When a borrower stops paying, foreclosure is not the first step. It's usually the last. Most of the work happens long before that, and most loans that fall behind get worked out.
This is the question I get most from lenders. Here's how it plays out.
Step 1: The first missed payment
The servicer sends a late notice and reaches out to the borrower. Most late payments are just that: late. A job change, a medical bill, a bad month. Many borrowers catch up on their own within a few weeks.
Step 2: Find out what happened
If the borrower stays behind, the goal is to talk with them. What changed? Can they still afford the home? Do they want to keep it? The answers decide what comes next.
Step 3: Work it out
Most of the time, there's a path that works for both sides:
- A payment plan to catch up the missed amount over a few months.
- A loan change, like a new payment or a longer term, if their income changed for good.
- A short pause in payments, called forbearance, for a temporary problem.
- A graceful exit, like selling the home, or handing over the deed instead of going through foreclosure.
A borrower who keeps paying is worth far more than a foreclosure. That's why the workout comes first.
Free lender guide: 5 questions to ask before you lend to anyone, plus a 12-item document checklist.
Step 4: Foreclosure, if nothing else works
If the borrower can't or won't work anything out, foreclosure is the backstop. For most homeowners living in the home, federal rules generally say a servicer can't start foreclosure until the loan is more than 120 days behind. After that, the timeline depends on the state. Here's why judicial and non-judicial states are so different.
Step 5: After the sale
At the foreclosure sale, someone buys the home, or the note holder takes it back. If the note holder takes it, the home gets sold, and that money pays back what's owed. This is where the cushion between the loan and the home's value matters most.
What it means for a lender
If you lend to a note investor, the homeowner falling behind doesn't change what you're owed. Your loan is to the note investor. But it's still worth asking how they handle defaults:
- Who talks to the borrower, and how fast?
- What workouts do they offer?
- Who pays the legal costs if it goes to foreclosure?
- How big is the cushion, and does it cover a long timeline?
See how I check every deal in my due diligence checklist, and how a collateral assignment ties your loan to the note.
Common questions
How long after a missed payment can foreclosure start?
For most homeowners living in the home, federal servicing rules generally require the loan to be more than 120 days behind before the first foreclosure filing. State rules then decide how long the rest takes.
Do most late borrowers end up in foreclosure?
No. Many catch up on their own, and many more work out a payment plan or loan change. Foreclosure is the last option, not the plan.
What is a deed in lieu of foreclosure?
The borrower signs the home over to the note holder instead of going through foreclosure. It's usually faster and cheaper for both sides, and easier on the borrower's credit than a foreclosure.
Written by Larry Hoffman
Managing Member of LJH Investments, LLC in Madison, Indiana. In real estate since 2006, with 300+ mortgage notes bought. Author of Mailbox Money Retirement.
General education, not legal, tax, or investment advice. Talk with your own attorney and tax adviser about your situation. All investing has risk, including loss of principal.