What Does It Mean to Receive a Notice of Default?
A notice of default is the first step to a bank or mortgage lender's foreclosure process. In some states, the notice of default is also attached to the home, generally on the front window or door. It states that the borrower is behind on mortgage payments and the bank is in the process of rectifying the situation. If the mortgage is not paid up to date, the lender will seize the home.
A notice of default is also known as a reinstatement period, notice of public auction, or notice of foreclosure.
Federal Laws Regulating Foreclosure
It used to be that a lender could file a notice of default at its own discretion, but federal laws since the 2008 crisis have ensured that banks provide enough time and make thorough communication efforts before beginning the foreclosure process. This means that, in most cases, banks must reach out and offer help by the time a borrower is 45 days late on their payment. Foreclosures cannot begin in earnest before a borrower is more than 120 days delinquent.
Extended Steps for California Notice of Default
Some states have more specific laws. In California, for instance, lenders must contact a delinquent borrower at least 30 days before issuing a notice of default. This means there must be an official warning from the bank 30 days before the foreclosure process begins.
Once the bank issues a notice of default in California, the borrower has three months to catch up on all payments. If a borrower has equity, sometimes the smart thing to do is put the home on the market and try to find a buyer. If the borrower finds a buyer who happens to be an investor, the buyer must comply with the Home Equity Sales Act to meet the standards of care in place. These protect a homeowner when occupying a home in default and give them the right to dissolve the sale within a certain time period.
After 90 days have passed, the lender is required to publish a notice for 20 days, during which time the only way a homeowner can stop the foreclosure is to completely pay off the mortgage. After those 20 days, the lender may sell the property to the highest acceptable bidder on the courthouse steps.
If no acceptable bid is received, the trustee then conveys the property to the lender. Sometimes lenders make the opening bid so high that nobody will bid on the home. Some industry insiders speculate that this allows the lender to retain the foreclosed home in its inventory on the books at its original value for accounting purposes—a move that tends to protect the bank's stock value.
Notice of Default and the Short Sale
Federal law also now prohibits dual tracking, or the process of moving toward foreclosure while a homeowner is also pursuing short sale or other loss mitigation options. An application for a short sale or another type of loan modification pauses the foreclosure process until the application is reviewed. California and other states have even more restrictive rules for dual tracking.
While a lender always retained the option to stop a foreclosure action, it wasn't required to do so. In fact, some investors, especially before the housing crisis, routinely proceeded with the foreclosure if it was the fastest option and likely to produce more money than a short sale. The Pooling and Servicing Agreement for some conventional loans also contained financial incentives that encouraged foreclosures over short sales.
If you are at risk of defaulting on your loan, the best thing you can do is communicate with your lender early and often. Good communication will help you explore other options besides foreclosure.
The Bottom Line
No one should be surprised by a notice of default. It may be the official start of the foreclosure process, but it shouldn't come until you're well behind on your loan and your lender has made several attempts to reach you. Federal and state laws protect borrowers from being blindsided by these notices. If you're at risk of default, be sure you know your rights and get in touch with your lender.