Foreclosure

under foreclosure, following the popping of the U.S. real estate bubble.]] Foreclosure is the legal process by which a mortgagee, or other lien holder, usually a lender, obtains a court ordered termination of a mortgagor's equitable right of redemption. Usually a lender obtains a security interest from a who mortgages or pledges an asset like a house to secure the loan. If the borrower defaults and the lender tries to repossess the property, courts of equity can grant the borrower the equitable right of redemption if the borrower repays the debt. While this equitable right exists, the lender cannot be sure that it can successfully repossess the property, thus the lender seeks to foreclose the equitable right of redemption. Other lien holders can also foreclose the owner's right of redemption for other debts, such as for overdue taxes, unpaid contractors' bills or overdue homeowners' association dues or assessments.

The foreclosure process as applied to residential mortgage loans is a bank or other secured creditor selling or repossessing a parcel of real property (immovable property) after the owner has failed to comply with an agreement between the lender and borrower called a "mortgage" or "deed of trust". Commonly, the violation of the mortgage is a default in payment of a promissory note, secured by a lien on the property. When the process is complete, the lender can sell the property and keep the proceeds to pay off its mortgage and any legal costs, and it is typically said that "the lender has foreclosed its mortgage or lien". If the promissory note was made with a recourse clause then if the sale does not bring enough to pay the existing balance of principal and fees the mortgagee can file a claim for a deficiency judgment.

Types of foreclosure

The mortgageholder can usually initiate foreclosure at a time specified in the mortgage documents, typically some period of time after a default condition occurs. Within the United States, Canada and many other countries, several types of foreclosure exist. In the U.S., two of them – namely, by judicial sale and by power of sale – are widely used, but other modes of foreclosure are also possible in a few states.

Foreclosure by judicial sale, more commonly known as judicial foreclosure, which is available in every state (and required in many), involves the sale of the mortgaged property under the supervision of a court, with the proceeds going first to satisfy the mortgage; then other lien holders; and, finally, the mortgagor/borrower if any proceeds are left. Under this system, the lender initiates foreclosure by filing a lawsuit against the borrower. As with all other legal actions, all parties must be notified of the foreclosure, but notification requirements vary significantly from state to state. A judicial decision is announced after the exchange of pleadings at a (usually short) hearing in a state or local court. In some rather rare instances, foreclosures are filed in federal courts.

Foreclosure by power of sale, also known as nonjudicial foreclosure, is authorized by many states if a power of sale clause is included in the mortgage or if a deed of trust with such a clause was used, instead of an actual mortgage. In some states, like California, nearly all so-called mortgages are actually deeds of trust. This process involves the sale of the property by the mortgage holder without court supervision (as elaborated upon below). This process is generally much faster and cheaper than foreclosure by judicial sale. As in judicial sale, the mortgage holder and other lien holders are respectively first and second claimants to the proceeds from the sale.

Other types of foreclosure are considered minor because of their limited availability. Under strict foreclosure, which is available in a few states including Connecticut, New Hampshire and Vermont, suit is brought by the mortgagee and if successful, a court orders the defaulted mortgagor to pay the mortgage within a specified period of time. Should the mortgagor fail to do so, the mortgage holder gains the title to the property with no obligation to sell it. This type of foreclosure is generally available only when the value of the property is less than the debt ("under water"). Historically, strict foreclosure was the original method of foreclosure.

Acceleration

The concept of acceleration is used to determine the amount owed under foreclosure. Acceleration allows the mortgage holder to declare the entire debt of a defaulted mortgagor due and payable, when a term in the mortgage has been broken. If a mortgage is taken, for instance, on a $100,000 property and monthly payments are required, the mortgage holder can demand the mortgagor make good on the entire $100,000 if the mortgagor fails to make one or more of those payments. The mortgage holder will also include any unpaid property taxes and delinquent payments in this amount, so if the borrower does not have significant equity they will owe more than the original amount of the mortgage.

Lenders may also accelerate a loan if there is a transfer clause, obligating the 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, a short sale, 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.

Strict foreclosure/judicial foreclosure

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 lender must sue the defaulting borrower in state court. Upon final judgment (usually summary judgment) in the lender's favor, 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 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.

