Financial Dictionary -> Mortgages -> Foreclosure

All types of loan can default. This means that the borrower has broken the terms of the loan (for example failing to make several payments) and is therefore taken through various legal proceedings to ensure the borrower is rightfully compensated.

In regards to a mortgage, which is simply a loan taken out to finance the purchase of a house or property, foreclosure is the legal proceeding which follows after a borrower defaults on the mortgage. There are usually many attempts to help the borrower make repayment before they are taken to court to go through the foreclosure process.

When a borrower takes out a mortgage to fund the purchasing of a house, they give up what is called collateral. This involves the signing over of the outstanding equity in the home (or another home of value) and the forced sale of the property to cover the losses to the lender.

For example Eric takes out a $100,000 loan to purchase a $150,000 house. He pays off $20,000 of the loan, which means he has $70,000 worth of equity in the home. He basically owns $70,000's worth of the home and the rest is still being paid off to the lender. If he defaults on the mortgage at this point, he'll be taken to court, the collateral agreement will be exercised and the home will be auctioned off. The mortgage company will then get the proceeds of this sale (minus what the owner owns and has already paid back; although in some cases they can get the full amount) to cover the outstanding loan and any legal costs. There is usually a certain period of 'redemption' where the mortgage holder can find other means to make the repayments.

In Canada this process is known as Power Of Sale.