Foreclosure

From Wikinvestor

Foreclosure is the process through which a lien holder, often a lender (mortgagee), enforces their equitable right of redemption with a court ordered termination of borrower's (mortgagor's) rights. A borrower in order to obtain a mortgage, pledged the asset now being foreclosed on to a lender to secure a loan. In the event the borrower now defaults, the lender will proceed with procedures to repossess the property originally used to secure the loan.

In some jurisdictions a borrower can be granted an equitable right of redemption when the borrower repays the debt. When the right of redemption exists, the lender may not know whether they will be able to successfully repossess the real estate, so they would seek to foreclose the equitable right of redemption. Any lien holder may seek to foreclose for unpaid debts, contractors with a lien, taxing jurisdictions, Home owner's associations, etc.

Specifically in residential mortgage loans the foreclosure procedure is a lender, creditor, selling the property once a prior agreement (the mortgage, or deed of trust) between the lender and borrower has been breached. Usually a failure to repay mortgage as agreed would be a default in the payment of a promissory note, secured by a lien on the property in question. Through the foreclosure process the lender can sell the property with funds going to pay off the debt, legal costs incurred, other lien holders and the remainder (if any) in some cases may be returned to borrower. If the promissory note contained a recourse clause then the mortgagee may also file for a deficiency of judgment, when the foreclosed property sale does not bring enough money to pay the existing balance.

Foreclosure types

After a condition of default occurs the mortgagee can begin the foreclosure process at a time stated in the mortgage, usually after a period of time. The mortgage holder can usually initiate foreclosure at a time specified in the mortgage documents, typically some period of time after a default condition occurs. Typically by judicial sale, or other methods of foreclosure in some places.

Foreclosure by judicial sale, or Judicial Foreclosure, is practiced everywhere and required in some states. A Judicial foreclosure is when the property is sold under court supervision, with the mortgage first being satisfied and then other lien holders and lastly the borrower may receive funds if any are left, though by it's nature this usually doesn't happen. Requirements to notify all parties vary in procedure, but are required in every state. After a short hearing a judicial decision is then usually announced.

Foreclosure by power of sale, may be used if the power of sale clause was used in the mortgage documents, or in the case of a Deed of trust. In this case the Deed of trust is the mortgage. When this kind of mortgage goes into default, the property may be sold without the court supervising. This process can be faster and easier than the Judicial sale.

strict foreclosure, not as widely used except in the states including New Hampshire, Vermont, Connecticut, the mortgagee files suit and if successful, a court orders mortgagor to pay within a specific time. Strict foreclosure was historically the original type of foreclosure.

Acceleration

Acceleration can be used as a process to determine the financial obligation owed.

--- If a mortgage is taken, for instance, on a $10,000 property and monthly payments are required, the mortgage holder can demand the mortgagor make good on the entire $10,000 if the mortgagor fails to make one or more of those payments.

Lenders may also accelerate a loan if terms are there is a transfer clause, obligating mortgagor to notify the lender of any transfer, whether; a lease-option, lease-hold of 3 years or more, land contracts, agreement for deed, transfer of title or interest in the property.

The vast majority (but not all) of mortgages today have acceleration clauses. The holder of a mortgage without this clause has only two options: either to wait until all of the payments come due or convince a court to compel a sale of some parts of the property in lieu of the past due payments. Alternatively, the court may order the property sold subject to the mortgage, with the proceeds from the sale going to the payments owed the mortgage holder.

Process

The process of foreclosure can be rapid or lengthy and varies from state to state. Other options such as refinancing, alternate financing, temporary arrangements with the lender, or even bankruptcy may present homeowners with ways to avoid foreclosure. Websites which can connect individual borrowers and homeowners to lenders are increasingly offered as mechanisms to bypass traditional lenders while meeting payment obligations for mortgage providers.

