RFINANCE10: Defaults and Forclosure
Chapter 13:
- A Chapter 13 bankruptcy is known as a "wage earner proceeding." This plan is designed for the rehabilitation of the debtor. - The funding of the plan is designed to come from future wages and earnings of the debtor - During the period covered by the plan, creditors must accept payments as they are provided in the plan and may not seek to collect their debts by other means. - If the plan is successfully completed, debtors receive a release of all the debts provided for in the plan, except for those long-term obligations for payments that extend beyond the plan period. - The Chapter 13 plan may not modify the rights of a lender whose lien is secured by the debtor's personal residence. - Lenders are given this favored treatment because the success of a reorganization plan could be put at risk if foreclosure of the mortgage disrupts the affairs of the debtors by forcing them to find another place to live. - A Chapter 13 filing will prevent any impending foreclosure and allow the debtor to repay, over a reasonable period of time, those arrearages that existed on the date the bankruptcy was filed.
Many people believe that if they lose their home in a foreclosure, they will owe no taxes. This is not necessarily true.
- 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 there has been a gain. Here are some examples of whether or not taxes would be due on a foreclosure sale. Greta owes $100,000 on a property she bought for $95,000. It is now worth $80,000. If she is foreclosed, Greta will be taxed as if she had sold the property for $100,000. Greta's profit of $5,000 is subject to the rules for sale of residences (personal exemption for a residence occupied for two years or more applies) or rental property, depending on her use of the property. Mike owes $100,000 on a property he bought for $95,000. At the foreclosure auction, it sells for $110,000. Mike is taxed as if he had sold the property for $110,000. Bob owes $100,000 on a property he bought for $130,000. It is now worth $80,000. If Bob is foreclosed, he will be taxed as if he had sold the property for $100,000. In this case, Bob has a loss. Bob's loss of $30,000 is not deductible if it is his residence, but it is deductible if the property is a rental. Given these possibilities, it is important for all borrowers to be aware of the tax consequences of a foreclosure.
Chapter 11:
- Chapter 11 bankruptcy is available to owners of a business. - While Chapter 7 bankruptcy results in the liquidation of the debtor's assets, Chapter 11 looks to safeguard the debtor's assets while putting together a plan of reorganization. - Once a reorganization plan is filed, the debtor must get the creditors to accept the plan. - It takes a majority of the creditors to approve the plan. - - Once it's approved, the court will analyze the plan, and confirm it. - Even if some creditors are not an agreement, the court can still confirm the plan if it meets certain requirements. - Chapter 11 bankruptcy proceedings should be a great concern to lenders who may find that their security is tied up for years during the reorganization process. - Even lenders who have a mortgage on a Chapter 11 personal residence could find that they are unable to foreclose on their liens if the foreclosure would interfere with the debtor's reorganization plan.
During the auction, the bids will probably not be much larger than the balance of the mortgage debt.
- If the proceeds from the auction are not sufficient to cover the outstanding loan balance plus the costs, then the lender can sue on the note for the deficiency. - If the lender wants to be able to get a deficiency judgment, he or she cannot bid at the auction.
Forclosure:
- Most lenders are not anxious to take property from borrowers, especially when the borrowers have been candid about their situation and have been willing to cooperate as best they can. -After all, lenders are in the business of lending money, not handling real estate. - The management and sale of property requires skills that most lenders do not have at their disposal and would be expensive to obtain. - For that reason, most lenders prefer to collect what's owed to them and are usually willing to be patient in doing so when circumstances allow. - Most lenders are willing to change mortgage contracts to minimize the possibility of foreclosure, as we have already discussed. - However, after months of patience and leniency, a lender may be forced to institute a foreclosure proceeding.
Before a lender would agree to an extension agreement, he or she would examine some issues:
- The current condition of the property. Has it been well maintained or does it show evidence of neglect? - The status of any liens. Have liens been filed after the mortgage was recorded? If so, what would be the ramifications of an extension? - The status of any grantees who may have assumed the mortgage. Would the issue of an extension release the grantees from liability? NOTE: If the borrower is able to refinance the loan on more favorable terms, it's probably not a good idea to apply for an extension agreement. However, the borrower should realize that refinancing may cause changes that favor the lender, such as an increase in the interest rate.
Deed of Trust:
As we mentioned in an earlier unit, California almost exclusively uses the deed of trust when financing mortgages. - With this form of financing there are three parties to the loan: the borrower, the lender, and a trustee. - The deed of trust gives the trustee the power of sale in the event of a default. - In this situation, if there is a default the lender will notify the trustee in writing of the borrower's delinquency and will instruct the trustee to begin the foreclosure process. - However, the trustee has the option to foreclose judicially if there is the possibility of getting a deficiency judgment, since California does not allow a deficiency judgment on a power-of-sale foreclosure.
