Foreclosure & Alternatives Law

How Do Creditors Get Paid When Foreclosing on a House to Satisfy Unpaid Debts?

Creditors are sometimes involved in foreclosure proceedings when borrowers refuse or are unable to make their monthly payments on an existing loan. Once a foreclosure takes place, the home is then put up for sale, and the proceeds are distributed to the creditors.

What Is a Foreclosure?

A foreclosure is a legal process involving a lender, typically a bank or credit union, and a borrower such as a homeowner with a mortgage. If a mortgage holder misses too many payments, the lender will send notices, demand payment, and begin foreclosure. Foreclosure means that the lender takes ownership of the property in question, as this asset is the collateral in the initial lending agreement. Essentially, if you cannot pay the mortgage on your house, the lender takes the house. Generally, creditors receive the amount of money from the foreclosure sale equal to the borrower's unpaid debt plus any expenses taken on in collecting the debt. It's possible for other creditors to also receive their share of the proceeds. Any remaining proceeds can then go to the debtor.

How Does a Lien Work?

A lien is a legal tool allowing lenders to have some security when taking on borrowers. The borrowers place their property against the loan as collateral. If you fail to make your agreed-upon payments, a lien against the property allows the lender or bank to legally take possession of the property. The lien against the home allows the home to be put up for sale, with the proceeds going toward the borrower's outstanding debt.

How are Unpaid Debts Paid in a Foreclosure?

In most foreclosure proceedings, the creditors are paid in order of priority. First priority is generally the bank, even if a third-party lender or creditor initiated the legal proceedings against the delinquent borrower. The bank holds a lien as a first mortgage to purchase the home and is usually the first priority in the sale proceeds. If the foreclosure is a result of a creditor enforcing a judgment, that creditor may still be second in line behind the first mortgage holder in receiving proceeds from the foreclosure sale. Priority and how creditors are paid in the mortgage foreclosure process varies from state to state. In some states, a creditor may foreclose a mortgage without going to court while in other states it requires a complex court proceeding.

How to Stop a Foreclosure

There are several ways to stop a foreclosure, at least temporarily. Filing bankruptcy won't clear your property of a lien against it, but you may be able to — depending on the timing — eliminate debt. Bankruptcy proceedings halt the foreclosure process for as long as it takes for you to discharge your debts. It is best to consult an attorney specializing in bankruptcy and foreclosure if you are considering bankruptcy to stop foreclosure. You can also try to sell the home before foreclosure proceedings take place. Lenders will usually consider any attractive offers made on the home, so finding a qualified and serious buyer can help you stop foreclosure. Because foreclosure is unattractive to both borrower and the lender, you might also consider working with the lender to renegotiate the terms of your loan. This might help you to catch up on payments and avoid foreclosure.