When a bank forecloses on a property, it takes possession of the property and forces a sale in an attempt to satisfy the debt. Charge-off of a debt is an accounting procedure where the creditor removes the debt from its operating ledger. A foreclosure and a charge-off may occur in tandem or independent of one another.
Charge-Offs
As the mortgage debt continues to age, the bank becomes less likely to collect the unpaid balance. After a period of time, generally 120-180 days, the bank charges-off the debt so that it does not appear on the balance sheet.
A bank creates a provision for bad debts on the balance sheet each year based on historical performance. When a debt is charged-off it is removed from the bank's receivable accounts and deducted from the provision; if the provision is inadequate, the charge-off becomes a bad debt expense.
Although the debt is removed from the bank's receivables on the balance sheet, the debt is still owed and collectable. The bank may also forward the debtor's account to an outside collection agency to pursue payment.
Foreclosure
If the debt continues to accrue, the bank may pursue foreclosure. The bank initiates the process by sending the debtor an official notice demanding payment of all past-due charges and fees; if payment is not received within a specified period, foreclosure proceedings begin. The bank will present the property for sale at public auction and attempt to sell it for an amount sufficient to satisfy the debt.
Deficiency
Any amount of debt remaining above and beyond the purchase price is known as a deficiency, and is still due and owing from the debtor. The bank may pursue collection activities on the deficiency. If the debtor refuses to satisfy any remaining deficiency, the bank may sue the lender in court to obtain a deficiency judgment.
Statute of Limitations
The statute of limitations specifies how long the lender has to file a lawsuit against the debtor to collect the debt. The lender may continue to pursue collection activity after the statute has expired but no longer pursue legal activity.
State laws specify the statute of limitations for various types of debt. The mortgage debt is subject to the statute of limitations for written contracts; the limit varies by state. Certain states impose a shorter statute of limitations to a deficiency judgment; check your state statute of limitations.
Credit Reporting
A foreclosure may appear as a public record item on the debtor's credit report as well as on the individual mortgage item detail. Alternatively, the individual item may show a charge-off while the foreclosure is reported separately. Both a foreclosure and a charge-off will appear on a credit report for seven years from the date of foreclosure or the last payment date.
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