Foreclosure is a catch-all term for the processes used by mortgage-holders (mortgagees) to take mortgaged property from borrowers (mortgagors) who default on their mortgages. Foreclosure, like mortgages generally, is governed by the law of the place where the mortgaged item is located.
Under 735 Illinois Compiled Statutes 5/15-1203, foreclosure is defined as an action commenced to terminate legal and equitable interests in real estate. The 8th Circuit Court of Appeals case Hiscox Dedicated Corp. Member, Ltd. V. Taylor notes that foreclosure could also simply refer to a foreclosure sale.
Failure to make payments results in the foreclosure of the mortgage. The conditions for entering default vary, based on state law and terms in mortgage agreements. Once a mortgagor enters default, they start to accumulate various fees and charges that are added to their outstanding debt, as determined by the mortgage agreement and state law.
Foreclosure allows the mortgagee to declare that the entire mortgage debt is due and must be paid immediately. The acceleration clause in the mortgage makes this process possible. However, mortgagees do not have to foreclose on mortgages that are in default. They can negotiate with mortgagors. For example, mortgagees might agree to adjust the terms of the mortgage, refinance, allow the mortgagor to sell the property, or allow the mortgagor to make up for their missed payments. In some jurisdictions, borrowers may undo the mortgagees’ invocation of acceleration clauses and avoid foreclosure by making up past-due payments and compensating the mortgagee for some or all the costs associated with the borrower’s default.
There are two types of foreclosure: judicial foreclosures, which requires mortgagees to first get a court order to foreclose on a mortgage, and non-judicial foreclosures, which enables lenders to foreclose property without first getting a court order.
In recent years, lenders frequently bundled groups of mortgages into mortgage-backed securities, and then sold shares of the securities to investors. As a result, some mortgages have many owners. Others have changed hands so many times that it is difficult to determine who owns them. As a result, it is often difficult for mortgagors to modify the terms of their mortgage. Similarly, mortgagees might have trouble proving that they own a mortgage they want to foreclose on.
Most states require mortgagees to sell foreclosed property at public auction. If the property is not sold at auction, the mortgagee keeps it, and later resells it in a regular real estate sale. State laws vary regarding what happens if foreclosed property sells for less than the mortgagor's unpaid debt. In some states, mortgagors are liable for the difference. In others, they are not. In every state, if the property sells for more than the mortgagor's unpaid debt, the mortgagor keeps the difference.
In some states, mortgagors have a right of redemption that allows them to get back foreclosed property. If the original mortgagee owns the property, mortgagors may exercise the right by paying the bank the unpaid balance of their mortgage. If the property was already resold at auction, mortgagors must pay the purchaser whatever they paid for it. Rights of redemption only last for a limited time, which varies by state.
[Last updated in November of 2023 by the Wex Definitions Team]