In the United States, there are two types of foreclosure in most common law states. Using a "deed in lieu of foreclosure," or "strict foreclosure", the noteholder claims the title and possession of the property back in full satisfaction of a debt, usually on contract. In the proceeding simply known as foreclosure (or, perhaps, distinguished as "judicial foreclosure"), the property is subject to auction by the county sheriff or some other officer of the court. Many states require this sort of proceeding in some or all cases of foreclosure, in order to protect any equity the debtor may have in the property, in case the value of the debt being foreclosed on is substantially less than the market value of the immovable property (this also discourages strategic foreclosure). In this foreclosure, the sheriff then issues a deed to the winning bidder at auction. Banks and other institutional lenders may bid in the amount of the owed debt at the sale but there are a number of other factors that may influence the bid, and if no other buyers step forward the lender receives title to the immovable property in return.

Other states have adopted non-judicial foreclosure procedures in which the mortgagee, or more commonly the mortgagee's servicer's attorney or designated agent, gives the debtor a notice of default and the mortgagee's intent to sell the immovable property in a form prescribed by state statute. This type of foreclosure is commonly referred to as "statutory" or "non-judicial" foreclosure, as opposed to "judicial". With this "power-of-sale" type of foreclosure, if the debtor fails to cure the default, or use other lawful means (such as filing for bankruptcy which provides a temporary automatic stay to the foreclosure proceeding) to stop the sale, the mortgagee or its representative will conduct a public auction in a similar manner as the sheriff's auction described above. The highest bidder at the auction becomes the owner of the immovable property free and clear of any interest of the former owner but the property may be encumbered by any liens superior to the mortgage being foreclosed (e.g. a senior mortgage, unpaid property taxes etc). Further legal action, such as an eviction may be necessary to obtain possession of the premises.

Defenses - The Constitutional Issue of Due Process has affected the ability of lenders to foreclose property. In Ohio, the Federal District Court has dismissed numerous foreclosure actions by lenders because of the inability of the alleged lender to prove that they are the real party in interest.^[1] In Colorado, on June 19, 2008, a District Court Judge dismissed a foreclosure action because of failure of the alleged lender to prove they were the real party in interest.^[2]^[3]

"Strict foreclosure" is an equitable right available in some states. The strict foreclosure period arises after the foreclosure sale has taken place and is available to the foreclosure sale purchaser. The foreclosure sale purchaser must petition a court for a decree that will cut off any junior lienholder's rights to redeem the senior debt. If the junior lienholder fails to do so within the judicially established time frame, his lien is cancelled and the purchaser's title is cleared. This effect is the same as the strict foreclosure that occurred at common law in England's courts of equity as a response to the development of the equity of redemption.

In most jurisdictions it is customary for the foreclosing lender to obtain a title search of the immovable property and to notify all other persons who may have liens on the property, whether by judgment, by contract, or by statute or other law, so that they may appear and assert their interest in the foreclosure litigation. In all US jurisdictions a lender who conducts a foreclosure sale of immovable property which is the subject of a federal tax lien must give 25 days' notice of the sale to the Internal Revenue Service: failure to give notice to the IRS will result in the lien remaining attached to the immovable property after the sale. Therefore, it is imperative that the lender obtain a search of the local Federal Tax Liens so that if the persons or companies involved in the foreclosure have a federal tax lien filed against them, the proper notice to the IRS will be given. A detailed explanation by the IRS of the Federal Tax Lien process can be found.^[4]

The US congress passed and President Bush signed into law a temporary change to the tax code. For the period Jan. 1, 2007, through Dec. 31, 2009, homeowners will not have to pay tax on any debt that is cancelled.

Contesting a Foreclosure

Because the right of redemption is an equitable right, foreclosure is an action in equity. In order to keep the right of redemption the debtor can ask an equity court for an injunction. If repossession is imminent the debtor would need to seek a temporary restraining order. However, the debtor may have to post a bond in the amount of the debt. This would protect the creditor if the attempt to stop foreclosure were a naked attempt to cheat the lender and skip on the debt.

