Foreclosure: What it is and how to avoid it

If you fail to make mortgage payments for an extended period, your lender may take control of the property and sell it. For much of this process, known as foreclosure, you'll still have the chance to get caught up on payments or make other arrangements that allow you to keep your home. But, eventually, you may be evicted.

Foreclosure can also cause your credit score to drop more than 100 points, according to FICO, and make it difficult to buy another house. That's why it's important to reach out to your lender proactively if you don't think you'll be able to make timely payments. 

Here, CNBC Select walks through the foreclosure process, including the different types of foreclosure and how to avoid being foreclosed.

There are three main types of foreclosure, depending on where you live and the arrangements made when you signed your mortgage agreement.

Judicial foreclosure

In this form of foreclosure, a lender must sue a borrower who has not made mortgage payments to reclaim the house and sell it. The borrower must be behind on mortgage payments for at least 120 days before a lender can begin the foreclosure process.

All U.S. states have judicial foreclosure as an option, and close to half require it in some situations.

Non-judicial foreclosure

In a non-judicial foreclosure, the mortgage lender can claim its right to a property without a court order. This is only an option in about half of U.S. states — and only if a power-of-sale clause was included in the mortgage or deed of trust. 

Non-judicial foreclosures tend to be a cheaper and faster way for lenders to take hold of a property.

Strict foreclosure

In a strict foreclosure, the borrower doesn't necessarily have to surrender the home. Instead, a judge instructs them to pay the balance of their mortgage by a set date. If they fail to do so, the lender is then given ownership. 

Only Vermont and Connecticut have rules that allow for strict foreclosure, which is used sparingly.   

Foreclosure can take anywhere from a few months to several years, depending on the state and type of proceedings. 

Late payment periods (1-2 months of non-payments)

If you've only missed a couple of mortgage payments, your loan provider will likely give you a call or send a letter to request the funds. Its chief interest is in getting the money, so the lender will likely be willing to work with you on a solution, according to the US Department of Housing and Urban Development (HUD), and may accept a partial payment. 

Demand letter (3 months)

If you've gone 90 days without making payment, your lender may send you a "demand letter," also known as a "notice to accelerate." It's a form that indicates how delinquent you are and gives you another 30 days to bring your account current.

There is still time to work on a solution with your lender or a housing counselor. But if you don't make arrangements, formal foreclosure proceedings may begin.

Notice of default (4 months)

At the end of the additional 30-day period, your lender may file a public notice with a state court indicating you are behind on payments.

Notice of sale 

When a lender is ready to repossess and sell a property, it will send a letter and tape a notice to the front door of the property with details of the sale. The notice may also be publicly advertised in newspapers.

In many cases, this is the last opportunity you'll have to work with your lender to keep your home. 

Date of sale

This is when the home is put up for auction. If it sells for less than what you owe on the mortgage, some states allow the lender to require you to pay the difference.

Redemption period 

Even if your home has been sold at auction, many states will allow you to reclaim it if you can pay the outstanding balance and additional costs incurred during the foreclosure process. The length of this redemption period and its availability vary greatly, according to HUD, and is often tied to whether the foreclosure is judicial or non-judicial.

Check with your state government to find out if it has a redemption period, judicial or non-judicial foreclosures and other information about foreclosure laws. 

Eviction

After the foreclosure sale, your lender must give you at least 90 days to vacate the property.

The best way to head off foreclosure is to address the issue early on.

Talk to your mortgage lender

Reach out to your lender as soon as you know you're having trouble paying your mortgage and see if they're willing to discuss options to avoid foreclosure. 

You can also contact HUD to connect with housing counselors who can advise you about your options.

Mortgage repayment plan

If you've fallen behind on a few payments because of a temporary setback — a job loss or medical emergency, for example — your lender might agree to a structured plan for you to catch up on missed payments. There could be additional fees and interest, however.

If you're delinquent because of other unsecured debts, a debt settlement company could help you broker a deal with your other creditors. (Debt settlement companies can't help with your mortgage since its a secured loan that uses your house as collateral.) National Debt Relief works with customers who owe at least $7,500 in credit card bills, medical bills, personal loans and other unsecured debts.

It received an A+ from the Better Business Bureau and claims that, after factoring in its fee, clients realized savings of nearly 25% on average in 2022.

While it works with all kinds of unsecured debt, Freedom Debt Relief (FDR) specializes in credit card debt, and claims it can reduce your liability by as much as 50%. In business since 2002, FDR has worked with more than a million clients and resolved over $18 billion in unsecured debt.

A forbearance, or temporary pause or reduction in your required payments, can give you time to get your finances in order. You would need to prove you're facing a financial hardship, such as a job loss or major illness, according to the Consumer Financial Protection Bureau.

Most servicers will extend forbearance for up to 12 or 18 months, depending on your circumstances. It can damage your credit score, according to the U.S. Public Interest Research Group, but not as much as foreclosure,

Loan modification

A loan modification changes the terms of your existing mortgage. If your lender agrees, you may be able to pay your loan off in smaller increments over a longer time or even get part of your loan forgiven. 

Partial claim

A partial claim is an interest-free loan from HUD that can be used as a one-time payment to bring your mortgage current and avoid foreclosure. It can be for as much as 30% of your unpaid principal, but you must be between four and 12 months delinquent and prove you have enough income to make monthly payments normally.

In addition, if you want to sell or refinance the property, you'll have to repay the partial claim first.

Deed-in-lieu agreement

In a deed-in-lieu of foreclosure agreement, you transfer ownership of the property to your lender in exchange for forgiving the remainder of the mortgage. This eases your financial burden and enables the lender to get the property without a protracted legal process.

Some borrowers request a deed-in-lieu agreement when a mortgage is underwater, meaning more is owed on the house than it's worth. You will lose any existing equity in the property and you might owe tax on your forgiven loan balance.

Short refinance

In some cases, if you're in default, a lender may allow you to refinance your mortgage loan for a lesser amount. The remaining debt is then forgiven.

Home sale/short sale

Selling your home can be a hard choice, but it protects your credit and saves you from having your home repossessed.

Your lender may allow you to arrange a short sale, in which the borrower sells the house for less than what remains on the mortgage. The lender then accepts the discounted sale price as full payment and forgives the remaining debt.

Foreclosure is the process by which a lender repossesses a property for lack of payment. The best way to avoid foreclosure is to talk to your lender as soon as you know you're falling behind on mortgage payments. There are options to avoid foreclosure, including forbearance, modifying the terms of your loan and selling your house.

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