Last editedOct 20212 min read
Foreclosure is the term used to describe the legal process through which a lender recovers an unpaid debt by taking ownership of the asset the original loan was secured with. This generally occurs in the form of a mortgage lender taking ownership of a property that the debtors have failed to keep up payments for, resulting in them defaulting on the debt. The lender then sells the property to recover the unpaid debt.
Foreclosing on an asset held in collateral involves several terms that describe the different elements of the foreclosure process. Here we highlight three of the most important, which are:
The first step in a foreclosure process is the acquisition of the asset that was offered as collateral for the loan. Usually a house being mortgaged serves as the collateral for the mortgage, so if the mortgage payments are defaulted, then the mortgage lender becomes the legal owner of the property and the debtor is evicted.
Once the foreclosed asset becomes the legal possession of the debtor through acquisition, the lender releases the debtor from their payment obligation.
The disposition part of the foreclosure process represents the sale of the asset being foreclosed by the debtor. Once the asset is sold, the debtor removes it from their balance sheet and records the amount gained from the sale. Any profit gained is recorded as a credit, with any loss recorded as a debit.
Impairment is the term used to describe a foreclosed asset that has decreased in value since the loan was first agreed. In such cases the asset must be re-evaluated to discern how much it has decreased in value.
How foreclosure works
Foreclosure is legally allowed because the loan agreement gives the lender the right to take ownership of the asset offered as collateral in case the debtor defaults on the loan repayments.
Foreclosure processes can vary according to the agreement outlined in the loan contract and any local legislation variables, but they usually begin once a debtor misses a minimum of one payment on a loan. A lender will not instigate full foreclosure immediately after just one missed payment, though it can depend on the circumstances of each loan agreement. Usually the lender will send a missed payment notice, followed by a demand letter for the missed payments should another payment be missed. Even at this stage, many lenders are willing to communicate with the debtor to establish how the payments can be repaid and get the loan agreement back on track.
If the debtor continues to miss payments then the lender can send a notice of default after 90 days of missed payments. Then begins the reinstatement period, which is the last chance the debtor has to make the due payments and reinstate the loan agreement.
Continued failure to pay the debt results in the lender instigating foreclosure to recover the debt. The debtor is then evicted from the property and the property is sold, usually via auction.
How to avoid foreclosure
Even after missing payments, it is still possible to avoid foreclosure. One way, as mentioned above, is during the reinstatement period when the debtor can arrange to pay back everything outstanding by a set date. This usually includes all the missed payments plus interest and any penalty fees.
There is also the possibility of short refinance, which means agreeing a new loan amount that is less than the outstanding amount. This is only possible when the lender deems it more cost-effective than the foreclosure proceedings.
If the lender can demonstrate they are in a state of temporary financial hardship, then the lender might also agree to special forbearance where they agree to reduce or suspend payments for an agreed amount of time.
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