lesson 10: defaults and foreclosures

A portion of paragraph 5, in the Fannie Mae Deed Trust

If Borrower fails to maintain any of the coverages described above, Lender may obtain insurance coverage, at Lender's option and Borrower's expense. Lender is under no obligation to purchase any particular type or amount of coverage. Therefore, such coverage shall cover Lender, but might or might not protect Borrower, Borrower's equity in the Property, or the contents of the Property, against any risk, hazard or liability and might provide greater or lesser coverage than was previously in effect.

Tax Impact of Foreclosure

If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable by IRS. 2008-2014. not existing anymore

Paragraph 6, in the Fannie Mae Note, is the acceleration clause:

1. BORROWER'S FAILURE TO PAY AS REQUIRED (A) Late Charge for Overdue PaymentsIf the Note Holder has not received the full amount of any monthly payment by the end of ___________ calendar days after the date it is due, I will pay a late charge to the Note Holder. The amount of the charge will be _____% of my overdue payment of principal and interest. I will pay this late charge promptly but only once on each late payment. (B) Default If I do not pay the full amount of each monthly payment on the date it is due, I will be in default. (C) Notice of Default If I am in default, the Note Holder may send me a written notice telling me that if I do not pay the overdue amount by a certain date, the Note Holder may require me to pay immediately the full amount of Principal which has not been paid and all the interest that I owe on that amount. That date must be at least 30 days after the date on which the notice is mailed to me or delivered by other means. (D) No Waiver By Note Holder Even if, at a time when I am in default, the Note Holder does not require me to pay immediately in full as described above, the Note Holder will still have the right to do so if I am in default at a later time. (E) Payment of Note Holder's Costs and Expenses If the Note Holder has required me to pay immediately in full as described above, the Note Holder will have the right to be paid back by me for all of its costs and expenses in enforcing this Note to the extent not prohibited by applicable law. Those expenses include, for example, reasonable attorneys' fees.

Delinquency

A borrower is said to be delinquent on his or her payments if he or she fails to pay the principal, interest, taxes, or insurance for a loan on time or at all. Most lenders would rather work with a borrower in default than foreclose on a property. Lenders are willing to recast the loans of delinquent borrowers or to allow a suspension of payment for a period of time, known as a moratorium.

Deed In Lieu of Foreclosure

A borrower who cannot make the monthly payments for a loan may voluntarily transfer title to the lender to avoid foreclosure. This arrangement has several advantages: The borrower's credit is not as damaged, as in the case of a foreclosure. The borrower need not worry about a deficiency judgment as long as it is written into the arrangement that the Deed in Lieu of Foreclosure is "in full satisfaction of" the debt. The lender does not have to incur the expense of a foreclosure. A disadvantage of a deed in lieu of foreclosure is that it does not eliminate junior lien holders the way that foreclosure does.

Holding a Distressed Property

As a general rule, an owner should hold the property if the net present value of all of its future cash flows exceeds the net present value of the owner's best alternative investment opportunity.

1. Equitable Redemption

Equitable redemption occurs before the sale (auction) of a property. It is derived from common law and allows defaulting debtors to pay the defaulted portion of the debt (as well as costs the lender incurred) in order to reinstate the loan and prevent a foreclosure sale. Other parties with an interest in the real estate also can pay the defaulted portion off, in which case the debtor usually becomes responsible to that party for the redemption cost. The redeemer must pay the entire loan at this time if the debt has been accelerated.

Paragraph 22 of the Fannie Mae Master Deed of Trust gives the details in the Acceleration Clause:

Lender shall give notice to Borrower prior to acceleration following Borrower's breach of any covenant or agreement in this Security Instrument (but not prior to acceleration under Section 18 unless Applicable Law provides otherwise). The notice shall specify: (a) the default; (b) the action required to cure the default; (c) a date, not less than 30 days from the date the notice is given to Borrower, by which the default must be cured; and (d) that failure to cure the default on or before the date specified in the notice will result in acceleration of the sums secured by this Security Instrument and sale of the Property. The notice shall further inform Borrower of the right to reinstate after acceleration and the right to bring a court action to assert the non-existence of a default or any other defense of Borrower to acceleration and sale. If the default is not cured on or before the date specified in the notice, Lender at its option may require immediate payment in full of all sums secured by this Security Instrument without further demand and may invoke the power of sale and any other remedies permitted by Applicable Law. If Lender invokes the power of sale, Lender or Trustee shall give notice of the time, place and terms of sale by posting and filing the notice at least 21 days prior to sale as provided by Applicable Law.

deficiency judgment

Lenders sometimes seek a deficiency judgment against a defaulted borrower, guarantor on a loan, or endorsers if a foreclosure sale does not generate enough money to pay off the loan and cover the costs of the foreclosure. Deficiency judgments require the defaulted borrower to pay any remaining balance owed to the lender.

Tax Liens

Real estate loans include a tax clause that states the borrower's obligation to pay property taxes in full when they become due. Most residential mortgage loans use escrow accounts to collect taxes month by month, allowing the lender to closely monitor and ensure the payment of taxes.

