Foreclosure in the Real World is Debt Collection
Despite what some courts have held, foreclosure is a form of debt collection in the real world. To put it simply, creditors sell something of yours to pay a debt they claim you owe. This is not, as some legal theory would hold, merely a transference of title back to the “true” owner.
To understand why this is so, you need to know some history and law.
Debt Collectors sometimes threaten to repossess and auction off property that secures a loan unless you pay them, or else they actually repossess and sell off the property, in order to pay the debt. This video and article discuss the way the process works.
What Foreclosure Does
Foreclosure is designed to allow for possession (or repossession) of property that secured an unpaid debt. Most people simply think of foreclosure as “getting kicked out of your house.” And in many situations that is an appropriate understanding. In reality foreclosure addresses ownership rather than possession, however. It involves the termination of at least one person’s ownership in favor of another person. This can, but does not always, lead to eviction.
English Law and the History of Foreclosure and Property Rights
We don’t think of it often, but one of the great inventions of English law was the division of property into different property “interests” or rights that could co-exist in the same property.
The state “owns” physical property in one way. The landowner owns it in another, and the tenant also has certain ownership rights. If the landowner is married, both spouses will have rights in the property, and it is possible to divide the rights up in many other ways, too.
Another form of coexisting rights is the way you could own your home have it subject to a mortgage and also various sorts of liens.
We are primarily interested in the mortgage and liens because these are subject to “foreclosure.”
Most people (including the courts) only think of “purchase-money mortgages” (the mortgage you take out in order to buy your house) when they analyze foreclosure. But people can place liens on your house in other ways, too. The state can for taxes or judgments, to name two examples, and there are others.
All liens can be foreclosed. Mechanically what happens is that the foreclosing party causes the property interests to be divided and paid off. The way that is accomplished is by selling the property and splitting the money up according to the priority of interests.
There is a hierarchy of interests. The money goes to pay off the higher interests before the lower interests get anything. Eventually, if there is enough to pay every creditor with money left over, the property “owner” would get that. Or to put it another way, being the property owner means that you get whatever is left after paying all the other interests off.
You get the “equity.” But usually, if there is not enough to cover all the secured interests, you will owe the secured parties money personally.
Two Examples of Foreclosure
Let’s consider two examples. In the first, Owner A and B each own houses worth $100,000 on the open market. That’s what they would sell for.
Owner A has the following liens against the property: a purchase money mortgage of $35,000, a home equity loan of $10,000, and a mechanic’s lien of $1,000.
$100,000 Value of House
($35,000) Purchase Money Mortgage
($10,000) Home Equity Loan
($ 1,000) Mechanic’s Lien
$54,000 – Equity
Owner B has the following liens against the property (in this order – the order of liens is beyond the scope of this article): a purchase-money mortgage of $110,000 (the house is “underwater” because the loan remaining is more than the house is worth); a home-equity loan of $10,000, and a mechanic’s lien of $1,000.
$100,000 Value of House
($110,000) Purchase Money Mortgage
($ 10,000) Home Equity
($ 1,000) Mechanics lien
($21,000) equity (a negative number)
If neither one can pay off the purchase money mortgage, go into default, and someone forecloses, here’s what happens.
Results of Foreclosure
A loses possession of the house, and all security interests in the property are “extinguished.” The money is enough for the mortgage, so the bank takes that. Because the home was security for the home equity loan and mechanic’s liens, the foreclosure breaches the contract with the lender. It intervenes (legally) in the foreclosure and demands its money and gets it before anything goes to A. Because the lien was “subject” to the other agreements, the money goes to pay the lien before A gets anything.
In B’s situation, the bank gets all the money. The other lenders get nothing, but keep their claims against B. The sale extinguishes their security interests in the property, and chances are good they’ll lose everything they lent.
Why Debt Collectors Often Do Not Foreclose
What if, instead of not paying the bank, A and B had failed to pay the home equity loan? In that situation, the Home Equity lender could foreclose on the loan. Lower level security interests can foreclose on the loan. Any other person with an interest in the property, including the mechanic, might take some action to intervene in order to protect its interests, although in B’s case, especially, this is unlikely. The bank will get all the money, and the home equity lender will get nothing even though it is the one that foreclosed.
This explains why debt collectors rarely foreclose on a house. It will cost them money but get them nothing. But that isn’t to say they couldn’t or that it would never make sense for them to do or threaten to do.