9

I know it is a long complicated process, but what is the high level overview of what a bank does when it forecloses on a house? Beyond credit getting hurt, what else?

Where does the bank get it's money? How does PMI play into it? How do the homeowner's taxes change for that year? For the upcoming years? Please let me know from a bank's point of view as well.

5

Foreclosure is at a high level the bank declaring that the debtor cannot pay their promissory note (their debt). This is shortly followed by default, which is the removal of debtors rights to the property. After the debtor has defaulted, he either chooses to voluntarily remove himself and his belongings from the property, or is forcibly evicted. In the US eviction is carried out by local law enforcement, such as the sheriff's office.

The bank is now the sole owner of the property, and proceeds to sell it, in an attempt to recoup their investment. If the bank cannot recoup their investment by selling the house, the rest may be converted to unsecured debt against the debtor. If the bank chooses to forgive the remaining debt, the debtor may have a tax liability for cancellation of debt. Also the debtor may also be liable for any appreciation the house did before it was sold, but this likely to be nontaxable if the house in question is the debtor's primary residence.

They also send the credit bureaus the notice of foreclosure, which is how your credit score is hurt. Private Mortgage Insurance or Lenders Mortgage Insurance will pay the lender some amount back to cover their losses.

See Also:

3

The home owner does not start foreclosure, the bank decides when to foreclose. Therefore you cannot really decide a time to foreclose if you are trying to time the decision.

The process

  1. You miss payments, and the banks will send you a late notice for the missing payments. Expect many notices.

  2. The bank will call you at home, on your cell phone and at work. They will mail you letters regarding the missing payments.

  3. If you continue to miss payments, the bank will probably demand the loan be paid in full. You will owe the bank the full balance of the principle, all past due interest, all past due late charges and junk fees. The bank won't even take a normal monthly payment from you should you try to pay your regular payment again.

  4. Some law enforcement will notify you on the bank's intent to foreclose. The bank has begun legal proceedings.

  5. Legal notices are published in the local newspaper.

  6. Soon the notices and the legal waiting period will expire. Court proceedings happen. The court will then allow the bank to foreclose.

  7. Notices to into the paper again about the updated status of the foreclosure.

  8. The house is sold at auction.

  9. Money from the auction is used to pay taxes owned, then mortgages, then other liens or creditors who file.

Further debt for the home owner

  1. In recourse states, the bank can assign you the difference in what the home sold for and what was owed and try to collect it like any other debt. This amount you owe is called "deficiency".

Taxes

  1. When sold, if the mortgage debt exceeds the home's fair market value, US Federal Tax rules say the selling price as the fair market value.

  2. The fair market value can still be higher than the tax basis (which I think is the value of the house at the time of original purchase plus improvements.). If the fair market value is higher, you will own taxes on sale. However tax rules in the US say if you have owned the home more than two years and make less than $250,000 in the transaction ($500,000 if married) you will not owe any tax. State taxes can be different.

  3. Additionally, if the mortgage lender forgives the debt and doesn't create a deficiency, that income is taxable as well. This is more an more common these days. There are exceptions if the home is your primary residence.

This whole process an take several months to occur, but depends on where you live. If you continue to live in the home after the auction, the new owner must evict you from the property which is another set of legal proceedings.

Your credit and ability to buy are home will be damaged for the next several years.

I am not so sure on how PMI works for the banks, but I know they are getting some money back.

0

PMI (Private Mortgage Insurace) is not part of foreclosure. It is part of the MORTGAGE process.

Say a bank wants a 20% down payment, for a mortgage and you can only put up 5%. You can take out PMI for the 15% difference. The bank will force you to do this every year (usually for lesser amounts) until your house has risen enough in value so that you have 20% equity.

That's because banks want a maximum loan to value (LTV) ratio of 80% (sometimes less, nowadays).

OK, by allowing you to buy a house with skimpy equity, PMI increases the chance of foreclosure.

  • So, when do you supposed they might cash in such a policy? Perhaps during foreclosure? – MrChrister Jun 6 '11 at 6:57
  • @mrchrister: I believe so. At least they get something back from the PMI company for the "missing" equity. – Tom Au Jun 6 '11 at 18:17

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