Chapter 4: Unit 7 - Foreclosure (Notes)

Deed in Lieu of Foreclosure

A defaulting borrower who faces foreclosure may avoid court actions and costs by voluntarily deeding the property to the mortgagee. This is accomplished with a deed in lieu of foreclosure, which transfers legal title to the lienholder. A lender may not accept a deed in lieu of foreclosure from a borrower the lender deems financially capable of making mortgage payments. With the deed in lieu option, a borrower voluntarily deeds collateral property in exchange for a release from all obligations under the mortgage. The transfer, however, does not terminate any existing liens on the property. - The deed in lieu alternative to foreclosure offers several advantages to both the borrower and the lender: - The borrower obtains immediate release from most or all of the personal indebtedness associated with the defaulted loan. - There is no public foreclosure proceeding. - The borrower may receive more generous terms than would be available in a formal foreclosure. - The borrowers' credit is hurt less than in a formal foreclosure. - The lender achieves a reduction in the time and cost of a repossession. - There is less risk to the lender that the borrower will damage the property in revenge for the loss of the property.

Deficiency Judgment (Judicial Foreclosure)

A foreclosure does not necessarily extinguish all the liens against the property, such as what may be owed in real estate taxes. Also, the foreclosure sale may not yield enough money to pay the loan balance in full. As a result, the borrower may still owe money to the lender after the foreclosure. In some cases, the lender may be able to get a personal judgment against the borrower for what is left unpaid. This is called a deficiency judgment. This enables the lender to attach and foreclose a judgment lien on other real or personal property the borrower owns. The lender's ability to pursue such a judgment may be limited, however. State laws may restrict the possibility of obtaining a judgment, and if the mortgage is a non-recourse debt (as is often the case with original owner-occupied residential mortgages), the lender cannot go after borrower's assets. Refinanced loans and home equity lines of credit are not subject to the same restrictions. If the lender does not or cannot pursue a deficiency judgment, the amount that remains unpaid may be taxable to the borrower as "forgiven debt."

Short Sale

A short sale occurs when a lender allows a borrower in default on mortgage loan payments to sell the mortgaged property for less money than necessary to satisfy the loan in order to avoid the delay and expense of a foreclosure sale. The lender usually forgives the mortgage balance owed after the sale. Other avoidance options include refinancing, temporary arrangements with the lender (loan workout), and bankruptcy.

Reinstatement and Redemption (Non-Judicial Foreclosure)

During the notice of default and notice of sale periods, the borrower may pay the lender and terminate the proceedings. Exact reinstatement periods vary from state to state. There is no redemption right in non-judicial foreclosure.

Acceleration and Filing (Judicial Foreclosure)

If a borrower has failed to meet loan obligations in spite of proper notice and applicable grace periods, the lender can accelerate the loan, or declare that the loan balance and all other sums due on the loan are payable immediately. The mortgage holder will include unpaid property taxes and delinquent payments in the accelerated amount, so the borrower can end up owing more than the original amount of the mortgage. If the borrower does not pay off the loan in full, the lender then files a foreclosure suit, naming the borrower as defendant. The suit asks the court to: - terminate the defendant's interests in the property - order the property sold publicly to the highest bidder - order the proceeds applied to the debt

Deficiency Suit (Non-Judicial Foreclosure)

If proceeds do not cover the debt, the lender does not obtain a deficiency judgment or lien, but must file a new deficiency suit against the borrower.

Judicial Sale (Judicial Foreclosure)

If the default is not cured by equitable right of redemption or statutory right of reinstatement, the judicial foreclosure will move forward. This leads to a judicial sale, also called a sheriff's sale, whereupon - all parties are notified in writing of the sale. - the sale is advertised in a newspaper with general circulation. - the property is sold to the highest bidder. The winning bidder receives a certificate of sale, not a deed. The person holding the certificate will receive a sheriff's deed only after the sale has been confirmed.

Writ of Execution (Judicial Foreclosure)

If the defendant fails to meet the demands of the suit during a prescribed period, the court orders the termination of interests of any and all parties in the property, and orders the property to be sold. The court's writ of execution authorizes an official, such as the county sheriff, to seize and sell the foreclosed property.

Right of Reinstatement (Judicial Foreclosure)

In some states, mortgagors have statutory right of reinstatement, if not redemption. This option is available when the borrower wants to cure the default (bring payments up to date) and reinstate the loan as if the loan had not been accelerated at all. In these states, the borrower may exercise statutory right of reinstatement within a statutory number of days after service of summons or publication date. The lender may choose to extend the period for reinstatement to the full length of the period for equitable right of redemption. If reinstatement occurs, the lender must dismiss the suit and the mortgage continues in effect as if no foreclosure had been undertaken.

Lis Pendens (Judicial Foreclosure)

In the foreclosure suit, a lis pendens gives public notice that the mortgaged property may soon have a judgment issued against it. Lis pendens is a Latin term that means "action pending" or "pending litigation." This notice enables other lienholders to join in the suit against the defendant. The lender generally obtains a title search and notifies all other lien holders so that they may appear and assert their interest in the foreclosure litigation. If the property has a federal tax lien against it, the foreclosing lender must give 25 days' notice of the sale to the Internal Revenue Service or risk having the tax lien remain attached to the real property after the sale. A notice of pendency is NOT the same as placing a lien on a property. It is only legal notice of a pending action that involves the title to, or possession of, a specific piece of real estate. The notice is filed in the office of the county clerk. The notice could not be used in a suit to recover attorney fees or broker commissions. The end result of filing a lis pendens, however, is that the property cannot be freely sold or encumbered. So the title to the property is unmarketable during the period of the litigation.