Nonjudicial foreclosure

Historically, the vast majority of judicial foreclosures have been unopposed, since most defaulting borrowers have no money to hire counsel. Therefore, the U.S. financial services industry has lobbied since the mid-19th century for faster foreclosure procedures that would not clog up state courts with uncontested cases, and would lower the cost of credit (because it must always have the cost of recovering collateral built-in).

In response, a slight majority of U.S. states have adopted nonjudicial 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 (NOD) and the mortgagee's intent to sell the immovable property in a form prescribed by state statute; the NOD in some states must also be recorded against the property. This type of foreclosure is commonly referred to as "statutory" or "nonjudicial" foreclosure, as opposed to "judicial", because the mortgagee does not need to file an actual lawsuit to initiate the foreclosure. A few states impose additional procedural requirements such as having documents stamped by a court clerk; Colorado requires the use of a county "public trustee," a government official, rather than a private trustee specializing in carrying out foreclosures. However, in most states, the only government official involved in a nonjudicial foreclosure is the county recorder.

In 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 to temporarily stay the foreclosure) to stop the sale, the mortgagee or its representative conduct a public auction in a manner similar to the sheriff's auction. Notably, the lender itself can bid for the property at the auction, and is the only bidder that can make a "credit bid" (a bid based on the outstanding debt itself) while all other bidders must be able to immediately present the auctioneer with cash or a cash equivalent like a cashier's check.

The highest bidder at the auction becomes the owner of the immovable property, free and clear of interest of the former owner, but possibly encumbered by liens superior to the foreclosed mortgage (e.g., a senior mortgage or unpaid property taxes). Further legal action, such as an eviction, may be necessary to obtain possession of the premises if the former occupant fails to voluntarily vacate.

Defenses

In some states, particularly those where only judicial foreclosure is available, the constitutional issue of due process has affected the ability of some lenders to foreclose. 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. In June 2008, a Colorado district court judge also dismissed a foreclosure action because of failure of the alleged lender to prove they were the real party in interest.

In contrast, in nonjudicial foreclosure states like California, due process has already been judicially determined to be a frivolous defense. The entire point of nonjudicial foreclosure is that there is no state actor (i.e., a court) involved. The constitutional right of due process protects people only from violations of their civil rights by state actors, not private actors. A further rationale is that under the principle of freedom of contract, if debtors wish to enjoy the additional protection of the formalities of judicial foreclosure, it is their burden to find a lender willing to provide a traditional conventional mortgage loan instead of a deed of trust with a power of sale. The difficulty in finding such a lender in nonjudicial foreclosure states is not the state's problem. Courts have also rejected as frivolous the argument that the mere legislative act of authorizing the nonjudicial foreclosure process thereby transforms the process itself into state action.

Equitable foreclosure

"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 cuts off any junior lien holder's rights to redeem the senior debt. If the junior lien holder fails to do so within the judicially established time frame, his lien is canceled 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.

Title search and tax lien issues

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. This is accomplished through the filing of a lis pendens as part of the lawsuit and recordation of it in order to provide public notice of the pendency of the foreclosure action. In all U.S. 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 results in the lien remaining attached to the immovable property after the sale. Therefore, it is imperative the lender search local federal tax liens so if parties involved in the foreclosure have a federal tax lien filed against them, the proper notice to the IRS is given. A detailed explanation by the IRS of the federal tax lien process can be found.

Contesting a foreclosure

Because the right of redemption is an equitable right, foreclosure is an action in equity. To keep the right of redemption, the debtor may be able to petition the court for an injunction. If repossession is imminent the debtor must seek a temporary restraining order. However, the debtor may have to post a bond in the amount of the debt. This protects the creditor if the attempt to stop foreclosure is simply an attempt to escape the debt.

A debtor may also challenge the validity of the debt in a claim against the bank to stop the foreclosure and sue for damages. In a foreclosure proceeding, the lender also bears the burden of proving they have standing to foreclose.

One note-worthy but legally meaningless court case questions the legality of the foreclosure practice is sometimes cited as proof of various claims regarding lending. In the case First National Bank of Montgomery vs Jerome Daly Jerome Daly claimed that the bank didn't offer a legal form of consideration because the money loaned to him was created upon signing of the loan contract. The myth reports that Daly won, and the result was that he didn't have to repay the loan, and the bank couldn't repossess his property. In fact, the "ruling" (widely referred to as the "Credit River Decision") was ruled a nullity by the courts.

