Real Estate Finance: Chapter 13 Loan Defaults & Foreclosures

Intro The basic responsibilities of the parties to real estate financial contract are relatively clear-cut.In exchange for money loaned, a borrower is obligated to repay the loan according to conditions stipulated in the contract and to preserve the value of the collateral and the priority lien position of the lender.In the event the borrower breaches these obligations, the lender can exercise its power of acceleration and insist the loan balance, accrued interest, and costs be paid immediately and in full.In the vast majority of real estate financing arrangements, a comfortable rhythm of lending and repayment is established between the participants, with few unusual circumstances occurring to interrupt the legal relationship between these parties and to cause a breach in the loan agreement.Every lender seeks to make a “good” loan, one that will serve a borrower’s financial needs, while simultaneously providing the lender with a safe and profitable yield on the investment.Financial lenders are bound by law and company policy to display the highest ethical responsibility in granting real estate loans.The extent of their loan underwriting efforts includes an individual consideration of each applicant’s ability and attitude to be qualified for a loan and the estimation of the value of the collateral to be pledged as security.A lender will establish a real estate loan on the basis of availability of funds general economic conditions, local economic stability, and competitive lenders’ actions as well as the borrower’s financial position and the property’s values.The terms and conditions of a particular real estate loan involve many variables that may be assessed objectively and subjectively in order to establish the payment structure and interest rate for a good loan.Except for infrequent periods in our economic history when severe depressions or recessions created serious financial difficulties, a borrower who pledges realty as security for a loan generally enjoys the benefits of a steady inflation in the economy that usually increases the value of the property.At the same time, the balance owed on the loan is being paid down.The interaction between this growth in value and the lessening of the loan balance creates the ultimate protection for the lender against risk.The subtle, slow, and steady increase of an equity position locks the borrower into continued payments on the loan in order to protect the growing the growing investment.Even a borrower on a 100% loan soon develops some measurable equity in the property and a commensurate desire to protect it.The equity position injuries to the advantage of the lender by lowering the incidences of mortgage defaults.Foreclosures in this country historically represent a very low percentage of the total loans.When a real estate loan does fail, it is often the result of events that are beyond the control of the parties to the loan.As always, there are circumstances under which individuals and companies suffer personal or financial setbacks that may jeopardize their ability to maintain normal payment patterns.Some of the more readily recognized problems include loss of employment, illness, divorce, bankruptcy, loss of tenants’ rent as a result of local economic setbacks (overbuilding of income properties), or ordinary mismanagement.Under such conditions, real estate loan payments usually cannot be met, and defaults and foreclosures result.The financial crisis of 2007 & 2008 led to an alarming increasing in the number of foreclosures throughout the country.The resetting of subprime loans was largely blamed for many homeowners’ inability to make their mortgage payments.The Center for Responsible Lending projected that 53.6% of subprime loans would end in foreclosure by 2012 compared to 8.7% of other mortgages.Among the hardest hit states were Nevada, Florida, and California where RealtyTrak,Inc., reported that the foreclosure rate was 6.6 times the national average.Adding to the problem was the fact that tightened lending standards made it difficult for potential buyers of foreclosed properties to obtain mortgage loans.HOPE NOW is an alliance of counselors, servicers, investors, and other market participants to maximize outreach efforts to at-risk homeowners.These homeowners are encouraged to call the HOPE Hotline at 888-995-HOPE to talk to HUD-approved credit counselors to guide them through possible options such as a loan work-out or modification.
Acceleration Clause The clause in a mortgage or trust deed that stipulates the entire debt is due immediately if the mortgagor defaults under the terms of the contract.
*Defaults A default is the breach of one or more of the conditions or terms of a loan agreement.When a default occurs, the acceleration clause contained in all loan contracts is activated, allowing the lender to declare the full amount of the debt immediately due and payable.If the borrower cannot or will not meet this requirement, the lender is empowered to foreclose against the collateral to recover any loss.Although legally any default in a loan contract enables the lender to accelerate the debt, most lenders will seek to avoid foreclosure and arrange a plan with the borrower that will protect the interest of both parties and avoid costly and time-consuming court procedures.However, in an irreconcilable situation between a defaulted borrower and the lender, acceleration and ultimate foreclosure are the lender’s last resort.It is generally accepted that most lenders do not want to own the real estate that is pledged as collateral for their loans.Defaults do occur, even though most lenders will expend every effort to qualify their borrowers in order to ensure the success of their loans.
