borrower may still be able to keep its property if it can negotiate a settlement with the lender (e.g., pay the full amount due, court costs, receiver costs, attorney’s fees, etc.) before the sale date.
Depending on whether the foreclosure is judicial or non-juridical, and the terms of the loan document and state law, the sale may be conducted by the county clerk, the trustee or another party. It will occur at the place identified in the notice of sale, often on the county courthouse steps.
The sale may be postponed at the time and place originally set for the sale. Generally anyone may bid at the auction, and bidders may be required to provide proof they can pay the full amount they’ve bid.
Objections to Sale
Some states allow a party to object to the foreclosure sale within a certain time following the sale. In those states, the certificate of title may not be given to the bidder until this period has passed without objection, or until a court has resolved the objection.
Example objections include mistake, collusion, notice or other procedural defects. In other states, if the court retains jurisdiction of the case through the sale, a party may file an objection to the court as a part of the existing foreclosure action.
Certificate of Title or Deed of Trust Issued
Following the auction, the highest bidder typically receives a certificate of title (judicial) or a deed of trust for the property (non-judicial) transferring title to the property to the bidder. A certificate of sale will identify the bidder, the sale amount and the bidder’s rights in the property. However, title may not transfer to the bidder until sale objections (where permitted) are resolved or, in states allowing redemption, until the redemption period has passed.
Following the auction, the sale proceeds are disbursed to the lender pursuant to the court’s judgment or the terms of the deed of trust. Generally proceeds are disbursed in the following order of priority: foreclosure expenses (e.g., auction holder may be entitled to a fee), the lender’s money judgment, paying off junior liens, and any remaining proceeds going to the borrower.
Transfer of Possession (Eviction of Owner and Tenants)
Once the bidder is given ownership, the borrower either relinquishes possession of the property voluntarily or the bidder must bring an eviction lawsuit under state law. As noted above, in some states if the borrower refuses to transfer possession it may lose its right to redemption.
In addition to the borrower, the new owner may need to deal with tenants remaining on the property. If the tenants were joined in the foreclosure action, the court may issue writs of possession to move the tenants out. In commercial cases, if the tenant’s lease included a subordination clause (meaning the tenant’s interest in the property is junior to the lender’s), the lender may terminate the lease and evict the tenant.
If, however, the lease included a non-disturbance clause (which gives the tenant, so long as they are not in default, the right to stay on the property even if it is sold or foreclosed), the lender cannot evict the tenant.
As described earlier in this article, the right of redemption grants a borrower the right to regain ownership of its property following the foreclosure sale by paying the winning bidder the sale price plus costs within a certain period of time. Redemption is not available in all states.
The redemption period varies by state (generally a year, though Rhode Island grants a three year period), as do related conditions. For example, in Missouri, a borrower must give notice within 20 days of the sale that it intends to pursue redemption, as well as give a redemption bond.
Again, a borrower may lose or not be eligible for a right of redemption, or have its redemption period shortened, under certain circumstances, such as (1) failing to give possession of the property to the new owner within a certain period, (2) abandoning the property, or (3) owing more than a certain percentage of the original loan amount at the time of judgment.
Setting Aside a Foreclosure Sale
In a judicial foreclosure, other than the methods listed above to object to the sale, the only ways to set aside the sale is by either appealing the court’s decision, filing a motion to reopen the case, or filing a new lawsuit to overturn the sale. The procedural requirements, including how quickly any of these actions must be taken, vary from state to state.
In a non-judicial foreclosure, there are two options: (1) if the state requires a court to confirm the sale, then the borrower may be able to object to the sale in the confirmation proceeding, or (2) bring a separate action to challenge the sale’s validity. Again state law governs procedures and time requirements.
Clearly while the concept of foreclosure is straight forward, the path to its end can be complex. However, given that the rules for foreclosure are generally explicit and detailed under each state’s statutes, if a party has an experienced real estate attorney familiar with the process, the path can become much clearer.
If you’ve seen a foreclosure action, successful or not, or if you have any comments or questions, please let us know in the section below.