The judicial foreclosure procedure can be used with:
Conventional mortgages Conventional insured mortgages FHA-insured mortgages VA-guaranteed mortgages Junior mortgages
Chapter 7:
- The purpose of Chapter 7 or "straight bankruptcy" is to give debtors a fresh start by clearing all of their debt and liquidating their nonexempt assets. Chapter 7 is available to any person regardless of the extent of his or her assets or liabilities. - A Chapter 7 petition can be filed voluntarily by a debtor or involuntarily by petitioning creditors. - In a Chapter 7 petition, the court will appoint a trustee who will evaluate the financial condition of the debtor and then report back to the creditors whether there will be any assets available for liquidation and distribution. - The objective of a Chapter 7 bankruptcy is to liquidate the debtor's assets and distribute the proceeds among the various creditors. - A lender will normally be paid in full if the value of the property is more than the balance due under the mortgage. - To foreclose on a mortgage and sell the debtor's property, the lender must first petition the bankruptcy court. - If the debtor is not behind in the mortgage payments and wants to keep the property, he or she can reaffirm the mortgage debt. - This means that although the debtor's obligation to repay the debt has been dismissed in the bankruptcy proceeding, the debtor makes a new agreement to repay the debt.
Check Your Understanding-Answers:
Describe the difference between equity of redemption and statutory redemption. The right to redeem property between the time of the default and the foreclosure sale is equity of redemption. The right to redeem the property after the foreclosure sale has taken place is statutory redemption. What is a deficiency judgment? Any outstanding debt remaining after foreclosure and sale of a property. With a judicial foreclosure, when is the Deed of Conveyance issued and who issues it? The sheriff will issue a Deed of Conveyance if the debtor does not redeem the property within the redemption period. What does the FHA expect a lender to do at the foreclosure sale for an FHA-insured property if the bids are less than the loan balance? FHA expects the lender to bid on the debt, take the title, and present it to the FHA along with a claim for insurance.
There are a number of alternatives that a lender can consider in a workout. They include:
Forbearance or moratorium. Restructuring the mortgage loan. Transferring the mortgage to a new owner. Deed in lieu of foreclosure. Friendly foreclosure. Prearranged bankruptcy.
In either case - assumption or "subject to" arrangement, the seller still has personal liability for the debt.
However, if the borrower is about to default and thinks that he or she will lose the property anyway, he or she may be willing to take the chance on a new purchaser being able to complete the mortgage obligation. The risk inherent in this approach is that the new buyer will default and the seller will regain responsibility for the debt yet again.
The sale proceeds are applied to the costs of lawsuit and attorney fees, the selling expenses, and as we said above, the amount due to the lender, the junior lien holders in order of priority, and, finally, any excess is given to the original debtor.
If the debtor does not redeem the property within the redemption period, the sheriff will issue a Deed of Conveyance and will record the deed. At that time, the new purchaser receives all rights, title, and interest as of the date the trust deed or mortgage was recorded. The new purchaser may now take action to evict the debtor or tenant in possession.
A moratorium is usually one of these four types:
- Waiver of principal payments -- A lender could choose to allow a delinquent borrower to suspend the payment of the principal and just pay the interest. Sometimes the lender will allow the borrower to skip the entire monthly payment of principal and interest. Any payments that are suspended would be added to the principal, which would result in higher payments later in the loan term. - Deferred interest -- A lender could choose to suspend the borrower's interest payments. The interest is not forgotten, but rather is added to the principal, similar to a negative amortization loan. This would be especially helpful to a person whose installments are almost all interest, either because of a high interest loan or because it's a newer loan. - Partial payments -- A lender could agree to accept just a partial payment of the mortgage. If the situation is caused by something such as temporary unemployment or disability, the lender may be willing to accept partial payments for a period of time with the promise that the borrower will add extra money per month at a later time to make up for the delinquent installments. - Prepayments --The lender may choose to reapply prepayments that were credited to the principal in the past. Also borrowers have been known to sell off part of their property to a highway department project or to a private party and use the proceeds from that sale to cure the deficiency.
Check Your Understanding-Answers:
- What kind of redemption rights does a defaulted borrower have under a power-of-sale foreclosure? The borrower has the right to redeem the property between the notice of sale and the actual sale (equity of redemption). But there is no statutory redemption period with a power-of-sale foreclosure. - In a nonjudicial foreclosure sale, the new purchaser will receive a trustee's deed to the property. But what potential problem exists? There is no guarantee that the title is clear. There may be some outstanding liens still in effect, such as a federal tax lien, real property taxes or assessments, or a valid mechanic's lien. - What is the disadvantage of a strict foreclosure? There is no clearly established value for the property because there is no public auction. The lender's losses cannot be established and there are no deficiency judgments with strict foreclosures. - Which form of bankruptcy is the least favorable to a lender? Chapter 11 bankruptcy is the least favorable because the lender may find that the security is tied up for years during the reorganization process.