Delinquencies XXXXX
Principal & Interest The most common form of default delinquency occurs when the payment of principal and interest is not made when due.Most loan agreements stipulate that the regular payment is due “on or before” a specified date, but lenders will allow a reasonable grace period, usually up to 15-days, in which to receive the regular payment.Many loan arrangements include a late payment charge of some specific amount that is applied if the borrower exceeds the grace period.This late payment fee is imposed to encourage promptness and to offset the extra bookkeeping costs that delinquent accounts entail.Most lenders are not disturbed by payments made within grace periods, but they will take remedial action when an account consistently incurs late charges or when a borrower exceeds a 30-day delinquent period.
Grace Period A time period allowed, usually 15-days, for making late payments without a penalty being imposed.
Late Payment Charge Penalty imposed for late payments.
Property Taxes Another frequently encountered default with real estate loans is the nonpayment or late payment of property taxes.In California, borrowers pay a tax service that remains in effect for the life of the loan.The tax service company tracks each property and notifies the lender if the taxes are delinquent.The nonpayment of property taxes is a technical default under a real estate loan.Property taxes represent a priority lien over most existing liens on real estate.If a tax lien is imposed, the lender’s position as priority lien holder is jeopardized.If a lender is unaware of a property tax delinquency and is not protected, the collateral property may be sold for taxes, eliminating the safe lien position.As a consequence, all realty loan agreements include a clause stipulating a borrower’s responsibility to pay property taxes in the amount and on the date required.
Other Liens Defaults may also occur when a borrower allows other liens that have priority over the loan to vest against the collateral property.Such liens might be imposed for nonpayment of federal or state income taxes or city taxes.Under these circumstances, a lender may consider a loan in default and pursue appropriate legal remedies.In California, mechanics’ or materialmen’s are junior in priority to existing encumbrances.In new construction, those liens take priority over a real estate loan that is recorded after start of construction unless the lender posts a bond with the county recorder.
Hazard Insurance Another common cause of default on a real estate loan is the nonpayment of HAZARD INSURANCE premiums required by the lender for the protection of the value of the improvements on the collateral property.The lender is named in the hazard insurance policy as an additional loss payee along with the borrower-property owner.If any losses are incurred by reason of fire, windstorm, or other insurable circumstance, the lender’s collateral position is preserved.The damages are repaired to the lender’s satisfaction, or the insurance proceeds are applied to reduce the balance of the loan to match the reduced value of the collateral.
Poor Property Maintenance Often lenders include a provision in a formal real estate loan agreement that requires a borrower to maintain the collateral property in such a manner that its value will not diminish to the point of disturbing the lender’s security position.A breach of this covenant will create a technical default of the terms of the loan.It is rater difficult to assess the amount of “waste” that would create such a defaulting situation, especially as its discovery would depend upon constant inspection by a lender, an impractical task when many loans are being serviced.Usually a lender will rely upon a borrower’s pride of ownership to protect the collateral, but serious violation can result in a loan default and acceleration of the debt.
*Adjustments Lenders are usually reluctant to proceed with foreclosing on defaulted borrowers, and most will go to great lengths to offset their borrowers’ short-term difficulties. Lenders are actually being directed by various government agencies, such as the FHA and the DVA, to extend to their delinquent borrowers every possible alternative that would prevent a foreclosure action, alternatives that are called workouts.
Workouts The various ways to offset a foreclosure; payment moratoriums, waivers, adjustments.
The Soldier & Sailors Civil Relief Act of 1940 This act protects military personnel and their dependents from the harassment of creditors in cases where their ability to comply with financial obligations has been materially affected by military service.The act limits the power of a creditor to sell, foreclose on, or seize the property of a member of the armed forces for nonpayment without first obtaining a court order.The courts have the right to grant relief to the borrower or make any other disposition of the case that is considered equitable.Perhaps the most powerful provision of the act rests in giving the court the right to suspend the enforcement of any civil obligation again a service person that arose prior to entrance into the military.In all cases the petitioning individual must show that the ability to meet the obligation has been materially affected by military service.
