What Is a Foreclosure and How Does It Work?

If you’re facing a foreclosure, hear this: It’s going to be okay. The process can be a long and hard road, but you will be okay. Let’s face the facts, one at a time, so you can see clear answers to what a foreclosure is and how it works—before, during and after.

What’s a Foreclosure?
How Many Mortgage Payments Can I Miss Before Foreclosure?
How Long Does a Foreclosure Stay on My Credit?
What Is the Foreclosure Moratorium?
How Does a Foreclosure Work?
How Do I Avoid a Foreclosure?
How Do I Move On After a Foreclosure?

A foreclosure is a legal process that begins when a homeowner has stopped paying (or defaulted on) their mortgage. To recover the balance of the home loan, the lender may force the sale or auction the property. 

A foreclosure can happen if you stop making payments on your home, property or timeshare. Don’t worry, most lenders won’t start the foreclosure process after one missed payment (though they can)—usually you’re looking at three to six months of missed payments. Still, one missed payment is a break in your mortgage agreement—and can mean late fees. And if you keep missing payment after payment, your lender could start the legal process of taking back their property.

Remember, if you have a mortgage, your home is technically still owned by the bank or mortgage lender—which means they have the right to take it back if you aren’t paying them. That’s why it’s so important to keep in contact with your lender if you think you’ll miss a payment. There are options out there to help you lower your payment, especially if you have a serious reason you’re having trouble making your payments (like losing your job). Communication is key.

We’re not pro-credit scores around here, but you need to know everything that happens in foreclosure—including what happens to your credit. A foreclosure (paired with those missed mortgage payments) can tank your credit score in no time flat. In most cases, your credit report will reflect your foreclosure for up to seven years after you miss your first loan payment.¹ Once seven years have passed, the foreclosure should fall off your report on its own. If not, you should contact your reporting agency and file a dispute.  

COVID-19 brought many challenges (understatement of the year right there)—one being that it was suddenly much harder for lots of people to make their mortgage or rent payments. So, individual mortgage program providers set up the foreclosure moratorium or mortgage moratorium to protect homeowners affected by the pandemic from losing their house—even if they couldn’t make payments.

The foreclosure moratorium applies only to federally backed mortgage program providers like Fannie Mae, Freddie Mac, HUD/FHA, VA and USDA.² But some private mortgage lenders and individual states might also have their own mortgage relief options in place. Keep in mind, a ban on foreclosures can’t last forever. Homeowners will eventually have to make back payments or face foreclosure when this relief effort comes to an end.  

Okay, none of this will sound pretty, but let’s talk about what happens in a foreclosure. Remember, this process could be a little different based on the state you live in and and the type of foreclosure you’re going through.

There are three types of foreclosures:

• Judicial: This type of foreclosure goes through the court system (and is one of the most common types of foreclosure).

• Power of sale (nonjudicial): Your lender can put the home up for auction without the oversight of the judicial system.

• Strict: The property goes back to the lender after a court-ordered time period. In strict cases, the home is usually worth less than what’s owed on it.³

Again, everyone’s circumstances and the rules in each state are a little different, but foreclosures often happen in these five stages:

1. You miss a few payments.

Of course, you never expected to miss a payment when you first held the keys to your new home. But it happens. There are a lot of reasons for a missed payment: forgetfulness, job loss or loss of income, divorce, death of a loved one, higher interest rates, and other bills that keep piling up.

Get help with your money questions. Talk to a Financial Coach today!

Whatever the reason, a few missed mortgage payments can bring on a foreclosure. If you’ve had a life event that impacts your payments, the best thing to do is contact your lender and let them know immediately. They might be willing to give you grace for a few months or work out a different payment plan until you can catch up on your payments.

2. Your lender submits a notice of default.

When you’re behind on your payments for at least three to six months, your lender will submit a notice of default to the county recorder’s office—meaning they’ll turn in a document saying you’ve broken your mortgage contract to pay your agreed amount each payment cycle. Before this happens, they’ll send quite a few letters to you asking for payment. And when they submit the notice of default, they’ll send you a certified letter with the form too. In other words, it won’t be a surprise.

This step is the official start of the foreclosure process. But listen, if you’ve just received a certified letter like this, it’s not too late! Often your lender will give you three months to get caught up and reestablish the home loan. So, contact them! Let them know how much you can put toward the loan and when, and you might be able to get back on track and avoid the rest of this process.  

3. Your home goes to the pre-foreclosure stage.

Once your lender or bank has submitted their notice of default to the county recorder, your property is now in what’s called the pre-foreclosure stage. In this stage, you have about three months (sometimes longer) to get your mortgage back on track. At this point, you have a few options:

• Catch up on your payments (if you can)
• Try to sell your house in a short sale
• Sign the home over to your lender with a “deed in lieu of foreclosure”

A short sale is similar to a regular home sale—except you’re trying to sell it as fast as you can at a lower price to beat the foreclosure. The name short sale comes from the fact that the price the house will go for will be short of the mortgage balance. The lender will have to approve going this route, but it’s often the best option for you and the lender.

