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What is a Foreclosure?

Updated on December 17, 2009

When you purchase a home using a home loan and cannot keep up with your mortgage repayments to your lender, the lender has the right to foreclose on your home. This often involves the lender auctioning off your house in order to regain some of the initial investment. Through a foreclosure, the homeowner forfeits all rights to the property, and the house in question becomes the property of the lender.

What causes foreclosures?

Foreclosures happen when homeowners can no longer make their mortgage payments. This can be caused by many things, including loss of a job, job transfer to another state, divorce, high or unexpected medical bills, large amounts of debt, violation of the terms of the original loan, and death. Often homeowners suffer from high interest rates on their loans, or have a fundamental misunderstanding of the loan terms. They find they cannot afford their mortgage payments.

Different types of foreclosure

In most US states, there are two different kinds of foreclosures. The lender taking back possession of your property (repossession) as payment for what you owe is called “Strict foreclosure.” Strict foreclosures are usually outlined in the initial contract between the homebuyer and the lender. After a strict foreclosure, the homebuyer does not owe anything to the lender. The lender usually auctions off the house, with a county Sherriff or another officer of the court presiding. Legally, the winner of the auction is not allowed to pay more than you owe on the house. So the lender cannot make a profit on your foreclosure, but rather only reclaim what is owed.

The other type of foreclosure occurs when the homebuyer is notified through a formal legal notice to the homebuyer, called a Notice of Default. This notice generally is issued after three months of payments have gone unmet. The notice contains the lender’s intent to sell the property and terminate the homeowner’s rights. The homeowner will have time between receiving the notice and action on the part of the lender, in which the homeowner can take steps to prevent the foreclosure, such as filing bankruptcy. If the homebuyer takes no action, foreclosure occurs.

How to avoid foreclosure

Foreclosures damage your credit and can haunt your financial life for years to come. In order to avoid foreclosure, do not agree to any loan whose terms you don’t fully understand. If your financial situation changes or you believe you will not be able to make the payments, contact your lender immediately and be honest about your situation. Meet with an HUD-approved counselor to discuss your options.

Image Credit: basicgov, Flickr

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