The Housing Act of 1964 Under the 1964 Housing Act, the FHA requires that lenders provide relief in situations in which default is beyond a borrower’s control.A lender might recast or extend the loan of a borrower who has defaulted because of unemployment during a serious illness.The DVA also requires leniency in the case of a borrower who is willing but unable to pay.The DVA itself may pay for such delinquencies in order to keep a loan current for a veteran, although these payment do not reduce the debtor’s obligation.The DVA retains the right to collect these advances at a future date.
Avoiding a Foreclosure A final foreclosure action is studiously avoided whenever possible.Before a lender decides to foreclose, full consideration will be taken of the amount of the borrower’s equity in the property, the general state of the current real estate market, and the positions of any junior lienholders.The lender will also judiciously weigh the circumstances that caused the default and the attitude of the borrower concerning the repair of the breach in the contract.The only time a foreclosure should be considered by the borrower is when the current market value of the collateral property is actually less than the balance of the indebtedness, and the borrower can no longer make the payment that has been adjusted to meet the emergency situation.Even under these extreme circumstances, a borrower should be aware that a foreclosure is not mandatory and that a deed in lieu of foreclosure from the borrower to the lender will end their relationship in an amicable, efficient, and legal manner.The greatest risk to a lender making a real estate loan is that a property pledged as collateral will be abandoned by the borrower.Although the risk is considerably less when unimproved land is the collateral, any improved property left vacant becomes an immediate and irritating source of concern for lender.An abandoned property may well indicate the complete and total frustration that a borrower has experienced in trying to solve the problem.A borrower is logically the first person to know of the trouble and should attempt to solve the problem with the help of the lender.Failing in this attempt, the borrower should seek to sell the property at a profit.If this is not possible because of market conditions, the borrower should try to recover the equity or, at the very least, try to give the property away to someone who will assume the loan.Only when a borrower has made every effort to give the property away and failed and when payments can no longer be made, adjusted or not, should abandonment be considered.At this point frustration may cause a borrower to blindly seek retaliation and perhaps even physically damage the collateral.A knowledgeable lender is aware of the possibility.Even if an abandoned property if left in good condition, a vacant building is often an invitation for vandalism.In some areas, an abandoned property is considered fair game for the stripping of any valuable parts.When investigating their delinquent accounts, many lenders have discovered empty shells of buildings.The wrecking of abandoned properties is often quite vicious, the apparent motivation just plain wanton destructiveness.An abandoned property is anathema to a lender.To perfect a fee in the collateral, quick legal action must be taken to gain immediate possession of the real estate, so that it may be protected during the foreclosing procedure.In the final analysis, most borrowers have more power than they realize and should be able to negotiate with their lenders from positions of strength rather than weakness.And increasingly, lenders ARE making every effort to cooperate and prevent a foreclosure action.These efforts include a variety of adjustment to the terms and conditions of the real estate loan contract to reflect emergency needs.
Moratoriums & Recasting The most common default on real estate loans is delinquent payments.These payment delinquencies can occur because of overextension of credit, loss of job, loss of earnings due to sickness or injury, personal tragedies, and other problems, such as alcoholism and drug-related problems.When a loan become a problem, the person charged with the responsibility for supervising the collection of delinquent accounts will contact the borrower to discover the cause.Most lenders will attempt to cooperate with those borrowers who have legitimate excuses for failing to make payments.Sometimes a lender will waive a portion of the payment, usually the principal amount, to help a delinquent borrower regain financial balance.At other times, the interest portion of the payment is waived as well and added to the balance owed toward the time when the borrower regains financial stability.Frequently, the entire payment is waived for some reasonable length of time.These partial or full payment waivers, described as forbearance or moratoriums, had their origins during the monetary crisis of the Great Depression.A lender expect that during the moratorium period the borrower can solve the problems by securing a new job, selling the property to a buyer qualified to make the loan payments, or finding some other acceptable solution.Granting a moratorium on payments can create peripheral problems for the borrower because these postponed amounts must eventually be paid sometime during the remaining life of the loan.A forbearance arrangement will usually require that a borrower add extra money to the regular payments when they are reinstated.These extra monies will be applied to satisfy the bubble of principal and interest that accrued during the moratorium.For the defaulted borrower just recovering sound economic footing, an increase in payments may present too great an additional burden.In order to offset any possible hardships that these extra payments might create, a lender may choose to extend the term of the loan by a time interval equal to the moratorium period.Then the borrower can continue to make regularly scheduled monthly payments at the same amount but for a longer period of time.Another alternative to increasing the amount of payments upon reinstatement of the loan would be for the lender to require one balloon payment for all the monies accrued during the moratorium, to be payable at the loan’s scheduled expiration date.Delinquent loans can also be recast to lower the payments to suit a borrower’s damaged financial position.When a loan has been paid down over a period of time (5-years), and a default in imminent as a result of a borrower’s financial crisis, the lender may redesign the balance still owed into a new loan extending for the original time period of even longer, if feasible.This recasting would effectively reduce the payments required and relieve the pressure on the borrower.Recasting invariably requires a new title search to discover is any intervening liens or second encumbrances have been recorded.This is especially necessary in the case of a delinquent borrower who might have sought aid from other sources.A lender may also require additional collateral and/or cosigners for the new financing agreement.In a severely depressed market, a new form of recasting has emerged: a mortgage crunch down.This involves the lenders rewriting the loan at a LOWER balance to reflect its loss in value.The lender absorbs the loss, which is estimated to be less than would be incurred in a foreclosure and subsequent sale of the collateral at a substantially reduced price.