Foreclosure auction

When the entity (in the US, typically a county sheriff or designee) 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 tries 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 gets 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 owner-occupied 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 the foreclosure auction's proceeds.

Renegotiation alternative

In the wake of the United States housing bubble and the subsequent subprime mortgage crisis there has been increased interest in renegotiation or modification of the mortgage loans rather than foreclosure, and some commentators have speculated that the crisis was exacerbated by the "unwillingness of lenders to renegotiate mortgages".

Countries other than the USA

Australia and New Zealand: Foreclosures are generally referred to as Mortgagee sales or Mortgagee auctions. In those cases, the bank or lender ("Mortgagee") sells under the terms of the mortgage. In both of these countries statutory reform has altered the manner in which real property dealings are conducted. What is termed a "mortgage" is a charge that is registered against the title of the property. Since in both countries, the Torrens title system of land registration is used, being registered as proprietor or as a mortgagee creates an indefeasible interest (unless the acquisition of the registration was by land transfer fraud). The mortgagee therefore never holds any title documents, and there is a statutory process for initiating and conducting a mortgagee sale in the event that the mortgagor defaults. In New Zealand, the land title database is now electronic so there are no paper "title documents".

United Kingdom: Foreclosure is a little used remedy which vests the property in the mortgagee with the mortgagor having no right to any surplus from the sale. Because this remedy can be harsh, courts almost never allow it. Instead, they usually grant an order for possession and an order for sale, which mitigates some of the harshness of the repossession by allowing the sale.

Ireland: Foreclosure has been abolished by the Land and Conveyancing Reform Act 2009.

Switzerland: Foreclosure takes place as a form of debt enforcement proceedings under Swiss insolvency law.

People's Republic of China: Foreclosure takes place as a form of debt enforcement proceedings under strict judicial foreclosure, which is only allowed by law of guarantee and law of property right.

Philippines: There are two modes of foreclosure in the Philippines. A mortgagee may foreclose either judicially or extrajudicially, as governed by Rule 68 of the 1997 Revised Rules of Civil Procedure and Act. No. 3135, respectively. A judicial foreclosure is done by filing a complaint in the Regional Trial Court of the place where the property is located. The judge renders judgment, ordering the mortgagor to pay the debt within a period of 90–120 days. If the debt is not paid within the said period, a foreclosure sale satisfies the judgment. In an extrajudicial foreclosure, the mortgagee need not initiate an action in court but may simply file an application before the Clerk of Court to secure attendance of the Sheriff who conducts the public sale. This is done pursuant to a power of sale. Note that these two modes specifically apply to real estate mortgages. Foreclosure of chattel mortgages (mortgage of movable property) are governed by Sec. 14 of Act No. 1506, which gives the mortgagee the right to sell the chattel at a public sale. It has also been held that as regards chattel mortgages, the law does not prohibit that the foreclosure sale be done privately if it is agreed upon by the parties. South Africa: For a developing country, there is a high rate of foreclosures in South Africa because of the privatisation of housing delivery. One of the biggest opponents of foreclosures is the Western Cape Anti-Eviction Campaign which sees foreclosures as unconstitutional and a particular burden on vulnerable poor populations.

See also

Deed in lieu of foreclosure

Equity stripping

Forbearance

Global financial crisis of 2008–2009

HUD auction

Loss mitigation

Repossession

Real estate trends

Short sale (real estate)

Tax taking - Tax Sales, Tax Auctions, Tax Foreclosures

Vacant property

References

Further reading

Rhodes, Trevor. American Foreclosure: Everything U Need to Know... about Preventing & Buying. 348 pages. McGraw-Hill, April, 2008. ISBN 0-07-159058-7

* Neighborhood Strategies for Addressing Foreclosure.

* The "First Amended Complaint" filed by the state of California against Countrywide Mortgage for those who had Countrywide mortgages and had been foreclosed, or would be foreclosed or at risk of foreclosure.

* The stipulated judgment against Countrywide and in favor of the state of California for those who had Countrywide mortgages and had been foreclosed, or would be foreclosed or at risk of foreclosure.

Category:Real property law Category:Mortgage Category:Personal financial problems Category:United States housing bubble