In a broad term, foreclosure means the act of forceful sale of a property that was used as collateral against a loan. Foreclosure happens only when the borrower has failed to repay the loan for over six months. It is usually related to any loan taken for building more assets and when a property is mortgaged with a lender to generate financial assistance. Within such an agreement, if the borrower fails to pay the monthly instalments towards the loan for more than six months, the property that is mortgaged, is sold by the lender to recover the outstanding loan amount. Thus, the loan is closed before the agreed term. The SARFAESI Act (Securitisation And Reconstruction of Financial Assets and Enforcement of Security Interest) of 2002 gives the bank the right to this action, without the intervention of the court, and, thus, it is included in the loan agreement. Defaulting borrowers, too, have rights and options to prevent foreclosure (discussed below).
Let us take, for instance, Mr. A, who has taken a particular amount of loan for a term of three years, keeping his house as mortgage. Mr. A diligently pays the loan for the first two years. However, due to recklessness or unforeseen circumstances, he runs into financial loss. In the third year, he is unable to pay his monthly installments. After failing the payments for six months, the lending institute sells off his house to recover the outstanding loan amount. In this case, even though Mr. A paid for first two years, he still has to forgo the house.
Foreclosure and Possession
The meaning of terms foreclosure and possession are different. But often, the term foreclosure is used instead of possession. Foreclosure is actually the initiative by the lending institute to close the loan in the absence of receiving monthly installments, for over six months, towards the loan. The lending institute can then issue a demand notice to the borrower to pay the amount specified in the notice by the date mentioned therein. The notice clearly mentions that in the case of failure to pay the amount stated in the notice, the lending institute can take possession of the property. Usually, the borrower receives two months notice and has to pay within that time frame. At the end of two months and in the absence of payment from the borrower, the authorized official takes the possession of the property. Thus, possession is a part of foreclosure.
Possession can be:
- Physical Possession: the property is physically taken over by the lending institute.
- Symbolic Possession: the lending institute proceeds towards disposal of the property even though the borrower has physical possession. The authorized official conducts a Panchnama, in the presence of two witnesses, and takes possession of such property, to be taken care of and insured until sold or disposed.
Following are the stages of foreclosure:
Stage One: Payments Missed
A borrower can miss payments due to loss of employment, medical expenses, death and such other unanticipated circumstances. Payments may be stopped intentionally, too, if the mortgage on the property is more than the worth of the property, the borrower is tired of managing the property, change of priorities, or any reason due to which the borrower decides not to make the payments. Thus, payment of monthly installments is missed.
Stage Two: Notice Issued
The lending institute sends a formal notice to the borrower about defaulted payments after the payments are missed for three to six months. This notice also warns the borrower that he/she risks losing the property and can be evicted from the premises.
Stage Three: Pre-foreclosure
Along with the notice the borrower is given grace period, usually two to three months, during which he has to make specified payments to the lending institute to continue having rights over the property. The borrower has the right to work out a payment method with the lending institute such as a short sale or payment of outstanding amount owed by the borrower. If the borrower is able to pay off the default, then the foreclosure ends. This avoids home eviction and sale of that property. But, if the borrower cannot pay and has to choose short sale, then it results in a negative credit report against the borrower.
Stage Four: Foreclosure Auction
When the borrower cannot pay the default and the short sale of the property cannot generate the sufficient amount, the property is put for auction. In the auction, the property is sold to the highest bidder who can pay the entire cash amount immediately. In certain cases, the lending institutes agree to accept the amount owed and grant the rest to the borrower from the property auction. Also, if the borrower is able to come up with the outstanding amount, he can stop the foreclosure process, before the property is auctioned.
Stage Five: Post-Foreclosure
If the property cannot be sold during the auction, its ownership rights automatically pass to the lending institute. Such a bank owned property can be sold via a local real estate agent or at a liquidation auction at a later date. Banks cannot hold such properties for over seven years.
Types of Foreclosure
- Judicial Foreclosure:
Judicial foreclosure involves sale or auction of the mortgaged property under the supervision of a court. The proceeds from this sale/ auction go towards the mortgage first, then the lending institute and, finally, to the borrower, if any amount is left. Judicial foreclosure is initiated by the lender, with appropriate and timely notices to all parties involved. It is called the Notice of Default (NOD), which, apart from indicating impending foreclosure, also, gives the borrower a time frame to object to the lenders claim. The borrower can be allowed to plead at a short hearing, in some cases, at the local court. (The lending institute files a civil lawsuit against the borrower with a foreclosure complaint and formal summons.) After the local courts judgment, the Notice of Foreclosure Sale, with date, time and place, is announced. At this stage, too, the borrower can stop foreclosure by paying the outstanding amount. The process takes, more or less, six months in the absence of legal issues.
- Non-Judicial Foreclosure:
Non-judicial foreclosure involves the sale of the property without the supervision of the court. It is done only if the Power of Sale clause is present in the loan contract. Non-judicial foreclosure is quicker and cheaper than judicial closure. It is also different from judicial foreclosure wherein the mortgage holder is the first claimant and the other lenders are second claimants to the proceeds from the sale. Even in the case of non-judicial foreclosure, borrower is issued NOD and granted a period of time to contest the lenders claim or pay the outstanding amount. However, at the end of this time period, the borrower cannot stop the foreclosure process. It can take up to 12 months to complete this foreclosure.
It is advised to consult a foreclosure expert to know which type of foreclosure suits the best to any borrower.
Alternatives to Foreclosure:
- Short sale
- Alternate finance
- Temporary arrangement with the lender
Difference between Real Estate and Foreclosure
Foreclosure is forceful sale of a property that has been mortgaged by a loan borrower, who has defaulted in his/ her monthly installments towards the loan. Foreclosure results in the lending institute recovering its capital according to the loan contract between the borrower and the lender. Real estate involves selling a property for profit. The proceeds belong to the seller and, partly to the agent (if any) as a commission. The property rates are usually high and volatile in the real estate market than the foreclosure sale.
Benefits from Foreclosure sale
- Cost of the property is lesser compared to the properties in the real estate market
- Properties in the foreclosure sale are in the developed localities whereas properties in the real estate might be in developing or under-developed localities
- Properties in the foreclosure sale are verified for their genuineness from legal agencies, reducing the risk of fraud. The genuineness of a real estate property needs to be verified by the buyer, who may not have appropriate funds and resources, increasing the risk of fraud.