What Is Foreclosure?

If you stop making payments on your mortgage, the property may go into foreclosure, which is when the lender takes legal ownership of your home. It’s a highly stressful time for you and a costly process for your lender, and everyone involved is better served by working together to take an alternative path.

Key takeaways

• Foreclosure is a multistage process, and the details will depend on where you live.

• There are alternatives to foreclosure that are less damaging to your financial profile and may even allow you to keep your home.

• Having a game plan for dealing with foreclosure and knowing your next steps will help you regain control of your credit and position yourself to eventually buy again.

» MORE: What to do if you can't pay your mortgage

What are the stages of foreclosure?

The exact timeline and processes for foreclosure will vary from state to state, and you can check your state’s laws through the website for the U.S. Department of Housing and Urban Development. You can expect that most lenders will start the foreclosure process about three to six months after your first missed payment.

By the third missed payment you’ll get a “demand letter,” which is a warning to pay a specific amount or make arrangements within 30 days or else the lender will begin foreclosure proceedings. You’ll then be in pre-foreclosure.

What is pre-foreclosure?

When the lender has begun the foreclosure process but you still own your home, this window is known as “pre-foreclosure.”

This early stage is an important opportunity for you to take back control of the situation. According to Terica Lynn Swangin, a HUD-certified housing counselor at Neighborhood Housing Services of Camden in New Jersey, it’s a good idea to talk with a housing counselor even before going to your lender.

“When you’re in foreclosure, it’s an emergency. You’re confused, you’re scared, you’re panicked, and a panicked person should not talk to a servicer,” she says. “You want a housing counselor to help you work through the issue first. What is the problem? What could be solutions for you? You want to create a game plan before you talk to the lender.”

The next steps of the process may depend on where you are and what kind of foreclosure you’re facing.

What are the different types of foreclosures?

In addition to specific laws and norms within your state, the type of foreclosure that’s underway will affect how quickly the process moves and how much time you may have to course-correct.

• Judicial foreclosure: This common kind of foreclosure requires the lender to get approval from a court to file a civil lawsuit against you. If you fail to pay within 30 days of receiving a demand letter, the court or sheriff’s office will try to sell the house at auction.

• Non-judicial foreclosure: Many states allow this type of foreclosure, which empowers the lender to move forward with the public auction itself after an established waiting period.

• Strict foreclosure: In Connecticut and Vermont, a lender can sue you for money owed on the mortgage in a process known as strict foreclosure. If you can’t pay within a specified time, the lender takes over the home, rather than sending it directly to auction.

What is REO foreclosure?

If the home doesn’t get a satisfying offer at auction, the lender or mortgage owner (which can be a bank or a government entity like Fannie Mae, the U.S. Department of Agriculture or HUD) takes possession of the home, making it an REO, or real-estate owned, property. Then this new owner will try to sell the repossessed home to traditional home buyers or real estate investors.

Of course, this happens only if foreclosure moves forward at all. There are other solutions that can satisfy your lender and keep you in a better financial position — and maybe even in your home.

» MORE: How to find and buy REO properties

What are the alternatives to foreclosure?

It’s important to take stock of your situation as early as possible and move quickly to maximize your options for avoiding foreclosure.

• Reinstatement: By paying back what you owe, including interest and fees, you can get caught up and restore the mortgage. This is the most obvious remedy if you can afford to do it.

• Forbearance: If you’ve fallen behind on your mortgage payments for a specific, temporary reason like an illness or a job loss, your lender may allow you to make lower payments (or none at all) for a set term. You’ll still owe that money and interest will accrue, but you’ll have more breathing room and some time to straighten out your financial situation.

• Loan modification: You may be able to work with your lender to change the terms of your mortgage to lower your monthly payments. You’ll have to qualify and the exact terms will be up to the lender, which could include extending the length of your loan, reducing your interest rate or switching to a fixed rate from an adjustable rate.

• Deed-in-lieu of foreclosure: Rather than be forced out by a foreclosure, some homeowners choose to voluntarily surrender ownership to the lender in order to be released from the mortgage debt and have a more flexible exit. You may even qualify for relocation assistance.

• Short sale: This is a last-resort option to avoid foreclosure, as it involves selling the house for less than you owe on the mortgage. You should only consider this option if your lender won’t agree to forbearance or a loan modification.

What happens if my home is foreclosed?

Foreclosure has several implications for your financial health and ability to buy another home.

• You’ll lose your home. Your eviction will be on the lender’s terms, unlike alternative solutions that give you more flexibility and control over your transition. The laws of your state determine how much time you’ll have to stay in your home, but in all cases, the clock starts ticking once ownership transfers.

• You’ll have to wait to get another mortgage. How long you’ll wait depends on what kind of mortgage you had. Typically, it’s two years for a U.S. Department of Veteran's Affairs loan, three years for Federal Housing Administration and U.S. Department of Agriculture loans, and seven years for a Fannie Mae or Freddie Mac loan. However, if you have documented proof that the foreclosure happened because of a qualifying hardship, you might be able to significantly reduce this waiting period.

• It will hurt your financial profile for a time. A foreclosure stays on your credit report for up to seven years.

• You might still owe money. If the home sells at auction but the winning bid doesn’t cover everything that you owe to the lender, you may still be obligated to pay a balance.

• Your credit score will take a hit. Your score could drop by over 100 points.

» MORE: How long does a foreclosure stay on your credit report?

How can I survive foreclosure?

Foreclosure is extremely stressful, but it’s not a life sentence, nor is it totally hopeless. You can take steps to survive and even thrive after a foreclosure.

• Take an alternate path if possible. You can work with a HUD-approved counselor and your lender to explore what alternatives to foreclosure may be best for you.

• Seek out new streams of income. According to Jessica Galindo, a HUD-certified housing counselor at Open Door HousingWorks in Hillsboro, Oregon, counselors can also help clients brainstorm resources to increase their income and get back on their feet.

• Document everything. You could shorten your timeline for getting a new mortgage by years if you can present documentation (such as hospital bills or police reports) that proves you had a qualified reason for defaulting.

• Start rebuilding your credit. Although the foreclosure will stay on your credit history for years, you can strengthen your score by consistently paying your credit card balance on time — or at least making the minimum payment — and using less than 30% of your available credit.

» MORE: How to build your credit score