Problem Loans and Foreclosures

1
Chapter 10

• Problem Loans and Foreclosures

2
Actions Short of Foreclosure

• After loan closing, borrower contact with lender
  is limited to
• Audit report asking for verification of data on
  service companys books
• Escrow analysis to determine adequacy of balances
  held by the service company for insurance and
  taxes
• Personal contact (collections) if payments are
  not received within the established grace period

3
Actions Short of ForeclosureProgressive Pain

• Lenders insert provisions into loan documents
  that will empower them to exert selective and
  progressive pain when borrowers fail to honor
  their obligations
• Late charges
• Additional penalty (add-on payments)
• Seize control of property
• Acceleration clause (that the unpaid balance is
  to become due and payable if specified events of
  default should occur) is an option for the
  mortgagee

4
Alternatives to Foreclosure

• Lenders do not want to foreclose on a mortgage if
  they can salvage the situation
• Foreclosed property held by the lender, known as
  Other Real Estate Owned (OREO) or Real Estate
  Owned (REO), on the lenders balance sheet is a
  threat to operations

5
Voluntary Conveyance

• If salvage efforts fail, lenders strip mortgagors
  of their ownership interest. Depending on nature
  of the lien interest and provisions of state
  statutes, this is typically done by public sale
  pursuant to a foreclosure proceeding or by a
  trustees sale of the mortgaged property
• Transfer (or deed) in lieu of foreclosure, or
  friendly foreclosure
• Voluntary conveyance enables defaulting
  mortgagors to avoid foreclosure suit and negative
  marks on credit ratings (and possibility of
  residual liability for loan balance not satisfied
  by proceeds of foreclosure sale)
• Voluntary conveyance can be attractive to
  mortgagees because the immediately acquire title
  for quick resale

6
Foreclosure A Lenders Last Resort

• Mortgages and deeds of trust typically contain
  words of conveyance, followed by a defeasance
  clause intended to render nominal conveyance void
  on satisfaction of the debtors obligation

7
Equity of Redemption

• By the early seventeenth century, the opportunity
  to redeem property after default had been
  converted from a privilege granted under unique
  circumstances to a vested right

8
Foreclosure Suits

• In modern foreclosure suit, the court enters a
  decree specifying an exact time period during
  which the equity of redemption will exist
• Actual foreclosure may be accomplished by
  transferring title directly to the mortgagee
  (strict foreclosure), or by public sale
  (foreclosure by sale)
• Foreclosure by sale prevents mortgagees from
  profiting by a mortgagors misfortune sales
  proceeds are applied in specific order

9
Application of Funds from Foreclosure Sale

• First to cover disposal costs and expenses
  incurred to secure possession
• To maintain the property, and prepare it for sale
• Then to satisfy balances due mortgagees
• Any remaining funds are remitted to the mortgagor
• If same proceeds are insufficient to cover
  amounts due, mortgagees may seek a deficiency
  judgment, which leads to attachment and sale of
  the mortgagors other assets

10
Statutory Right of Redemption

• Equitable rights of redemption are extinguished
  by a foreclosure sale 27 states have enacted
  laws that give a defaulting mortgagor one last
  opportunity to redeem statutory right of
  redemption
• Generally permit a mortgagor, for a period of
  time fixed by the statute, to reclaim property by
  remitting the foreclosure sale price (plus
  expenditures incurred for maintenance,
  improvements, and interest) to the successful
  bidder
• Redemption periods start with the foreclosure
  sale and run for a period of time (generally 6 to
  12 months) specified in enabling legislation
• In states having statutory right of redemption,
  successful bidders receive certificates of sale
  instead of deeds

11
Priority of Creditors Claims

• Any mortgage that results in a foreclosure sale
  and extinguishes all other mortgage interests is
  called a senior mortgage interests subordinate
  to the senior mortgage are called junior liens
• Lien property becomes important if a lienholder
  wishes to sell the security interest in mortgages
  property or to otherwise employ it in a financial
  transaction
• Market value of a credit interest is determined
  in part by the level of risk that the underlying
  credit obligation will not be honored

12
Priority of Creditors Claims (continued)

• Lien Priority and Mortgage Default
• In most states a defaulting mortgagors interest
  is foreclosed by public sale of mortgaged
  property sales proceeds are applied first to
  cover administrative costs, then to satisfy
  mortgage indebtedness
• Lien property becomes critical when sales
  proceeds are insufficient to satisfy all
  remaining liens
• Senior lienholders entire claims are satisfied
  before any funds are allocated to junior
  lienholders
• Junior lienholders claims are then met in the
  order of priority of their liens, until the funds
  are exhausted

13
Priority of Creditors Claims (continued)

• Lien Priority Governed by Recording Statutes
• Recording laws in most states provide that the
  priority of mortgage liens on single parcels of
  real estate is established by the order in which
  they are recorded, rather than that in which they
  are executed
• Time of recording does not establish priority
  where mortgagees have actual knowledge of
  previously executed mortgage or if they are
  parties to a written agreement to the contrary
  called a subordination agreement it may be
  executed between mortgagee and mortgagor or
  between two mortgagees
• Actual notice or knowledge when mortgagees have
  direct information about a lien constructive
  notice is the presumption that parties have the
  responsibility to examine the public records

14
Priority of Creditors Claims (continued)

• Seniority of Purchase Money Mortgages
• Properly recorded purchase-money mortgages
  generally have priority over all other liens
  created by a purchasers actions
• Generally a purchase-money mortgage must be
  recorded simultaneously with the deed involved in
  the conveyance
• Where parties so desire, the priority of the
  purchase-money mortgage may be reduced by
  appropriate wording in the mortgage

15
Priority of Creditors Claims (continued)

• Priority of Mechanics and Materialmens Liens
• Exception to the general rule that lien
  priorities are established by the order in which
  they are recorded relates to claims arising from
  having provided building materials (materialmens
  liens) or services (mechanics liens) in
  connection with construction or property
  improvements

16
Priority of Creditors Claims (continued)

• Priority of Tax Liens
• Most state statutes give property tax liens
  priority over all other liens on a property,
  without regard to the time the obligation was
  created or recorded