Forbearance (Moratoriums)The postponement for a limited time of a portion or all of the payments on a loan in jeopardy of foreclosure.See moratorium.
Moratoriums (Forbearance)A temporary suspension of payments due under a financing agreement in order to help a distressed borrower recover and avoid a default and foreclosure.
Recast A design of an existing loan balance into a new loan for the same period of longer to reduce payments and help a distressed borrower.
Crunch Down Recasting an existing loan to a lower level to avoid a foreclosure.
Voluntary Conveyance of Deed When all efforts at adjusting the terms of a loan to solve a borrower’s problems have failed and the property cannot be sold to a buyer willing and able to assume the loan’s balance, a lender often will seek to secure a voluntary conveyance from the borrower.This action prevents the costly and time-consuming process of foreclosure.By executing either a quitclaim deed or a regular deed, a borrower can eliminate the stigma of a foreclosure suit, maintain a respectable credit rating, and avoid the possibility of a deficiency judgement.On all applications for a new loan, the borrowers are asked if they ever executed a voluntary deed in lieu of foreclosure.A DEED IN LIEU OF FORECLOSURE is a mutual agreement under which the delinquent owner of a property deed it to the lender in return for various considerations, usually a release from liability under the terms of the loan.It can be completed quickly, without the cost of a foreclosure, and the rights of third parties having interests in the property are left undisturbed.The efficiency of this technique for avoiding a foreclosure is sometime offset by it being disallowed if it has been used to avoid the inclusion of the asset in a bankruptcy.It is necessary to verify that the borrower was solvent at the time of the voluntary transfer.Also, as already mentioned, the rights of third parties must be protected; hence, the borrower may still be liable for junior encumbrances not cleared prior to the transfer.Lenders are fully aware of the difficulties with evictions as well as the costs and time involved in full foreclosure process.Most often, a lender encourages a hopelessly defaulted borrower to transfer a deed voluntarily.Nevertheless, a lender must take care to be protected against any future claims of fraud or duress by the borrower.
Voluntary Conveyance Voluntarily signing over to the creditor the property pledged as collateral on a defaulted loan.
