People sometimes just use the word “foreclosures” and often it can be very confusing! Foreclosures as a general term can mean a lot of different things.
What “foreclosure” actually means will depend on:
1) who bought the property and for what purpose (are they owners who will live there as a primary residence? Investors who rent out a house or condo?)
2) who gave out the loan to the owners (bank, credit union, etc.) and where the loan has ended up
3) what kind of loan the owners took out (is it: a VA Loan, a HUD loan, a owner-occupied bank-owned loan or even an investor commercial loan?)
4) whether or not there are any local (city/county) or state taxes which are past due (overdue tax liens)
We will now review how and why different kinds of mortgages are made; it will be necessary to how they are made so you can see how they go into default and then proceed, eventually, into foreclosure. More importantly, depending on what kind of mortgage the original home buyer had on the property, this will determine where you may find information on the property for sale and what procedure you might follow to eventually bid and buy the foreclosed home.
HOW A MORTGAGE WORKS
When someone buys a home without paying the entire amount in cash upfront, they take on a mortgage with a bank or credit union. Most of the time these are typical home loans which are set up so that they conform to a set of guidelines to make them very similar to one another. The simplest mortgages have a fixed rate (say 5%) over a set time (say 15, 20 or more typically 30 years); these are called Fixed-Rate Mortgages since the rate of interest for the money which is borrowed is the same for the life of the loan. A standard feature of all these mortgage loans is that they all require that the house be put up as collateral (as a guarantee) for paying off the loan. When a new homeowner signs the loan papers to buy the house at a closing, the lending institution demands that he additionally sign a paper stating that he will forfeit his “ownership” to that house to the institution if he cannot or will not pay back what he owes in full.
FIXED-RATE VERSUS ADJUSTABLE-RATE MORTGAGES (ARMs)
Another more recent innovative option for home mortgages are Adjustable-Rate Mortgages (called ARMs). These ARMs work such that the interest rate will often stay the same for a short period of time (3 or 5 years, for example) and then vary annually according to some independent, standardized financial interest rate (such as the Federal Prime Interest Rate). In many cases (and especially during the most recent housing bubble bursting), people bought significantly more house than they really could afford. Loan officers for the banks and mortgage companies would actually tell prospective buyers that this was a good idea since the home that they were buying was certainly going to go up in value (it was foolishly considered a truism that all housing would automatically appreciate no matter what). The theory was that a buyer could buy a more expensive house with interest-only payments (an extreme kind of ARM mortgage) or with a super-low teaser interest rate (like 1 or 2%) for the first few years, then if the owner decided he wanted to keep the house long-term, they would refinance the mortgage (with the home having “increased” in value with a new appraisal) with a normal fixed mortgage that now had an artificially lower loan-to-value ratio. These non-conforming loans can (and during the recent housing bubble, they often were) also be resold and packaged together into risky financial products which hedge funds and investment banks buy and sell.
WHY ARE MORTGAGE LOANS MADE SIMILAR AND WHAT IS A “CONFORMING” LOAN?
The reason for standardizing these home loans is that a large percentage of the loans which banks make to individuals are then repurchased over time from those banks by professional investors, such as other banks, pension funds, the Federal Reserve, hedge funds, brokerage houses– anyone who is seeking to get a long-term reasonable rate of return on their money. What actually happens is that two large quasi-government institutions called Fannie Mae and Freddie Mac set the guidelines (reviewed annually) for what is considered a “conforming” loan and then often repurchase the majority of them as a kind of wholesaler to sell onto these other professional investors. Fannie Mae (officially known as the Federal National Mortgage Association) was setup during the Great Depression to help refresh the pool of money which local banks use to give out new loans. (Freddie Mac, officially known as the Federal Home Loan Mortgage Corporation, was created in 1970 to provide additional money and generate a healthy competition so Fannie Mae would not be a monopoly). These 15- and 30-year single-family owner-occupied home loans, when bundled together with other loans with similar conditions, are lumped together and sold to these other professional investor groups for slightly less than they are theoretically worth, and over time, as the homeowners pay their mortgages off, these investors can realize a steady, reliable return on their money.
Then, the banks take that money they get for selling each individual loan, realize a small profit for doing business, and replenish their amount of money to go ahead and make new additional loans to other people who wish to buy homes. Like George Bailey says in It’s a Wonderful Life when confronted by people of Bedford Falls who are demanding all their money back from his bank, most of the money is not actually sitting in a vault in the bank— it is being “recycled” into new loans for your neighbor’s house or business. The bank is making profits for its shareholders as well as returning “fresh” money into the pool for borrowing to new potential homeowners or businesspeople to expand, etc..