Mortgage Power of Sale:
-Even though the power-of-sale foreclosure process is used mostly in states where a deed of trust is most commonly used as the financing instrument, the power-of-sale process can be incorporated into a standard mortgage contract. Several states that do not use the deed of trust allow this process to be used for mortgages. - Foreclosing a mortgage under the power of sale is essentially the same as the process used to foreclose on a deed of trust. - The one difference is that in most states, the lender cannot bid on the sale. - Also, the states tend to limit the amount that the lender may recover by suing for a deficiency judgment. Some states even prohibit any deficiency judgments in mortgage power-of-sale proceedings. These limitations tend to curtail the use of the mortgage power-of-sale.
Summary/Review:
A default is a failure to carry out a contract, agreement, or other obligation, especially a financial obligation such as a note. A mortgage default can result from any breach of the mortgage contract. The most common default is the failure to meet an installment payment of the interest and principal on the note. Other defaults include: Failure to pay taxes when they are due. Neglecting to pay hazard insurance premiums. Failure to pay taxes or insurance premiums could cause the lender to state that the full amount of the loan is due and payable (acceleration). If the borrower can't meet the requirement for full payment, the lender can bring an action for foreclosure. Some loans also have stipulations regarding property upkeep. In some cases, failure to keep the collateral in repair may constitute what is called a technical default. The Soldiers and Sailors Civil Relief Act of 1940 protects military personnel and their dependents from being harassed by creditors, if their ability to pay their bills has been affected by military service. The Act restricts the power of the creditor to sell, foreclose on, or confiscate the property of a member of the armed services for nonpayment without first obtaining a court order. Under The Housing Act of 1964, the FHA requires that lenders provide relief in circumstances where the default is beyond the borrower's control. The VA also requests relief for a veteran borrower who wants to pay but cannot. The VA itself may choose to keep up the payments for the veteran in order to keep the loan current.
Summary/Review:::
A foreclosure is a legal procedure in which the property that is used as security for a debt is sold to satisfy the debt in the event of a default. During the period after a default and before a foreclosure sale, the borrower has a right to reclaim the property that was forfeited due to the mortgage default. The borrower can claim the property by paying the full debt, plus any interest and costs. The right to redeem property between the time of the default and the foreclosure sale is called the equity of redemption right. Once the foreclosure sale has taken place, any right to redeem the property is known as the right of statutory redemption. There are three types of foreclosure proceedings: Judicial foreclosure Nonjudicial foreclosure Strict foreclosure A judicial foreclosure allows a property to be sold by court order after sufficient public notice. Most lenders will seek a judicial foreclosure when they want to get a deficiency judgment, which is any outstanding debt remaining after the foreclosure and sale of a property. The judicial foreclosure procedure can be used with Conventional mortgages Conventional insured mortgages FHA-insured mortgages VA-guaranteed mortgages Junior mortgages
At the same time this is happening, the court will order a title search to determine the identities of everyone who has an interest in the property.
A lis pendens is filed with the court, which is a document giving constructive notice that an action affecting a particular piece of property has been filed. - All parties who have an interest in the property are given notice of the foreclosure action with a request that they appear to defend their interests. - If they choose not to appear, they give up any future rights or claims on the property by judgment of the court. It's critically important for the lender to notify all of the junior lien holders of the foreclosure action. If they do not, the junior lien holders may not participate in the property auction and will gain a right to file a suit of their own at some future time.
If a borrower is unable to meet his or her monthly mortgage payments and is in danger of default, he or she may be able to find someone who can purchase the property and either assume the mortgage or take the property "subject to" the existing mortgage.
A new buyer may be willing to accept this transfer of mortgage if he or she thinks that the value of the property is more than what is still owed on the mortgage.
Summary/Review::::
A nonjudicial foreclosure is also known as a power of sale. With this type of foreclosure, a lender or a trustee has the right to sell the property without spending the time, effort and money involved in a court foreclosure. This form of foreclosure eliminates the statutory redemption period that is allowed in the judicial foreclosure process. The deed of trust gives the trustee the power of sale in the event of a default. If there is a default, the lender will notify the trustee in writing of the borrower's delinquency and will instruct the trustee to begin the foreclosure process. However, the trustee has the option to foreclose judicially if there is the possibility of getting a deficiency judgment, since California does not allow a deficiency judgment on a power-of-sale foreclosure. At the sale, the property will go to the highest bidder. The new purchaser will receive a trustee's deed to the property, but there will be no guarantee that the title is clear. There may be some outstanding liens still in effect, such as a federal tax lien, real property taxes or assessments, or a valid mechanic's lien. The power-of-sale process can be incorporated into a standard mortgage contract. Several states that do not use the deed of trust allow this process to be used for mortgages. Using the strict foreclosure method, a lender could get ownership to a property that has a value above the loan balance. The problem with strict foreclosure, however, is that there is no clearly established value for the property because there is no public auction. In this case, the lender's losses cannot be established. There are no deficiency judgments with strict foreclosures.
A judicial foreclosure allows a property to be sold by court order after sufficient public notice.
An attorney for the lender files a suit to foreclose the lien on the mortgage. - Once the facts are presented in court, the court will order that the property be sold. - A public sale will be advertised and held and the real estate will be sold at auction to the highest bidder. Most lenders will seek a judicial foreclosure when they want to get a deficiency judgment.