*Foreclosures When all else has failed, a lender will pursue legal prerogatives to recover the collateral in order to sell it and recoup the investment.By definition, to foreclose means to shut out, exclude, bar, or deprive one of the right to redeem a mortgage or deed of trust.Foreclosure is not only a process to recover a lender’s collateral but also a procedure whereby a borrower’s rights or redemption are eliminated and all interests in the subject property are removed.A borrower in the 14th-century England had few rights in property beyond possession.If the borrower did not pay on time and in the amount called for, any property rights were immediately forfeited and full ownership vested in the lender.This instantaneous and often capricious deprivation of property rights aroused widespread criticism and eventually was brought before the monarch who assigned the adjudication of these grievances to a court of equity under the jurisdiction of a Lord Chancellor.Certain hardship cases were ruled upon according to their merit, rather than upon legal technicalities, and a system gradually developed wherein a distressed borrower was allowed extra time to raise the funds necessary to protect property rights.This relief was called an equitable redemption period, taking its name from the Lord Chancellor’s court of equity.Under this ruling, a borrower could secure a certain period beyond the the default time in order to redeem property.This could be accomplished either by bringing the payments current or by repaying the total amount of the principal due in addition to interest owed and any court costs incurred.Borrower began to abuse their equitable redemption rights.Some defaulted borrowers remained in possession of their property beyond the redemption period and otherwise created great difficulties for lenders trying to reclaim the forfeited collateral.Complaints to the court of equity resulted in the decree of foreclosure, a legal process whereby the equitable period of redemption could be terminated under appropriate conditions.This became known as strict foreclosure or strict forfeiture.Present-day redemption and foreclosure processes in the United States have evolved from those medieval court decisions.During the 1800s, when the U.S. economy was still basically agrarian, many states expanded the strict foreclosure procedure to include additional protection for borrowers’ equity interests in anticipation of better harvests in the following year.At the end of the the equitable redemption period, the lender was directed to sell the property at public auction, rather than automatically take title to the collateral.It was hoped that the foreclosure sale would obtain a fair market value for the property and save part of the borrower’s equity.The defaulted borrower was given another redemption period AFTER THE SALE to recover the property before title to the collateral was transferred.This additional time period is termed the statutory redemption period because it came into being as a result of the enactment of state statutes.During the redemption periods, the defaulted borrower is allowed to retain possession of the property.Lenders are concerned not only with maintaining the integrity of their collateral but also with the disposition of the income generated by the property.Therefore, in certain cases, lenders can petition the courts for the right of possession to protect the collateral.If possession is granted, and it invariably is in the case of abandoned property, the lender must maintain accurate records of the distribution of income from the property during the redemption periods.Any balance left after deductions for the required payments and property maintenance must be credited to the reduction of the debt.The California Foreclosure Prevention Act, CFPA, enacted on June 15, 2009, may preclude a foreclosure sale for an additional 90-days beyond the current law requirements in order to allow the parties to pursue a loan modification.ABX2 7 and SBX2 7 established the California Foreclosure Prevention Act.Subchapter 14 was added to Chapter 3, Title 10 of the California Code of Regulations (CCR).These regulations clarify the application of Sections 2923.52 and 2923.53 of the Civil Code.The law and rules are available at or may be directed to the Mortgage Loan Activities Unit of the Bureau of Real Estate.
Equitable Redemption Period A period of time established by custom, usually 6-months, that allows a defaulting borrower to redeem property by bringing all payments current before foreclosure.
Strict Forfeiture (Strict Foreclosure)Under a land contract, enables a lender to foreclose in as little as 30-days when the defaulting borrower has less than 20% equity.
Statutory Redemption Period Legislated redemption period allowing borrower time to redeem defaulted property.
Power-of-Sale Foreclosure An alternative to the judicial foreclosure process is the power-of-sale method of collateral recovery.Under this form, a lender or the trustee has the right to sell the collateral property upon default without being required to spend the time and money involved in a court foreclosure suit.In fact, under this form of lender control, a borrower’s redemption time frame is shortened considerably by the elimination of the statutory redemption period granted in the judicial process.
