Foreclosure

Foreclosure is the legal process by which a bank or other secured creditor either sells or repossesses a parcel of real property, home or land after the owner has failed to comply with the mortgage or deed of trust agreement with the lender. Most frequently, the violation of the mortgage agreement is the default of payment. The completion of the foreclosure process allows the lender to sell the property and keep the proceeds to pay off the mortgage as well as any legal costs. The length of the foreclosure process varies from state to state.

If the foreclosed property is sold for less than the remaining primary mortgage balance, and there is no insurance to cover the loss, the court overseeing the foreclosure process may enter a deficiency judgment against the borrower. Deficiency judgments can be used to place a lien on the borrower’s other personal property, obligating the borrower to repay the difference or suffer the loss of one’s property. It gives the lender a legal right to collect the remainder of debt out of the borrower’s other existing assets. 

However, there are exceptions to this rule. If the mortgage is classified as “non-recourse debt,” then in the event of foreclosure the borrower has no personal liability. This is often the case with residential mortgages. If so, the lender may not go after the borrower’s personal assets to recoup additional loss. The lender’s ability to pursue a deficiency judgment can be restricted by state laws. In California and some other states, original mortgages (the ones taken out at the time of purchase) are typically non-recourse loans; however, refinanced loans and home equity lines of credit are not. If the lender chooses not to pursue deficiency judgment—or can’t, because the mortgage is non-recourse—and writes off the loss, the borrower may have to pay income taxes on the un-repaid amount even if it can be considered “forgiven debt.”

Any other loans taken out against the property being foreclosed (second mortgages, home equity lines of credit) are “wiped out” by foreclosure (in the sense that they are no longer attached to the property), but the borrower is still obligated to pay them off if they are not paid out of the foreclosure auction’s proceeds.

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