As we mentioned, a deed of trust provides a time before the sale for the debtor to reinstate the loan by bringing payments current and paying any expenses incurred in the default proceedings. Deeds of trust have no right of redemption after the sale, but the debtor can reinstate the loan as late as five business days before the trustee's sale.
If the loan has not been reinstated by the debtor within the three-month time period since the filing of the Notice of Default, the trustee will record a Notice of Trustee's Sale, mail the notice to interested parties and publish the notice with the sale date included. The notice must be recorded at least two weeks before the sale. The notice must be published at least 20 days before the sale and must be posted simultaneously in a public place in the city, judicial district, or county of the sale, as well is in a conspicuous place on the property itself. - As with the judicial sale, the sale itself must be held between 9 a.m. and 5 p.m. on a business day in the county where the property is located. All bids must be for cash, cashier's check or cash equivalent. The borrower will have the opportunity to buy back the property one last time before the auction. - The trustee has the right to reject any bids that he or she deems to be inadequate. The trustee can postpone the sale and announce a new sale date to be held at the same location. The trustee can postpone the sale, by making an announcement at the time and place of the sale, up to three times. If there are more than three postponements, the trustee will have to record, publish, mail and post a new Notice of Sale. - As expected, the property will go to the highest bidder. The new purchaser will receive a trustee's deed to the property, but there will be no guarantee that the title is clear. There may be some outstanding liens still in effect, such as a federal tax lien, real property taxes or assessments, or a valid mechanic's lien. Recording the trustee's deed eliminates all junior liens, any encumbrances that exist on the property except for valid leases, and any further rights of reinstatement on the part of the defaulted borrower. The new purchaser is entitled to take immediate possession of the property. However, he or she may be forced to pursue the eviction of the defaulted borrower. - The sale proceeds are distributed first to the trustee for the expenses related to the sale, then to the first lien holder, then to any junior lien holders in order of priority, and then finally to the defaulted borrower, if anything remains.
Failure to pay taxes when they are due may also result in a default.
In California, borrowers pay for a tax service that is in effect for the life of their loan. - The tax service company tracks each property and notifies the lender if the taxes have not been paid. -Since property taxes represent a priority lien over most existing real estate liens, if the borrower does not pay his or her taxes, the lender's position is at risk. -Because of this, loan agreements usually include a clause that specifies that the borrower is responsible for paying property taxes in the appropriate amount and on time.
Prearranged Bankruptcy:
In some cases, a borrower can use the threat of filing for bankruptcy as a way to manipulate the lender into reducing his or her obligation under the original mortgage agreement. - This is not a good position for a lender to be in. If the property that is securing the debt is not worth as much as the principal amount of the debt, the deficiency will be treated as unsecured debt in the bankruptcy process. - If however, the borrower will agree to a prearranged bankruptcy before he or she actually files for bankruptcy, this will be a better situation for the lender. - In a prearranged bankruptcy, the borrowers and all their creditors agree in advance to the terms on which they will turn the assets over to the creditors in exchange for the release from the liability. - This can save considerable time and expense compared to what would happen if there is no advance agreement.
The potential for bankruptcy under Chapters 7, 11 and 13 of the Bankruptcy Code affects the value of real estate as collateral.
Lenders should be aware of the possibility that a borrower may file bankruptcy and know how such filing will change their positions. Both investors and lenders should have a basic understanding of their rights in a bankruptcy proceeding in order to negotiate with one another and resolve their differences before a bankruptcy proceeds.
Borrowers can have difficulty making payments for a variety of reasons. A borrower could:
Lose his or her job. Lose pay due to an extended illness or injury. Suffer a personal tragedy. Overextend his or her credit by running up credit cards.
Summary/Review:::::
Many people believe that if they lose their home in a foreclosure, they will owe no taxes. This is not necessarily true. 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 there has been a gain. The potential for bankruptcy under Chapters 7, 11 and 13 of the Bankruptcy Code affects the value of real estate as collateral. The objective of a Chapter 7 bankruptcy is to liquidate the debtor's assets and distribute the proceeds among the various creditors. A lender will normally be paid in full if the value of the property is more than the balance due under the mortgage. A Chapter 11 bankruptcy is available to owners of a business and looks to safeguard the debtor's assets while putting together a plan of reorganization. Chapter 11 bankruptcy proceedings should be a great concern to lenders who may find that their security is tied up for years during the reorganization process. A Chapter 13 bankruptcy is known as a "wage earner proceeding." This plan is designed for the rehabilitation of the debtor. The funding of the plan is designed to come from future wages and earnings of the debtor. During the period covered by the plan, creditors must accept payments as they are provided in the plan and may not seek to collect their debts by other means.