2. Statutory Redemption:

When states allow debtors to redeem a property after a foreclosure sale, debtors are said to have a statutory redemption period in which debtors have a specified length of time to recover their property. The court may appoint someone to take control of the property during the statutory redemption period. The purchaser at the foreclosure sale usually has the right to collect rents until the property is redeemed. There is no statutory redemption in Texas.

acceleration clause

to protect the lender in the event of default. This clause states that whenever there is a breach of contract on the part of the borrower, the lender may make the entire amount of the loan due immediately. This protects the lender from having to sue for every late payment as it becomes due. Default occurs when a borrower is delinquent on payments or fails to properly maintain the collateral.

There are two types of short sales:

1. The lender forgives the debt. (This is considered debt forgiveness and at times has been taxable income for IRS purposes; clients should check with a tax consultant.) 2. The lender requires the buyer to sign a note to repay the difference between the amount due on the mortgage and the amount they receive at the time of the sale. In this instance, the debt is not forgiven.

Paragraph 7, of the Fannie Mae Deed of Trust, reads as follows:

7. Preservation, Maintenance and Protection of the Property; Inspections. Borrower shall not destroy, damage or impair the Property, allow the Property to deteriorate or commit waste on the Property. Whether or not Borrower is residing in the Property, Borrower shall maintain the Property in order to prevent the Property from deteriorating or decreasing in value due to its condition. Unless it is determined pursuant to Section 5 that repair or restoration is not economically feasible, Borrower shall promptly repair the Property if damaged to avoid further deterioration or damage

judicial foreclosure.

A foreclosure that is processed through the court

Recasting

A lender may recast a loan in place of a payment moratorium or may recast in addition to the moratorium. These sums can be repaid through one of three methods. The lender can: 1. Increase the monthly payments after the moratorium 2. Extend the term of the loan 3. Allow for a balloon payment at the end of the current loan term

Properties in Distress

A property in distress is one that is in poor condition either physically or financially. The task of managing these properties often falls to a lender who has foreclosed on a property for default. In such a case, the lost loan amount is a sunk cost—it is irrecoverable—and should not affect the owner's decisions.

Short Sales

A short sale means that the lender will agree to accept less than what is actually due on the mortgage before the property goes into foreclosure—but this choice is strictly the lender's. The new buyer gets clear title to the property.

Insurance and Maintenance

Since the loan is secured by the lien on the collateral property, the lender will do everything necessary to make sure that the property is taken care of. This includes requiring that the owner has proper hazard insurance and flood insurance, if appropriate.

Non-Judicial Foreclosure

Some deeds of trust and mortgage documents contain a power-of-sale clause, which allows the lender to bypass the courts and take possession of and sell a collateral property when the borrower defaults on his or her loan. Additionally, some states (including Texas) allow strict foreclosure, where the lender gives notice of the default, and, if it is not paid in some specified time period, the lender may foreclose on the property, eliminating the borrower's redemption rights (both equitable and statutory).

Redemption on Mortgage Foreclosures

Texas does allow equitable redemption (before the auction) but does not allow statuary redemption (after the auction), which allows debtors to redeem (regain possession of) their property. There are two types of redemption:

Non-judicial foreclosures are beneficial to lenders in several respects

They are simpler, faster, and less costly than judicial foreclosures. In the case of a deed of trust, the lender simply notifies the trustee and instructs her or him to begin the foreclosure. For power-of-sale foreclosures, an auction is held, much like with a judicial foreclosure. For strict foreclosures, there is no auction: The lender takes control of the property and sells it to recover his or her losses.

moratorium

is from a Latin word meaning delay. If a borrower is delinquent because of a temporary setback—the loss of a job, illness, a death in the family, and so forth—the lender may consider a moratorium on payments, allowing the buyer to not make principal, interest, or principal and interest payments for a certain period of time. When the lender may legally foreclose due to default but chooses not to, it is called forbearance. The borrower can work with a lender to develop a payment plan for the missed moratorium payments. Sometimes moratoriums involve recasting, or a change of the loan terms.

Foreclosure

is the legal process whereby a lender takes control of a property held by a borrower in default and sells it to recover the lender's losses. Foreclosure usually happens only when the alternatives provided by moratoriums and recasting are not enough to allow the borrower to repay the loan amount. As a general rule, borrowers delinquent for three to four months who have not worked out a repayment plan with the lender are issued a Notice of Default and Intent to Foreclose.

Liquidating a Distressed Property

it will be best to liquidate a property in distress. If operation of the property would result in a loss—that is, total cost would exceed total revenue—selling the property is advisable. It is important to remember that the total cost of retaining the asset should not include any amount the lender lost on the loan, as that is a sunk cost. A distressed property may be worth no more than the land on which it is situated.

A physically distressed property

may be in poor repair: It may be dilapidated, infested with termites, have a mold problem and so on, or it may have environmental liabilities, such as lead-based paint, asbestos, radon, or other toxic hazards.

A financially distressed property

may have low returns or even be running at a loss. It may have several years of taxes in arrears and be completely unmarketable. The owner of such a property is faced with the difficult task of making the property a financially viable asset, either to increase his or her own cash flow or to liquidate it.