Deeds of Trust The most common application of the power-of-sale foreclosure process is by exercise of the trustee’s responsibility created in a deed of trust.In the event of a default, the beneficiary (lender) notifies the trustee in writing of the trustor’s (borrower’s) delinquency and instructs the trustee to begin the foreclosure by sale process.A trustee may ELECT to foreclose judicially when there may be the possibility of securing a deficiency judgment.The beneficiary (lender) delivers the original note, trust deed, and all payment records to the trustee plus a document entitled DECLARATION OF DEFAULT.The trustee secures a title report as to the current conditions of record and prepares a notice of default and ELECTION TO SELL as prescribe by statute.The notice of default is recorded in the office of the county in which the property is located at least 3 MONTHS before the notice of sale is given.Copies of the notice of default must be sent by certified or registered mail to all persons indicating an interest in the proceedings as well as to the defaulting borrower at the last known address.The notice of default must be published for 3 weeks in a newspaper of general circulation in the property’s jurisdiction.The deed of trust is the most common form used for real estate finance in California.The time line in the event of a default is as follows:1. Beneficiary notices several months’ payment delinquencies and the borrowers are unable to remedy this problem2. Beneficiary notifies trustee to foreclose3. Trustee files Notice of Default (3 months prior to sale date)4. Reinstatement period(up to 5-days before the sale)5. Notice of trustee’s sale and publication of date, time, and place of the sale (3-weeks)6. Sale is held and the highest cash bidder wins7. Trustee’s deed is given to successful bidder(sale is final, borrower has no right of redemption)A deed trust, unlike a mortgage, does not provide any statutory redemption period.Under a mortgage foreclosure, the borrower has prescribed time periods after the public sale to redeem the property.A deed of trust foreclosure only provides time before the public sale to reinstate the loan by bringing its payments current and paying any expenses incurred in the default proceedings.Deeds of trust have no rights of redemption after the trustees sale but can be reinstated as late as 5-business days prior to the trustee’s sale.If the loan has not been reinstated (brought up to date) by the trustor within the 3-month reinstatement period, the trustee records, mails to interested parties, and publishes a NOTICE OF TRUSTEE’S SALE with a sale date to take place not sooner than 20-days after its recording.The notice must be published at least 20-days before the sale, and notice must be posted simultaneously in a public place in the city, judicial district, or county of the sale, as well as in a conspicuous place on the subject property (if a residence, on the front door).The sale is to be held in a public place on any business day between the hours of 9:00 AM and 5:00 PM and will be conducted as an auction.All bids must be for cash or a cash equivalent.The trustor (borrower) may redeem (pay off the entire loan balance, late charges, and trustee’s fee) the property on last time before the auction.California Civil Code 2924c, which refers to the date of recordation of the notice of default occurring on or after January 1, 1986, triggers a right to reinstate a defaulted loan secured by a deed of trust up to 5-business days before a trustee’s sale is held.In the event of postponement of the trustee’s sale, this right to reinstate is extended again up to 5-business days before the new trustee’s sale is held.The sale is made to the highest bidder.The successful bidder receives a trustee’s deed to the property but without any guaranty that the title is clear.There may be some outstanding government liens still in effect.Recording the trustee’s deed eliminates all junior liens, encumbrances on the property (except valid leases), and any further rights of reinstatement.The purchaser is entitled to immediate possession but may have to pursue the eviction of the borrower or any tenant in default by filing an unlawful detainer action.The proceeds from the sale are distributed in the following order:1. To the trustee for costs and sale expenses2. To the beneficiary for the debt3. To junior lienholders in order of priority4. To the borrower (if there is any surplus)
Notice of Default In junior finance, where the borrower give the senior lender permission to notify the junior lender in the event of a default.
Reinstate In delinquent deeds of trust, the time prior to exercising the power of sale in which the errant borrower may bring the loan current.
Trustee’s Deed In a foreclosure, the deed given by the trustee under a deed of trust to the successful bidder at the auction.
Eviction Legally dispossessing occupants of real property for unlawful detainer.
Unlawful Detainer Persons in default and illegally retaining possession of property.
Judicial Foreclosure & Sale In California, a mortgage is usually foreclosed by initiating a court action for judicial foreclosure and sale at public auction.Only a few mortgages include a power-of-sale clause, similar to a trust deed, which eliminates the need for a judicial action.