Check Your Understanding-Answers:
Name three common types of default. Failure to meet an installment payment of the interest and principal. Failure to pay taxes when they are due. Neglecting to pay hazard insurance premiums. What does the Housing Act of 1964 require? Requires that lenders provide relief in circumstances where the default is beyond the borrower's control. What is a moratorium? A temporary or permanent, partial or full waiver of mortgage payments that the lender grants to the defaulting borrower. Define recasting. A redesign of a loan by changing the terms, either temporarily or permanently. Lenders can change terms such as interest rate, amortization period or payment amount.
Recasting:
Over the life of a real estate loan, the form of the mortgage can change at any time for any number of reasons. - When loans are redesigned, the process is called recasting. - A loan is most often recast by changing the terms, either temporarily or permanently. -Lenders can change terms such as interest rate, amortization period or payment amount to help alleviate the pressure on a borrower. -However, this must be done carefully so as not to run the risk of other liens taking priority over the recast loan. For example, a lender might choose to let a delinquency on a construction loan ride until the building sells, because the recasting of the loan might jeopardize the lien priorities.
Two popular forms of loan restructuring are:
Recasting Extension agreements
Friendly Foreclosure:
Since foreclosure is a time-consuming and expensive process, damage to the subject property can occur during the time it takes to complete the foreclosure. - In what is called a friendly foreclosure, the borrower accepts the jurisdiction of the court, gives up any right to declare any defenses and claims, relinquishes the right to appeal or argue with any judgment that is given, and otherwise agrees to cooperate with the lender in the litigation. - This shortens the time it takes to complete the foreclosure. - This also cuts off subordinate liens and provides better protection in case the borrower decides to file for bankruptcy. - A friendly foreclosure normally takes more time than a voluntary conveyance, but it is less time-consuming than the normal, distasteful foreclosure.
The foreclosure on a junior mortgage is essentially the same as on a senior mortgage.
Since many junior lenders are not institutional lenders, a junior lender will usually hire an attorney to administer the foreclosure process. - As with the foreclosure on a senior mortgage, the borrower is given a time period to correct the problem. - If he or she cannot correct the problem, the attorney will send notice to all those who have an interest in the property and then file for foreclosure. The junior lender is usually the bidder at the public auction and will obtain title to the property subject to the balance of the existing senior loan. It's usually the case that the senior loan must be paid in full, because the foreclosure triggers the due-on-sale clause in the mortgage note.
Neglecting to pay hazard insurance premiums is also a cause for default.
Since the lender is included in the policy as a loss-payee along with the borrower, any damage to the property will be repaired or the insurance proceeds are applied to reduce the loan balance. This action helps to maintain the lender's position in the property. If the payments are not made, however, the lender's position is compromised.
Strict Foreclosure:
Some states allow a lender to recover collateral through what is called a strict foreclosure process. - After notice has been given to the delinquent borrower and the proper papers have been filed, the court will establish a specific time during which the borrower may redeem the loan. - If the borrower does not exercise the option, his or her equitable and statutory redemption rights will be eliminated and full legal title will be awarded to the lender. - Using this method, a lender could get ownership to a property that has a value above the loan balance. - The problem with strict foreclosure, however, is that there is no clearly established value for the property because there is no public auction. - n this case, the lender's losses cannot be established. There are no deficiency judgments with strict foreclosures. - This type of foreclosure is seldom used because of the potential unfairness that might occur from a foreclosure of a property which has no established value.
Extension Agreements:
Sometimes a borrower may want to extend the terms of the mortgage. The lender can do this by extending the amortization period for the remaining principal.
Some government agencies actually direct lenders to give their borrowers every possible alternative available that would prevent a foreclosure action. Here are a couple of those situations.
The Soldiers and Sailors Civil Relief Act of 1940 and The Housing Act of 1964
During the period after a default and before a foreclosure sale, the borrower has a right to reclaim the property that was forfeited due to the mortgage default.
The borrower can claim the property by paying the full debt, plus any interest and costs. - Any attempt to have a borrower waive his or her redemption rights is unenforceable. - This right to redeem property between the time of the default and the foreclosure sale is called the equity of redemption right.
After the sale, the sheriff will issue a Certificate of Sale to the highest bidder.
The certificate will state that the title is subject to any redemption privilege of the debtor. - This certificate transfers the title to the purchaser. - The purchaser has no rights to possess the property for the period of redemption. - However, he or she does have the right to receive any rents. - The title the highest bidder receives is subject to any senior liens but not to any junior liens. - The Certificate of Sale will be recorded.
Most private mortgage insurance companies consider a default to be nonpayment of the loan for four months.
The lender is required to notify the insurer of the default within 10 days, and it is up to the insurer to decide whether or not the lender should foreclose.
The sale itself must be held between 9 a.m. and 5 p.m. on a business day in the county where the property is located.
The lender or creditor who is foreclosing the property, the debtor, junior lien holders and anyone else may bid at the sale.
However, most lenders do not plan to sue for deficiency judgments because they know that the borrower does not have the money. In light of this fact, many lenders will make the opening bid at the auction at an amount equal to the loan balance plus interest and costs.
