Foreclosure refers to the legal process by which a lender seizes a property when the owner stops making investment property mortgage payments. Property owners default on a loan due to reasons such as an unexpected job loss, medical emergencies, excessive debt obligation, and unexpected property maintenance expenses. Foreclosed properties are usually put up for auction by the mortgage lender to recover the loan amount.
A Quick Overview of the Foreclosure Process
The foreclosure process varies from one state to another. However, here is what it generally looks like:
- Payment default – Borrowers are in default when they miss at least one mortgage payment. If the payment is not made by the due date, the mortgage lender will send a missed payment notice. After the grace period (usually 15 days), the borrower will be charged a late fee. If the borrower defaults on two payments, the lender will send a demand letter.
- Notice of default – After 90 days of missed payments, a notice of default will be sent to the borrower. At this stage, the loan is transferred to the lender’s foreclosure department. The borrower will then be given an additional 90 days to clear the outstanding payment. This is known as the reinstatement period.
- Notice of trustee’s sale – If payment is not made within 90 days after the notice of default, the mortgage lender will visit the county recorder’s office and record a notice of trustee’s sale. The lender will also be required to place a notice in the local newspaper for at least three weeks before auctioning the property. If the property owner is able to clear the outstanding payments within at least five days before the auction, he or she can stop the foreclosure process.
- Public auction – At this stage, the income property is sold to the highest bidder. Once the sale is over, the borrower’s tenants will usually be given about three days to vacate the rental property.
- Real estate owned property – In case the house fails to sell, it becomes a real estate owned or bank owned property. The lender will then attempt to sell the house on its own, through an REO asset manager or through a broker. To make the offer attractive, lenders usually remove the liens and other costs. Meanwhile, the rental property owner’s tenants will be required to move out of the property.
The foreclosure process is usually a very stressful time for real estate investors. You may have been enjoying positive cash flow before, but dealing with negative cash flow and facing the fact that you may have to lose the investment property that you have worked so hard to acquire can be very painful. Learning how to avoid foreclosure as a real estate investor is therefore very important.
How to Avoid Foreclosure
Here are some strategies to consider for avoiding a foreclosure:
File for bankruptcy
If foreclosure is imminent within the next few days or weeks, you can prevent it right away by filing for bankruptcy. Once you file for bankruptcy, ‘automatic stay’ comes into effect. This stay prohibits lenders from foreclosing on your investment property to recover their investment loan. However, this does not mean that you are off the hook for your debts. Filing for bankruptcy just buys you more time so you can reorganize yourself and make your mortgage payments. However, be sure to consult an attorney first to find out if you are eligible to file for bankruptcy.
Go for a short sale
A short sale can be a very effective method when it comes to how to avoid foreclosure. It occurs when the lender allows a distressed borrower to sell their real estate investment for less than the amount owed. The lender then takes the proceeds of the sale and waives the remaining debt. A short sale is initiated by the property owner when they realize that they cannot catch up with their mortgage payments. Though the process varies from one state to another, these are the steps generally involved:
- Short sale package – The property owner submits a financial package to the lender. This includes copies of financial records and a letter describing the property owner’s hardship.
- Listing – Once the short sale request is accepted, the property owner works with a real estate agent to get the property listed. They will also prepare a sales contract that the lender will need to approve.
- Short sale offer – When an interested buyer makes a good offer, the listing agent sends the lender the buyer’s preapproval letter, an executed purchase agreement, and a copy of the earnest money check.
- Bank processing – The lending institution reviews the offer and either denies or approves the short sale.
Though short sales can be paperwork intensive and lengthy, they are not detrimental to your credit rating as a foreclosure is.
Get a deed in lieu of foreclosure
A deed in lieu of foreclosure is when a property owner surrenders the deed to the house to their lender voluntarily to prevent a foreclosure. In some cases, this strategy could help you avoid clearing the outstanding balance on your mortgage. Getting a deed in lieu of foreclosure is a drastic step that should only be taken when all other options fail. Since the process is conducted privately, it helps property owners avoid the embarrassment of long and public foreclosure proceedings.
Apply for a loan modification
You can prevent a foreclosure by applying for temporary or permanent changes to your loan. Most mortgage lenders find loan modification to be less time-consuming and costly compared to foreclosures. Here are some mortgage modification options to consider:
- Principal reduction – As the name suggests, this involves reducing the principal on loans. Your monthly repayments will then be calculated based on the decreased balance.
- Lower interest rate – The lender can lower your interest rates, thus resulting in reduced monthly payments.
- Extended-term – Also referred to as re-amortization, extended-term means that you will have a longer time to repay your debt.
- Fixed-rate loan – The lender can change your adjustable-rate loan to a fixed-rate mortgage that has a lower interest rate.
- Postponed payments – If you lose your job or have an unexpected medical emergency, you can apply for a temporary pause of mortgage payments.
Government programs such as FHA loans, VA loans, and USDA loans also offer mortgage modification options to their borrowers.
File a lawsuit
Wondering how to avoid foreclosure when your lender is not using a judicial process? You can file a lawsuit against the bank. However, to succeed in your lawsuit, you will need to give the court good reasons why the foreclosure should not happen. For example, you could argue that the foreclosing lender:
- Violated the state mediation requirements
- Cannot prove ownership of the promissory note
- Didn’t act in compliance with the state’s Homeowner Bill of Rights
- Did not adhere to all the steps in the foreclosure process
The downside of this strategy is that lawsuits can be very expensive. If you are not able to prove your case, you will have to pay the bank’s attorneys’ fees and court costs.
When it comes to how to avoid foreclosure, there are several options to consider. Consult a local foreclosure attorney to find out what would be best for your situation. You can also get free expert help from a housing counselor approved by the U.S. Department of Housing and Urban Development (HUD). However, beware of scammers that attempt to take advantage of vulnerable property owners.