If you’re looking at a short sale, you need an expert real estate agent to walk you through and help you find the right buyers. To find an agent we trust, try our Endorsed Local Providers (ELP) program.

If you can’t sell in a short sale, you might decide to give the deed of your home back to the lender with a “deed in lieu of foreclosure.” With this option, you’re basically giving up the house (and the mortgage), which lets your bank skip the long—and expensive—process of a foreclosure.

4. Your lender takes the home to auction.

What happens if lender gives the big N-O to a short sale or if no one buys your house in the short sale? Your lender will appoint a trustee to the property to take it to auction. This person will start the bid at the amount left on the balance of your mortgage, and the sale usually goes to the highest bid.

Okay, so in some states, even if the property goes to auction, you as the homeowner still have the right to try to purchase the home. Here’s the deal though: You’d have to pay the balance (and interest) plus anything your bank spent going through this process. And another lender probably isn’t going to risk taking you on at this point.

P.S. Ever wondered why you have to pay private mortgage insurance (PMI) if you put less than 20% down on your house? It’s for a situation like this. If you stop making payments, PMI protects your lender (not you) so they don’t lose money on the house if it goes to a foreclosure auction.

5. If the house doesn’t sell, it becomes a real estate owned property.

Let’s talk about what happens if the house doesn’t sell at auction: The property becomes the full responsibility of the bank or mortgage company. Taxes and all. At this point, the bank is very motivated to sell the property and get it off their hands (and their bottom line). If you’re still in the home, your lender will want you out as soon as possible. It’s time to move, but please keep reading. There is hope.

We’ve said this a couple times, but it’s worth calling out once more: Talk to your lender. If you’re worried about making payments, if you’ve missed a couple, if you’re already down this foreclosure path, talk to your lender. Yes, this is stressful and scary, and you might be embarrassed, but ignoring what’s happening won’t help anything. You may be able to avoid the full foreclosure process if you open up a clear line of communication with your lender. So, take a deep breath, and reach out as soon as possible.

If you just walked through the long and hard process of foreclosure, there’s light at the end of the tunnel. It may not seem like it now, but—like we said before—you can get through this.

Here’s how:

1. Find a new place to call home.

Yes, your house is gone. But finding a new home is your new priority. You’re probably looking at rentals right now. Most apartments and landlords will want to see proof that you’ve been making your payments in full and on time. They’ll also do a credit check.

It’s possible the foreclosure hasn’t hit your credit report yet. But no matter what, it’s important to be honest about your circumstances. Show your future landlords your proof of income, and let them know that you’re good for the monthly rent.

2. Take inventory.

Once you’ve got a new place to live, it’s time to look around you and give your situation a good, hard look. This won’t be easy, but it’s how you’ll move forward—up and away from this painful situation. Because listen: You don’t have to live through this ever again. But you can’t ignore what happened or why.

If you lost a job or had a financial emergency that wiped out your finances, we are so sorry. If the foreclosure came after a series of financial missteps, you don’t have to be ashamed. We all make mistakes, and you can get past this.

And guess what? You don’t have to go it alone. Reach out to a trustworthy financial coach to help you navigate what happened and how to rise above. No judgement. Just guidance.

3. Rebuild your life.

While you’re on the road toward healing, it’s time to start rebuilding your finances. Your FICO score might say one thing, but your worth and your life don’t revolve around a number. Read that again: Your worth and your life don’t revolve around a number.

As you begin rebuilding your finances, stay far away from credit. Debt did nothing for you in the past. Run away—and stay away. The goal is to get to a point where you don’t need to borrow from anyone else ever again.

We have a plan that will help you dig yourself out of debt and build security—for right now and far into the future. It’s called the 7 Baby Steps:

1. Save $1,000 for your starter emergency fund.
2. Pay off all debt (except the house) using the debt snowball.
3. Save 3–6 months of expenses in a fully funded emergency fund.
4. Invest 15% of your household income in retirement.
5. Save for your children’s college fund.
6. Pay off your home early.
7. Build wealth and give.

Okay, that probably seems like a lot to take in. Yes, it’s just seven steps, but how do you really jump in and start making them happen? Financial Peace University (FPU) breaks it all down into manageable, clear steps (without all the financial blah blah blah). In this nine-lesson course, you'll learn exactly how to pay off your debt, save for emergencies, and build wealth—so you never have to worry about a possible foreclosure in your future.

Listen, you will turn your life around. Foreclosure is horrible, but it doesn’t define you. Every day you take another step away from it. Don’t. Stop. Walking. Get started with FPU today!