Judicial Foreclosure

Judicial foreclosure allows the sale of the mortgaged property under the supervision of the court, with the proceeds going first to satisfy the mortgage, then other lien holders, and finally the borrower if any proceeds are left. Depending on state foreclosure law, "mortgage" may include: - Deed of trust - Installment (land) contracts that are payable over more than five (5) years and have an unpaid balance of less than 80% of the purchase price - Particular collateral assignments of the beneficial interest in land trusts used as security for lenders - Conventional mortgage instruments Judicial foreclosure occurs in states that use a two-party mortgage document (borrower and lender) that does not contain a "power of sale" provision. Lacking this provision, a lender must file a foreclosure suit and undertake a court proceeding to enforce the lien.

Foreclosure

Legal process by which a defaulting borrower loses his or her interest in the property used as collateral for a mortgage loan or deed of trust. All liens can be enforced by the sale, or other transfer of title of the secured property, whether by court action, operation of law, or through powers granted in the original loan agreement. The lender forces the sale of the real property in the event of default. When the process is complete, the lender can sell the property and keep the proceeds to pay off the mortgage and any legal costs. Lenders have their own rules regarding when to start the foreclosure process. It is not always based on a set period of delinquency, such as 90 days in arrears. The process is rarely quick or painless. Foreclosures can take months to complete. When a borrower loses a home to foreclosure, the results can be severe: - Any equity which existed is most likely lost. - The foreclosure becomes public record. - The borrower's credit is damaged, possibly preventing or making very difficult the purchase of another home - at least for up to seven years, the length of time it remains in the individual's credit file.

Foreclosure Process (Non-Judicial Foreclosure)

On default, the foreclosing mortgagee records and delivers notice to the borrower and other lienholders. After the proper period, a "notice of sale" is published, the sale is conducted, and all liens are extinguished. The highest bidder receives unencumbered title to the property.

Mortgage Lien Foreclosure

State law governs the foreclosure process. Broadly, a statutory or court-ordered sale enforces a general lien, including a judgment lien. A lawsuit or loan provision authorizing the sale or direct transfer of the attached property enforces a specific lien, such as a mortgage. Real estate tax liens are enforced through tax foreclosure sales, or tax sales. Three types of foreclosure processes enforce mortgage liens: - Judicial foreclosure - involves sale of the mortgaged property under the supervision of a court; initiated by a law suit; available in every state - Non-judicial foreclosure - involves sale of the mortgage property without court supervision; available in many, but not all, states - Strict foreclosure - involves court-ordered transfer of the mortgaged property to the lender; available in a few states.

Right of Redemption (Judicial Foreclosure)

The borrower's right of redemption (equity of redemption) is the right to reclaim a property that has been foreclosed by paying off amounts owed to creditors, including interest and costs. Redemption is possible within a redemption period. Some states allow redemption during the foreclosure proceeding at any time "until the gavel drops" at the sale. 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 equitable right of redemption. Other states have statutory periods of up to a year following the sale for the owner of a foreclosed property to redeem the estate. This is known as the statutory right of redemption.

Sale Proceeds (Judicial Foreclosure)

The new owner receives title free and clear of all previous liens, whether the lienholders have been paid or not. Proceeds of the sale are applied to payment of liens according to priority. After payment of real estate taxes (lienholders' claims and costs of the sale), any remaining funds go to the mortgagor (borrower). The order of payment in a foreclosure is as follows: - First, the cost of the sale (this refers to the advertising, attorney fees, trustee fees, etc.). - Second, any special assessment taxes and general (or ad valorem) taxes. - Third, the FIRST mortgage (determined by the order of recording). - Fourth, whatever is recorded next. Any liens resulting from second loans or home equity loans are "wiped out" by foreclosure, but the borrower is still obligated to pay off those loans if the proceeds of the judicial sale are insufficient. If any money remains from the foreclosure sale after paying off the debt, liens, expenses, and interest, that money would be paid to the borrower.

Non-Judicial Foreclosure

When there is a "power of sale" provision in the mortgage or trust deed document, a non-judicial foreclosure can force the sale of the liened property without a foreclosure suit. The "power of sale" clause in effect enables the mortgagee to order a public sale without court decree. Non-Judicial foreclosure requires the lender to give the borrower a notice of default (NOD) and of intent to sell the property in a form prescribed by state statutes. If the borrower fails to cure the default or use other legal means to stop the sale (such as filing a bankruptcy or filing to temporarily stay the foreclosure), the lender may conduct a public auction.

Strict foreclosure

the original form of foreclosure, involves a lawsuit filed by the lender against the borrower. Strict foreclosure is a court proceeding that gives the lender title directly, by court order, instead of giving cash proceeds from a public sale. This procedure is usually available only when the value of the property is less than the value of the debt. Procedure: - First, the lender must give appropriate notice to the delinquent borrower. - Next, the lender prepares and records the paperwork. - After a prescribed period, the lender files suit in court. - The court orders the borrower to pay the mortgage debt by a certain date. If the debt is not paid in full by the deadline, the court orders transfer of full legal title to the lender, and the lender gains title with no obligation to sell the property.