What is Foreclosure? How Foreclosure Works? Consequences of Foreclosure. A Deficiency Judgment.
How Does a Foreclosute Affect to Your Credit Score.
A Foreclosure is spoken of in hushed tones among buyers and sellers of real estate. Whether we’re talking about an investment property or a personal residence, foreclosure is the “worst-case scenario,” the worst thing that can happen to a property owner.
In a nutshell, if the property owner fails to make mortgage payments, the lender has the right to take the property back. “Foreclosure” is the judicial process of executing this seizure.
Ownership of real estate is transferred by an instrument called a deed. Whoever’s name is on the deed is the owner of the property, regardless of how much they owe on it.
When someone buys property with a mortgage, however, the deed used to transfer title is called a deed of trust. A deed of trust includes a lien, an encumbrance that attaches the property to a loan described in another legal document, the promissory note, which outlines the terms of the loan. The property cannot be sold or transferred without discharging the lien, usually by repaying the loan in full.
If the borrower defaults on the loan—usually by failing to make mortgage payments—the lender can file in the county court for the lien to be discharged by transfer of ownership back to the lender.
Foreclosure can be a lengthy and expensive process for the lender, and borrowers often have many legal remedies to slow or stall a foreclosure. However, if the lender is losing money on the note, it may be the only way for the lender to recoup some of the losses.
Foreclosure is so feared because the consequences for the borrower are dire. Laws vary from county to county, but in general, the following consequences can befall a borrower who loses a property to foreclosure:
●The Borrower Loses Rights to Access or Disposal of the Premises. When the court legally transfers ownership back to the lender, people become trespassers in their own houses. Either immediately or days later, the county sheriff is usually deployed to secure the foreclosed premises.
The sheriff can’t be reasoned with—the court has ruled and his/her hands are tied. Per his/her duty, the sheriff will oversee the removal of any personal property—often dragged to the side of the road. If need be, the sheriff will oversee the forcible removal of any unauthorized persons on the premise—including the former owner.
●The Borrower May Face a Deficiency Judgment if the house sells for less than the balance of the loan and be subject to property attachment or wage garnishment. (More on this below.)
●The Borrower Loses the Right to get a Fannie Mae-conforming loan for 7 years, limiting the borrower’s access to some of the best home financing options.
●The lender may file a 1099 with the IRS in the amount of the foreclosed loan, as if the loan was “forgiven” and this counts as “income” to the borrower, on which the borrower may then owe Federal taxes. Not every lender will do this, but if they do it’s especially brutal—they are essentially taking the home and siccing the IRS on the borrower.
●The borrower’s credit score will be severely damaged, limiting the borrower’s ability to get a new home loan, a credit card, a car loan … potentially even preventing the borrower from renting certain apartments or getting certain jobs. More on this below.
As you can see from this tidal wave of disasters, foreclosure is an outcome to be avoided at all costs.
A deficiency judgment may be issued against a borrower whose property has been foreclosed upon, compounding the damage to the borrower. A lender may be eligible for a deficiency judgment if the foreclosed property sells for an amount lower than the outstanding loan balance.
For example, if the lender forecloses a $200,000 loan and the foreclosed property only sells for $150,000, the lender may be able to get a deficiency judgment against the borrower in the amount of the difference—in this case, $50,000.
The deficiency judgment allows the lender to attempt to recoup the loss by attaching liens to the borrower’s other property (cars, other homes, etc.) or garnishing the borrower’s wages.
NOTE: the lender is only eligible for a deficiency judgment if the loan is full-recourse. This is the case for most home loans and many small commercial loans. However, non-recourse loans prohibit the borrower from recouping losses with deficiency judgments against the borrower.
There are actually many credit scores, compiled by various companies in the business of scoring consumers based on data found in their credit reports. Credit reports in the US are compiled by the companies Experian, Equifax, and TransUnon. Credit reports are detailed, but a credit score attempts to boil the data in the credit report down to a single number.
The best known credit score is promulgated by Fair Isaac & CO (FICO), rating consumers on a maximum scale of 850 in terms of their “creditworthiness”—that is, how risky they are to lend to.
Consumers with a lower FICO score are considered risky borrowers. Lenders may look at that credit score and make the decision to extend less credit, offer a higher interest rate, or decline to lend to them altogether.
Consumers with a high FICO score, on the other hand, most likely have access to large borrowing capacity and the lowest available interest rates.
The FICO credit score is based on the following metrics:
●On-Time Payment History and Derogatory Judgments (35% of the score).
●Credit Utilization, i.e. how “maxed out” your credit lines are (30% of the score).
●Age of Credit History (the older, the better, 15% of the score).
●Number of Accounts (the more, the better, 10% of the score).
●Hard Inquiries, aka how much credit you have applied for recently (10% of the score).
A foreclosure counts as a “derogatory judgement,” which means it falls into one of the biggest chunks of the credit score pie at 35%. Unfortunately, one derogatory judgment can drag this portion of the credit score all the way down from “excellent” to “fair” or worse, and continue to affect that credit score for up to ten years.
A deficiency judgment may result in two derogatory judgments, dragging the score down to the “poor” range. Needless to say, this makes it nearly impossible for the borrower, post-foreclosure, to get cheap credit, and sometimes impossible for them to get any credit at all.