While the number of new mortgages boomed between 2000 and 2003, foreclosure rates also hit record highs. Conditions have improved somewhat since mid-2003: over the last two years the foreclosure rate has flattened. The delinquency rate has also improved slightly with the number of delinquent loans hovering near 4.4%, down from highs of almost 4.8% a couple of years ago.

Yet more homes are being foreclosed upon than ever before. Why? While the foreclosure rate has remained fairly static, the rate of home ownership in the United States has continued to increase. In effect, the percentage rate has remained flat, but the total number of homes in foreclosure has risen due to increased home ownership. More homes are owned – and more homes are being foreclosed upon.

Experts predict the trend will continue. Home ownership is at record levels and interest rates have remained at historically low levels for a number of years. In addition, over 150 different types of mortgage loans now exist, allowing purchases by consumers who would not have previously been able to qualify for a home loan. Buyers enjoy zero-down mortgages, no-documentation loans, 106% loans to allow for no-cash closings, and even 40-year mortgages. Looser lending standards contribute to high foreclosure rates because owners with no equity in their homes find it easier to simply walk away from their mortgages. And if interest rates rise, many of the ever-increasing number of homeowners with ARMs may be unable to obtain suitable replacement financing or to meet the new, larger monthly payments required when the initial ARM term expires.

Studies show that a loan’s default risk is directly tied to the size of the down payment: the lower the down payment, the greater the likelihood of default. Even in cases where down payments were made, low interest rates have encouraged growth of home equity loan advances and cash-out refinancing, allowing homeowners to take out cash generated from down payments and from appreciation. The Census Bureau estimates that in 2004 approximately $569 billion in home equity was extracted through refinancing, taking out second mortgages, or simply pulling out cash during a move. The less equity that remains in a home the higher the likelihood of default, and with cash-out extractions continuing to rise, more and more homeowners are at risk.

Liberal lending standards have also led some consumers to borrow more than they can afford: the Census Bureau recently released statistics showing that the average household spends almost a third of their income on housing costs, up from about 20% in 2000. As a result, financial difficulties like the loss of a job, unexpected medical costs, or other emergencies quickly put a homeowner’s mortgage in jeopardy. Rising consumer debt burden means almost any disruption in financial circumstances like lost income, illness, or divorce can seriously impact a homeowner’s ability to make payments.

What’s the result? When interest rates rise, foreclosure rates will rise. And if the real estate market flattens or dips, homeowners with ARMS or interest-only may find themselves upside-down on their mortgages… with foreclosure their only real alternative.

The Foreclosure Process

The foreclosure process isn’t as mysterious as it may seem. “Foreclosure” is the term used to describe the process by which a property on which a borrower has not paid is sold to satisfy a loan against the property.

Due to federal and state laws, lenders must follow a specific process in order to foreclose on a property. Understanding the process will help you.

First, you’ll need to understand when a lender is allowed to foreclose. The process starts with the mortgage itself. A mortgage creates five covenants:

1. The homeowner promises to pay the principal mortgage debt

2. The homeowner will insure the building against fire or damage to help protect the bank’s interest in the property

3. The building or dwelling cannot be demolished or removed without the consent of the bank

4. The entire principal will become due in the event of default of payment of principal, interest, taxes, or assessments

5. The bank will consent to the appointment of a receiver in the event of foreclosure

The first three items are agreements the homeowner must adhere to. If those covenants are breached, the bank must pursue numbers 4 and 5. (Why the word “must”? Because banks are really “trust officers”: they aren’t loaning their own money, they’re loaning money that belongs to depositors. They don’t have the right to take risks with other people’s money, so they have to follow these covenants.)

The last two covenants give the bank the means to foreclose. One provides for the appointment of a receiver – typically a lawyer – who conducts the sale of the property. The other allows the bank to accelerate payments and ask for the entire balance. If the bank’s lawyers take a homeowner to court they want all of the money, and if it can’t be paid they want a judgment against the homeowner. Simply put: they want out of the deal because the homeowner has not lived up to his or her obligations.

It’s important to note that until a judgment has been obtained the homeowner is not truly under threat of foreclosure. Once the judgment is obtained the homeowner can be put out of the property immediately.

After a judgment has been handed down against the homeowner, a time is set for the public sale of the property at auction. If the homeowner can’t come up with the entire amount of the judgment award before the sale… that’s it: no more delays, no more compromises ― the sale will be held. Often these sales are held at the courthouse, and in many cases are actually held on the courthouse steps.

The court then appoints a receiver – again, typically a lawyer – to conduct the sale of the homeowner’s property. Ordinarily, real property can’t be transferred without both parties in the purchase agreement signing the transfer deed. Since the homeowner is unlikely to voluntarily sign away his or her home, the receiver has the legal authority to sign a valid deed transferring the ownership to a new purchaser.

Let’s look briefly at the stages of foreclosure. To make it simple, we’ll pretend you’re a homeowner facing financial difficulties.

If you’ve missed a payment, you’re normally sent a letter documenting the missed payment and requesting immediate payment of the past-due amount. Once you’ve missed several payments, you’ll be sent a letter from the bank’s lawyer. Receiving a letter from the lawyer means you’re in trouble; you haven’t just committed an oversight the bank wants corrected but are now considered a serious “problem debtor.” When you hear from the lawyer, it means the bank has committed resources (time and money) to getting you to pay on time – so they’re serious.

If you can’t reach an agreement with the lawyer you’ll be served with a summons. (The lawyer has very little reason to negotiate, so normally the only “agreement” you’ll be able to reach is that you’ll make your loan payments on time… starting immediately.) After “service,” which is the process by which you’re physically presented with the summons, the attorney will also file papers with the county courthouse. All other individuals with claims against the property ― they’re called “junior” obligations ― like second mortgages, judgments, or other liens, are served with papers so they have the right to try to protect their interests as well. (It’s important to note that if the foreclosing party is negligent in notifying junior lien holders, those creditors have a valid claim for repayment against the eventual new owner of the property. That’s why purchasing title insurance when buying foreclosure properties is absolutely essential: you protect yourself against subsequent claims you didn’t know about. After all, you don’t want to have to be responsible for a lack of attention to detail by the foreclosing party.)

To enforce money judgments you have to be served personally. That’s one reason foreclosure actions can take so long ― the homeowner(s) must be tracked down and physically handed the summons. Often the homeowners won’t want to be served and will do their best to avoid the server. Each jurisdiction has different laws and rules, but generally speaking if a person can’t be located and all reasonable efforts have been made to find them, a procedure for publication is put into place. This typically consists of a public notice printed in the classified section of the local newspaper.

Most jurisdictions also require public notice whether or not the homeowner has been served. This allows parties with a legitimate claim to come forward to protect their interests.

After the publication process is complete the foreclosure action will proceed. If you can’t come to an agreement with the bank’s lawyer, and can’t come up with the funds to pay off the loan, your property will be sold at a foreclosure auction, and you’ll be evicted from the property ― if you haven’t already left.

The foreclosure process is extremely painful for the homeowner. The legal proceedings can take months to complete. The homeowners are subjected to pressure from banks and lawyers, public notice that their home is in the foreclosure process, and the realization that they will soon lose their home.

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