A debtor may also challenge the validity of the debt in a claim against the bank in order to stop the foreclosure and sue for damages. In a foreclosure proceeding, the lender bears the burden of proving that there was a valid debt. There is case law to support the debtor's case: First National Bank of Montgomery vs. Jerome Daly, 1969, in the Justice Court State of Minnesota the Judge ruled in favor of the debtor on December 9, 1968: IT IS HEREBY ORDERED, ADJUDGED AND DECREED: 1.That the Plaintiff is not entitled to recover the possession of Lot 19, Fairview Beach, Scott County, Minnesota according to the Plat thereof on file in the Register of Deeds office. 2.That because of failure of a lawful consideration the Note and Mortgage dated May 8, 1964 are null and void. 3.That the Sheriff’s sale of the above described premises held on June 26, 1967 is null and void, of no effect.That because of failure of a lawful consideration the Note and Mortgage dated May 8, 1964 are null and void.

Foreclosure auction

When the entity (in the US, typically a county sheriff) auctions a foreclosed property the noteholder may set the starting price as the remaining balance on the mortgage loan. However, there are a number of issues that affect how pricing for properties is considered, including bankruptcy rulings. In a weak market the foreclosing party may set the starting price at a lower amount if it believes the real estate securing the loan is worth less than the remaining principal of the loan.

In the case where the remaining mortgage balance is higher than the actual home value the foreclosing party is unlikely to attract auction bids at this price level. A house that went through a foreclosure auction and failed to attract any acceptable bids may remain the property of the owner of the mortgage. That inventory is called REO (real estate owned). In these situations the owner/servicer will try to sell it through standard real estate channels.

Further borrower's obligations

The mortgagor may be required to pay for Private Mortgage Insurance, or PMI, for as long as the principal of his primary mortgage is above 80% of the value of his property. In most situations, insurance requirements are sufficient to guarantee that the lender will get some pre-defined percentage of the loan value back, either from foreclosure auction proceeds or from PMI or a combination thereof.

Nevertheless, in an illiquid real estate market or following a significant drop in real estate prices, it may happen that the property being foreclosed is sold for less than the remaining balance on the primary mortgage loan, and there may be no insurance to cover the loss. In this case, the court overseeing the foreclosure process may enter a deficiency judgment against the mortgagor. Deficiency judgments can be used to place a lien on the borrower's other property that obligates the mortgagor to repay the difference. It gives lender a legal right to collect the remainder of debt out of mortgagor's other assets (if any).

There are exceptions to this rule, however. If the mortgage is a non-recourse debt (which is often the case with residential mortgages in the U.S.), lender may not go after borrower's assets to recoup his losses. Lender's ability to pursue deficiency judgment may be restricted by state laws. In California and some other states, original mortgages (the ones taken out at the time of purchase) are typically non-recourse loans, however, refinanced loans and home equity lines of credit aren't.

If the lender chooses not to pursue deficiency judgment—or can't because the mortgage is non-recourse—and writes off the loss, the borrower may have to pay income taxes on the unrepaid amount if it can be considered "forgiven debt." However, recent changes in tax laws may change the way these amounts are reported.

Any liens resulting from other loans taken out against the property being foreclosed (second mortgages, HELOCs) are "wiped out" by foreclosure, but the borrower is still obligated to pay those loans off if they are not paid out of foreclosure auction's proceeds.

Foreclosure investment

Some individuals and companies are engaged in the business of purchasing properties at foreclosure sales. Distressed assets (such as foreclosed property or equipment) are considered by some to be worthwhile investments because the bank or mortgage company is not motivated to sell the property for more than is pledged against it.

During the slumping real estate market in 2008 and 2009, foreclosed properties increased significantly in number which increased public interest in the topic of foreclosure investment. While the number of foreclosures greatly increased, the actual number is the subject of some controversy and disagreement. In his syndicated newspaper column, Eric Tyson raised concerns about the accuracy of foreclosure data widely provided to the news media by RealtyTrac because of their primary business being in selling consumers access to a database of homes in foreclosure. The article went on to document the significant number of consumer complaints logged against the firm for inaccuracies and multiple counting of the same property.^[5]

Foreclosure

From Wikinvestor

Contents

Foreclosure types

Acceleration

Process

Contesting a Foreclosure

Foreclosure auction

Further borrower's obligations

Foreclosure investment

Further reading

References

See also

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