The lender then hopes that someone else will bid at least a dollar more to get the lender off the hook. - Any junior lien holders or other creditors, who had that same property as collateral for their loans, will have an opportunity to step in and bid to protect their position. - A bid from a junior lien holder or other creditor obligates them to repay the first mortgage. - If no other lien holders or creditors make a bid, the auction will close at the lender's bid price. - If this happens, any interest that the junior creditors had in the property is abolished. - However, if any other person bids an amount above the first mortgage amount, after the first lien is paid the excess funds are distributed to the junior lien holders in order of their priority. - Any money left over goes to the original debtor who defaulted on the mortgage.
Summary/Review::
The term workout is used to describe the activities that a lender will undertake to deal with a borrower who is in financial trouble. There are a number of alternatives that a lender can consider in a workout. They include: Forbearance or moratorium - The lender may choose to waive mortgage payments temporarily or even forgive all or some of the payments. A moratorium is usually one of these four types: waiver of principal payments, deferred interest, partial payments or prepayments. Restructuring the mortgage loan - The lender can redesign the loan through recasting (changing the terms such as interest rate or payment amount) or extension agreement (extending the amortization period for the remaining principal). Transferring the mortgage to a new owner - The defaulted borrower may be able to find someone who can purchase the property and either assume the mortgage or take the property "subject to" the existing mortgage. Deed in lieu of foreclosure - The lender may make or accept an offer to take the title to the property back from the borrower (also called voluntary conveyance). Friendly foreclosure - The borrower accepts the jurisdiction of the court, gives up any right to declare any defenses and claims, relinquishes the right to appeal or argue with any judgment that is given, and otherwise agrees to cooperate with the lender in the litigation. Prearranged bankruptcy - The borrowers and all their creditors agree in advance to the terms on which they will turn the assets over to the creditors in exchange for the release from the liability.
Any purchaser who acquires a property "subject to" the existing loan does not have any personal liability for the debt.
Therefore the new purchaser can only lose the equity that he or she has invested in the property to purchase it. -This investment could be very small, especially if the seller is facing foreclosure. - In a case such as this, the new buyer doesn't have much to lose by taking a chance on the property. -If it turns out to be a good investment, the new buyer will continue to make payments on the debt. - But if the buyer finds out that the property will not be worth more than the mortgage debt within a reasonable time, he or she can stop making payments and let the sellers have the property back.
After a lender investigates the possible causes for the lack of payments, the lender may choose to enter into an informal agreement with the borrower. For example, if the borrower cannot make all of the monthly mortgage payments, the lender may choose to waive these payments temporarily or even forgive all or some of the payments.
These waivers are known as forbearance or moratoriums. -In such a case, the lender may allow the borrower to keep possession of the property in return for meeting some monthly payments, which may or may not include payments towards the principal. -If an informal agreement such as this is reached, the lender will adjust the payment amount to the current payment abilities of the borrower. Then, if the borrower's financial condition improves, the lender may choose to have the borrower go back to the originally-scheduled payment amount.
The Soldiers and Sailors Civil Relief Act of 1940:
This Act protects military personnel and their dependents from being harassed by creditors, if their ability to pay their bills has been affected by military service. -The Act restricts the power of the creditor to sell, foreclose on, or confiscate the property of a member of the armed services for nonpayment without first obtaining a court order. -The court can grant relief to the borrower or do anything else that would be considered equitable. - This Act also gives the court the right to suspend the enforcement of any civil action that may have begun prior to the time the borrower joined the military. - However, the military person must show that his or her military service had a direct effect on his or her ability to meet the obligation.
In order to avoid a foreclosure, a borrower may make an attempt to "sell" the equity of the property to the lender.
To save time and minimize the expense that is associated with a foreclosure, the lender may make or accept an offer to take the title to the property back from the borrower. - If both parties agree that the property is more valuable than the mortgage balance, the lender may agree to pay some money back to the borrowers for their equity in the property. - If the value of the property is less than the mortgage balance, the lender may still be willing to accept the title and release the borrower from the debt. - This is called voluntary conveyance or giving deed in lieu of foreclosure. Lenders are usually willing to agree to this solution when the cost of a foreclosure is expected to exceed the benefits of taking such an action.
The Housing Act of 1964:
Under this Act, the FHA requires that lenders provide relief in circumstances where the default is beyond the borrower's control, for example non-payment of a loan due to unemployment during a major illness. -The VA also requests relief for a veteran borrower who wants to pay but cannot. -The VA itself may choose to keep up the payments for the veteran in order to keep the loan current. -However, in these cases, the veteran is not off the hook. The VA keeps the right to collect these advances from the veteran at a future date.
Deficiency judgments are unsecured claims and take the place alongside the borrower's other debts.
Unlike with the mortgage, the lender has no priority position. - Deficiency judgments attach only to real estate or other property that the defaulted borrower currently holds or may hold in the future. - Knowing this, defaulted borrowers could see to it that they do not acquire any future property or, if they do, they can have the titles recorded in names other than their own.