Conventional Mortgages Before a lender forecloses on a conventional first mortgage, the delinquent mortgagor is notified of the default and the reasons for it.An immediate solution is required, and all efforts must be expended to solve the problem as expeditiously as possible.If all attempts fail, a complaint is filed by the mortgage in the county court in which the property is located and a summons is issued to the mortgagor initiating the foreclosure action.Simultaneous with this activity, a title search is made to determine the identities of all parties having an interest in the collateral property, and a lis pendens is filed with the court, giving notice to the world of the pending foreclosure action.Notice is sent to all parties having an interest or else they will be foreclosed from any future rights by judgement of the court.It is vital for the complainant-mortgagee to notify all junior lienholders of the foreclosure action lest they be enjoined from participation in the property auction, and acquire the right to file suit on their own at some future time.Depending upon the number of days required by the jurisdiction for public notice to inform any and all persons having an UNRECORDED interest in the subject property that a foreclosure suit is imminent, and depending upon the availability of a court date, the complaint is eventually aired before a presiding judgement.In most instances, the defendant-mortgagor does not appear in court unless special circumstances are presented in defense of the default.Creditors who do appear to present their claims are recognized and noted, and a sale of the property at public auction by a court-appointed referee or sheriff is ordered by means of a judgement decree.A public sale is necessary so the actual market value of the subject property can be established.It is unlikely the auction will generate any bids in excess of the mortgage debt balance because if is assumed that the mortgagor made every effort to recover those monies prior to the foreclosure.A lender sues for foreclosure under the terms of the MORTGAGE.If the proceeds from the auction sale are not sufficient to recover the outstanding loan balance plus costs, a mortgagee may then sue on the NOTE for the deficiency.To establish this suit on a note, a lender MAY NOT BID at the auction.If pursuing a deficiency is not anticipated, and most are not because of the apparent financial straits of the defaulted mortgagor, the mortgagee makes the opening bid at the auction.This bid is usually in an amount equal to the loan balance plus interest to date and court costs, and then the lender hopes that someone else will bid at least one dollar more to “bail the lender out.”If there are any junior lienholders or other creditors who look to the property as collateral for THEIR loans, they now have the opportunity to step in and bid to protect their priority positions.Their bids obligate them to repay the first mortgage.When no junior lienholders or creditors enter a bid, the auction closes at the first mortgagee’s bid price.Any interests that these creditors may have in the property are effectively eliminated.If any other period bids an amount above the first mortgage after the first lien is paid, the excess funds are distributed to the junior lienholders in order of their priority, with any leftover money going to the defaulted mortgagor.
Lis Pendens Indicates that a lawsuit is in process.
Judgment Decree Specifies the award granted by the court in a civil case.
Conventional Guaranteed Mortgages Under the terms of the insurance policies of most private mortgage guarantee companies, a default is interpreted to be a nonpayment for four months.Within 10-days of default, the mortgagee is required to notify the insurer, who will then decide whether to instruct the mortgagee to foreclose.When a conventional guaranteed mortgage is foreclosed, the first mortgage is the original bidder at the public auction of the collateral property.Under these circumstances, the successful bidder-mortgagee files notice with the insurance company within 60-days after the legal proceedings have transpired.If the insurance company is confident of recovering the losses by purchasing the collateral property from the mortgagee and then reselling it. it will reimburse the mortgagee for the total amount of the bid and secure title to the property.If the company does not foresee any possibility for this recovery, it may elect to pay the mortgagee the agreed-upon amount of insurance; and the mortgagee retains ownership of the property.The collateral is then sold to recover any balance still unpaid.In any and cases of judicial foreclosure and sale, any ownership rights acquired by the successful bidder at the foreclosure auction will still be subject to the statutory redemption rights of the defaulted mortgagor.A full fee simple absolute title cannot vest in the bidder until these redemption rights have expired.
Equitable Redemption (Reinstatement Rights)Under judicial foreclosure, a borrower may cure the default and reinstate the loan any time before the entry of judgment by paying the delinquencies plus costs and fees.This immediately stops the foreclosure proceedings, and the loan continues in full force and effects as though no acceleration had taken place.
Statutory Redemption After the public sale at a judicial foreclosure, the defaulted borrower may redeem the property under the following circumstances:•Within 3-months if the sale proceeds satisfied the entire debt plus interest and costs of the action.•Within one year if the sale proceeds were insufficient to cover the debt plus interest and expenses.During the redemption period, the borrower may remain in possession of the property but must pay the successful bidder a reasonable rent.Sometimes a lender may take possession of the collateral under the ASSIGNMENT OF RENTS provision in the loan contract, manage the property during the redemption period, and apply the net proceeds to the balance owed.
FHA-Insured Loans Foreclosures on FHA-insured loans originate with the filing of form 2068 — Notice of Default — that must be given to the local FHA administration office within 60-days of default.This notice describes the reasons for the borrower’s delinquency, such as death, illness, marital difficulties, income depletion, and excessive obligations, employment transfers, or military service.In many cases involving delinquent FHA-insured loans, counselors from the local FHA offices will attempt to design an agreement between the lender and the borrower for adjustments to the loan conditions in order to prevent foreclosure.The most common technique used in circumstances when a default is beyond the borrower’s control but deemed curable is forbearance of foreclosure.If the problems causing the default are solved within a 1-year period, the lender informs the local FHA office of the solution.If not, a default status report is filed and the lender must initiate foreclosure proceedings.If the bids at the auction are less than the unpaid balance, the lender is expected to bid the debt, take title, and present it to the FHA along with a claim for insurance that may be paid in cash or in government debentures.With prior FHA approval, the lender may assign the defaulted trust deed directly to the FHA before the final foreclosure action in exchange for insurance benefits.If the property can be sold easily at a price that would repay the loan in full, the lender simply will sell the property after bidding at the auction and will not apply for FHA compensation.IF the FHA ends up as the owner of the property, the collateral will be resold “as is” or repaired, refurbished, and resold at a higher price to help minimize the losses to the FHA.
