Foreclosure is the legal process of the mortgage holder taking the collateral for a promissory note in default. The process is slightly different from state to state, but there are basically two types of foreclosure: judicial and nonjudicial. In mortgage states, judicial foreclosure is used most often, whereas in deed of trust states, nonjudicial (called power of sale) foreclosure is used. Most states permit both types of proceedings, but it is common practice in most states to exclusively use one method or the other. A complete state-by-state list of foreclosure proceedings can be found in Appendix B.

Judicial Foreclosure

Judicial foreclosure is a lawsuit that the lender (mortgagee) brings against the borrower (mortgagor) to force the sale of the property. About one-third of the states use judicial foreclosure. Like all lawsuits, a judicial foreclosure starts with a summons (a legal notice of the lawsuit) served on the borrower and any other parties with inferior rights in the property. (Remember, all junior liens, including ten ancies, are wiped out by the foreclosure, so they all need to be given legal notice of the proceeding.) If the borrower does not file an answer to the lawsuit, the lender gets a judgment by default. A person is then appointed by the court to compute the total amount due including interest and attorney’s fees.

The lender then must advertise a notice of sale in the newspaper for several weeks. If the total amount due is not paid by the sale date, a public sale is held on the courthouse steps. The entire process can take as little as a few months to a year depending on your state and the volume of court cases in your county. The sale is conducted like an auction, in that the property goes to the highest bidder. Unless there is significant equity in the property, the only bidder at the sale will be a representative of the lender.

The lender can bid up to the amount it is owed, without having to actually come out of pocket with cash to purchase the property. Once the lender has ownership of the property, it will try to sell it through a real estate agent. If the proceeds from the sale are insufficient to satisfy the amount owed to the lender, the lender may be entitled to a deficiency judgment against the borrower and anyone else who guaranteed the loan. Some states prohibit a lender from obtaining a deficiency judgment against a borrower (applies only to owner-occupied, not investor properties). In practice, few lenders seek a deficiency judgment against the borrower.

Nonjudicial Foreclosure

A majority of the states permit a lender to foreclose without a lawsuit, using what is commonly called a “power of sale.” Upon default of the borrower, the lender simply files a notice of default and a notice of sale that is published in the newspaper. The entire process generally takes about 90 days. Strict

Foreclosure

Two states—New Hampshire and Connecticut—permit strict foreclosure, which does not require a sale. When the court proceeding is started, the borrower has a certain amount of time to pay what is owed. Once that date has passed, title reverts to the lender without the need for a sale. Key Points • A mortgage is actually two things—a note and a security instrument. • Some states use a deed of trust as a security instrument. • Liens are prioritized by recording date. • Foreclosure processes differ from state to state.