The lender will send the trustee the original note, the trust deed and all payment records, plus a signed document called:
a Declaration of Default. - The trustee will get a foreclosure guaranty report from a title company showing the current condition of the record title, parties in interest and encumbrances. - Then the trustee will prepare a Notice of Default and record it in the office of the county in which the property is located at least three months prior to the Notice of Sale. - The trustee must send copies of the notice of default by certified or registered mail to everyone who has specified an interest in the proceedings, as well is to the debtor at his or her last known address. - Also, the trustee must have the notice of default published for four weeks in a newspaper in the area where the property is located.
A default is:
a failure to carry out a contract, agreement, or other obligation, especially a financial obligation such as a note. A mortgage default can result from any breach of the mortgage contract.
The alternative to a judicial foreclosure is the nonjudicial foreclosure. A nonjudicial foreclosure is also known as:
a power of sale. With this type of foreclosure, a lender or a trustee has the right to sell the property without spending the time, effort and money involved in a court foreclosure. This form of foreclosure shortens a borrower's redemption time by eliminating the statutory redemption period that is allowed in the judicial foreclosure process.
Once the foreclosure sale has taken place, any right to redeem the property must be created by:
a state statute. This is known as the right of statutory redemption. Note: In California, the statutory redemption period exists for judicial foreclosures, but is not available for debtors after a nonjudicial foreclosure sale. The period for statutory redemption is three months if the sale proceeds were adequate to satisfy the debt and one year if the sale proceeds were insufficient. During the redemption period, the borrower may stay in possession of the property.
In a deed in lieu of foreclosure situation, the title is usually transferred with:
a warranty or quitclaim deed from the borrower to the lender. - It's important for the borrower to get this release to be sure that he or she is no longer bound under the note and mortgage. - This is especially important in situations where the mortgage balance is more than the value of the property. - - Otherwise, the borrower may find that he or she still has an obligation to pay part of the mortgage note, even after the title is handed back to the lender.
While a foreclosure sale of a property could result in extra money that would go to the debtor, it may, on the other hand, be sold at a price that does not completely satisfy the lender's claim. When this happens, any deficit in the loan:
continues to be a claim by the lender against the debtor. Any outstanding debt remaining after foreclosure and sale of a property is known as a deficiency judgment.
Before a lender can begin a foreclosure on an FHA-insured mortgage, the lender must:
file a Form 2068 Notice of Default and deliver that form to the local FHA administrative office within 60 days of the default. - The notice of default describes the reasons for the default, which could include death, illness, marital difficulties, loss of income, excessive obligations, employment transfer or military service. - Counselors working in local FHA offices will probably attempt to design an agreement between the lender and the borrower that might prevent the foreclosure. - The most common technique used in these circumstances is forbearance of foreclosure, which we talked about earlier. - The lender will inform the FHA office if the problems that caused the default are solved within one year. If no solution is reached in that time, the lender files a default status report and initiates foreclosure.
As we said earlier, the lender will take whatever steps necessary to solve the problem of the default before initiating a foreclosure action. However, if all attempts fail, the lender will:
file a complaint in court in the county in which the property is located, and the court will issue a summons to the debtor, which initiates the foreclosure action.
The Mortgage Forgiveness Debt Relief Act that was passed by Congress in 2007:
gives relief to homeowners who received mortgage debt forgiveness as a result of a reduction in principal, foreclosure, short sale or deed in lieu of foreclosure. This act has been extended several times and is now due to expire on December 31, 2013. For more information see IRS Publication 4681.
The hearing date of the foreclosure action usually depends on:
how many days are required for public notice of those persons who have an unrecorded interest in the property and the availability of a court date. - The defendant-debtor does not usually appear in court, unless there are some special circumstances that need presenting. - Any creditors who do appear at the suit to present their claims are documented. - The court will order the sale of the property at public auction to be conducted by the sheriff or a court-appointed representative. - This is known as the decree of foreclosure and order of sale.
There are three types of foreclosure proceedings:
judicial foreclosure, nonjudicial foreclosure, and strict foreclosure.
By definition, a foreclosure is a:
legal procedure in which the property that is used as security for a debt is sold to satisfy the debt in the event of a default. - The foreclosure procedure brings the rights of all parties to an end and passes the property's title to either the holder of the mortgage or a third party who may purchase the real estate at the foreclosure sale.
Loans can be restructured in a number of ways. The restructuring could involve:
lower interest rates, accruals of interest, or extended maturity dates. -If the original loan is one in which the borrower is not held personally liable, called a nonrecourse loan, the lender might choose to make the borrower personally liable as part of the loan restructuring agreement. This exposes the borrower to significantly more risk if the restructuring fails. - The lender may also want a participation in the performance of the property as compensation for being willing to restructure the loan. For example, the lender could ask for a percentage of any increase in the income of the property over its current level.