DVA-Guaranteed Loans Unlike the FHA-insured trust deeds whereby a lender’s entire risk is recovered from the insurance benefits, a DVA loan is similar to the privately insured loan in that a lender receives only the top portion of the outstanding loan balance.In the event of a delinquency of more than 3-months on a DVA loan, the lender must file proper notification with the local DVA office, which may then elect to bring the loan current if it wishes, with subrogation rights to the lender against the borrower for the amount advanced.This means that the DVA claim against the defaulted veteran takes priority over the rights of the lender to these funds.Much like the FHA, DVA lenders are required to make every effort to offset a foreclosure through forbearance, payment adjustments, sale of the property, deed in lieu of foreclosure, or other acceptable solutions.Actual foreclosure is considered only as a last resort.In the event of a foreclosure, the lender will usually be the original bidder at the auction and will submit a claim for losses to the local DVA office.The DVA then has the option either to pay the unpaid balance, interest, and court costs and take title to the collateral or to require that the lender retain the property and pay only the difference between the determined value of the property on the date of foreclosure and the loan balance.The latter alternative is usually chosen when the property is badly deteriorated, accenting the importance for a lender to supervise the collateral property.
Junior Loans Defaults of junior loan are handled in exactly the same manner as are senior loans.The relationship is usually between two individuals rather than between an institutional lender and individual borrower.A junior lender will usually seek the counsel of an attorney to manage the foreclosure process.The delinquent borrower will be requested to cure the problem within a certain time period.If a cure cannot be accomplished, notice is given to all persons having an interest in the property, and the attorney then files for foreclosure.The junior lender is generally the original bidder at the public sale and secures ownership of the collateral property subject to the lien of the existing senior lien.The junior lender can then continue to make any payments required thereon, while seeking to sell the collateral to eliminate, or at least, the losses.
Tax Impacts of Foreclosure In a foreclosure, there may be an unexpected tax consequence for the person or entity that has borrowed the money.In the normal course of events,paying off a real estate loan has no tax consequences.When the last payment is made, all principal borrowed has been returned, plus the interest.In a foreclosure, the loan is retired without being paid in full.A tax is due when the property’s adjusted book value is less than the balance of the loan.As far as the IRS is concerned, a foreclosure is considered a sale; if the amount of the defaulted loan exceeds the tax basis of the property, the IRS considers that a gain.Example:Consider the owners of an income property who have totally depreciated the improvements and who have a remaining book value on the land for $100,000. They default on a $500,000 loan and are obligated to pay income tax on the $400,000 gain. This illustration is an extreme case, but it is possible that the value of such a property could drop below the balance of the loan, and the owners would consider offering the lenders a deed in lieu of foreclosure.Example:A more realistic example would involve a limited partnership that purchased a $1 million property with $200,000 cash and an $800,000 loan. Assuming an interest-only payment, if the loan is foreclosed at a later date, for example, when the book basis is reduced to $750,000, the individual investors would be obligated to pay income tax on the gain of $50,000.Every borrower should try to be aware of the tax consequence in a foreclosure.
Auctions Although the use of an auction to dispose of foreclosed properties is not a new concept, having been used extensively for years in farms and ranch finance, it is gaining new importance.Banks and savings associations are increasingly using auctions to dispose of their repossessed properties.The major reason for the interest in auctions is the pressure created by the costs for carrying defaulted properties.Auctions allow them to be sold quickly.Carrying costs include those for mortgage insurance, maintenance, management, property taxes, and other related expenses.Usually, these costs will not be recouped in the form of a higher selling price.Add to these costs the interest rates in the current market, and you can see that holding foreclosed properties creates an enormous burden on lenders.

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