As a homeowner, you might be surprised to learn that at the foreclosure sale, your own mortgage lender can place a bid (called a credit bid) on your home. Read more to learn about why mortgage lenders do this and what happens at a foreclosure sale.
Written by Natasha Wiebusch, J.D..
Updated July 22, 2021
What happens after your mortgage company decides to foreclose on your home? Well, what the foreclosure process looks like depends on what state you live in, but the end result is always the same if the affected homeowner doesn’t work out an alternative arrangement with their lender: a foreclosure sale. At foreclosure sales, foreclosed homes are auctioned off to the highest bidder.
As a homeowner, you might be surprised to learn that at the foreclosure sale, your own mortgage lender can place a bid (called a credit bid) on your home. Below, we’ll cover why mortgage lenders do this and how it can impact you financially. To understand credit bids, it’s important to know a little bit about how the foreclosure process works…
A mortgage lender will start the foreclosure process if a homeowner defaults on their loan. Under federal law and in most states, default happens when a homeowner hasn’t made their required monthly payments on their mortgage for at least 120 days.
A mortgage lender, sometimes called a secured creditor or secured lender, can start this process because mortgage loans are secured by the house. By securing the mortgage loan with the house, homeowners are giving lenders what's called a security interest in the home, hence the name secured lender.
In the case of a mortgage, a lender's security interest in the home means they can take the home back if the borrower doesn't make the required mortgage payments. In this way, mortgage lenders become the secured lender (or again, secured creditors) of the loan because they lent the money using a loan secured by the home. Secured creditors have what's called a secured creditor's right to the home. That’s what gives them the ability to foreclose on the home.
Generally speaking, the foreclosure process can proceed one of two ways depending on the state the borrower lives in: either through a judicial foreclosure or a non-judicial foreclosure. Some states only allow judicial foreclosures, but most allow both.
Judicial Foreclosure States
In a judicial foreclosure process, lenders have to go to court and get a judge's approval before they can foreclose on the home. This means that the lender has to file a lawsuit against you and notify you of that lawsuit so you have a chance to respond before it can proceed with a foreclosure sale.
States that allow judicial foreclosures only (and do not permit non-judicial foreclosures) include Connecticut, Delaware, Florida, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, New Jersey, New Mexico, New York, North Dakota, Ohio, Pennsylvania, South Carolina, Vermont, and Wisconsin.
Judicial foreclosure is sometimes used in the District of Columbia and Nebraska, and homeowners can request a judicial foreclosure in Oklahoma and South Dakota. Note that judicial foreclosures are sometimes required in states that allow for non-judicial foreclosures as well, usually depending on the terms laid out in a specific mortgage.
Non-Judicial Foreclosure States
Non-judicial closures are different because the lender doesn’t have to go to court to complete the foreclosure process. Generally, in non-judicial foreclosure states, lenders have to mail a notice of default to the homeowner. This notice gives homeowners an opportunity to dispute the default.
Then, the lender will need to accelerate the loan as outlined in the acceleration clause in the mortgage loan agreement. The acceleration clause allows the creditor to demand the full amount left to pay on the mortgage immediately. Once they’ve accelerated the loan, they need to file a foreclosure notice in the land records office, which is usually called the register of deeds.
Once the lender has filed the foreclosure notice with the register of deeds, they can start the sale process. In any foreclosure, lenders need to post a notice of the foreclosure sale on the property and advertise the date and time of the sale in the legal notices section of a newspaper. How long the notice must be posted depends on state law.
At least one state (Alabama) allows the notice to state the sale hours as “the legal hours of sale,” which could be any time between 10 a.m. and 4 p.m. Rules like this are rare because they make it difficult for bidders to know when to show up and generally discourage competitive bidding.
What Happens At A Foreclosure Sale?
At the opening of the foreclosure sale, your mortgage lender may place a credit bid, which is a bid to purchase the house. As a general rule, the lender will open its bidding at 20%–30% of the lender’s equity in the property. Anyone else who wants to bid on the home then has to bid ABOVE the credit bid. Unlike the other bidders, as the secured creditors of the loan, the mortgage company doesn't have to pay cash for their offer as long as its bid doesn't exceed the total amount owed to it. This is why it's called a credit bid or credit bidding.
Credit bidding from lenders is common because as the secured creditors of the mortgage loan, they have a secured claim against the house, which means they have the right to the proceeds of any sale. Ultimately, they want to make sure that if there are other bidders, the purchase price is enough money to pay off the mortgage. By placing a credit bid, the lender not only starts the sale process but also promotes competitive bidding on the home.
Credit bidding is also helpful for lenders because if others aren't bidding, the lender may be able to get a good deal and market the property to make a profit. When the lender does buy the property at a foreclosure sale, it's called REO (Real Estate Owned) property.
Although credit bidding can be a great deal for other bidders and secured creditors alike, some caution credit bidders against doing it without professional legal advice.
What Happens If The Mortgage Lender Doesn’t Make Enough Money From The Sale?
There are some cases wherein the mortgage lender is unable to recover the amount owed on the mortgage loan through the foreclosure sale or by selling REO property. If this scenario applies to your situation, you could be sued for a deficiency judgment.
If the lender wins and obtains a judgment, the resulting post-judgment collections process will proceed like any other lawsuit. Lenders may be able to garnish your wages or put liens on other property you own, like your car, to get the money they’re owed.
Ways To Keep Your Home...
Right Of Redemption
Many states have a right of redemption for a time after the foreclosure sale. Where a right of redemption is available, you can get your house back after the foreclosure sale by paying the full amount owed before the period of allowed redemption expires. How long the right of redemption lasts depends on the state.
Restructuring Your Mortgage
You can also ask your lender to restructure your mortgage. Restructuring a mortgage can help you lower your payments, but it will likely take longer to pay off the mortgage in full. And, how much you can lower your payments will depend on the valuation of the home and the amount of the debt on the original mortgage.
If your home is at risk of foreclosure, you may consider bankruptcy. A bankruptcy case can stop a foreclosure. Through bankruptcy, you can discharge debt from unsecured creditors. But, it's important to be aware that under the Bankruptcy Code, you can't discharge secured debt, which means you can't remove all creditor's liens. So, your lender will still have a secured claim against your home.
There is an exemption under bankruptcy law for a certain amount of equity in a debtor's primary home, but a bankruptcy sale can still occur when the equity in the home exceeds the exemption. In a bankruptcy sale, the trustee can sell your house.
Regardless of whether you live in judicial foreclosure or non-judicial foreclosure state, the foreclosure process will likely end in a foreclosure sale if you don’t make alternative arrangements to address your overdue mortgage balance. It’s normal for your mortgage lender to place a credit bid on a home to start the auction. This helps ensure that bidders don’t bid too low or that the lender can buy the home for a cheap price and make a profit on selling the home as an REO home.
Credit bids from lenders are normal, and sometimes they can help you by stopping bidders from bidding so low that you end up with a large deficiency judgment.