One important advantage of a deed in lieu of foreclosure is its:
speed. - It minimizes the expense of transferring the property and eliminates the uncertainty that comes with litigation. - It also avoids any negative publicity associated with foreclosure and allows the borrower to keep a decent credit rating. - However, on the down side, the deed in lieu of foreclosure does not erase any subordinate interest in the property. The lender must still deal with any other creditors. -A voluntary conveyance does not eliminate any outstanding junior liens. In some cases, holders of junior liens may be in a better position than before, if the title to the property passes to the more financially-sound lender. - In cases where the property is subject to junior liens, the lender may find it necessary to foreclose instead of doing the deed in lieu of foreclosure. - A deed in lieu of foreclosure gives the borrower a lawful way of freeing himself or herself from the claims of subordinate lien holders.
Failure to pay taxes or insurance premiums could cause the lender to:
state that the full amount of the loan is due and payable (acceleration). - If the borrower can't meet the requirement for full payment, the lender can bring an action for foreclosure.
Some loans also have stipulations regarding property upkeep. In some cases, failure to keep the collateral in repair may constitute what is called a:
technical default. -Many technical defaults can be cured by a borrower. Because of this, technical defaults rarely result in an actual foreclosure sale unless the property shows obvious evidence of neglect and waste. -This means that, even though there is a breach of contract, the lender may postpone doing anything about it. -However, if the property has a technical default and has been abandoned, the lender will probably act quickly to protect his or her interests against vandalism and other problems. This could happen even if the borrower is current on the loan payments.
The term workout is used to describe:
the activities that a lender will undertake to deal with a borrower who is in financial trouble. - Often the lender and borrower will work out an agreement that details the rules both will follow during the workout period. -The lender usually agrees to refrain from taking legal action. -In exchange, the borrower agrees to admit to his or her financial problems and agrees to certain conditions that will help alleviate the problem, such as giving the lender periodic and detailed financial statements or agreeing to deposit rents from a rental property into a special account that the borrower can withdraw from only with the lender's approval.
Even though most mortgage contracts outline penalties that would occur for any breach of contract, many lenders prefer to follow a course of action that will prevent a foreclosure if possible. Before a lender would even consider a foreclosure action, he or she will consider:
the amount of the borrower's equity, the state of the current real estate market, and the position of any other lien holders. -The lender will also examine what caused the default and determine the attitude of the borrower regarding possible ways to cure the default.
The most common default is:
the failure to meet an installment payment of the interest and principal on the note. Most lenders allow what's known as a grace period, usually 10 to 15 days, in which to receive the payment. A late payment charge will be imposed if the borrower goes beyond the grace period. Most lenders have no problem if the payments are made within the grace period, but will usually take action if a borrower is consistently late with payments or exceeds the 30-day delinquency period.
When there is a foreclosure action on a conventional insured mortgage,
the first lien holder is the original bidder at the auction. - The successful lender-bidder then files notice with the insurance company within 60 days after the legal proceedings. - If the insurance company believes that they can recover the losses by purchasing the property from the lender and then reselling it, they will reimburse the lender for the total amount of the bid and take title to the property. - If the insurance company doesn't believe they can recover this amount, they may decide to pay the lender an agreed-upon specific amount of insurance, and then the lender will keep ownership of the property and sell it to recover any unpaid balance. Note: The ownership rights acquired by the successful bidder at the auction are still subject to any of the original borrower's redemption rights. Only after those redemption rights have expired can the bidder gain fee simple absolute title.
If there is a foreclosure,
the lender is usually the original bidder at the auction. - Afterwards, the lender will submit a claim for the losses to the local VA office. -mThe VA then has two options. 1) It can pay the unpaid balance, interests, and court costs and take title to the property. 2) Or the VA can require that the lender keep title to the property and the VA will pay only the difference between the determined value of the property on the foreclosure date and the mortgage balance. If the property is in disrepair and/or badly damaged, the VA will usually choose the second option.
Since a VA loan is not an insured loan, the lender will not recover insurance benefits on a default, as is the case with an FHA loan. If a veteran borrower is delinquent on his or her loan payment of more than three months,
the lender must formally notify the local VA office. - The VA office could choose to bring the loan current with subrogation rights to the lender against the borrower for the amount it takes to bring the loan current. That means that the VA claim against the defaulted veteran takes priority over the rights of the lender for the advanced amount. Like the FHA, the VA expects the lender to do everything that can be done to avoid foreclosure and consider a foreclosure action only as a last resort.
If at the auction sale the bids are less than the unpaid balance of the loan, FHA expects
the lender to bid on the debt, take the title, and present it to the FHA along with a claim for insurance. - The FHA may pay the claim in cash or in government debentures. - If the FHA approves beforehand, the lender can assign the defaulted mortgage directly to the FHA before the foreclosure action in exchange for the insurance benefits. - If the lender can sell the property easily at a price that will repay the loan in full, the lender will sell the property after bidding at the auction and not apply for FHA reimbursement. - If the FHA takes title to the property, either they will resell it "as is," or they will repair, restore and resell it at a higher price.
