Today we embark on a five-minute exploration of Judicial and Non-Judicial foreclosure and the ramifications for different borrowers, and we will also go step-by-step through the non-judicial process.
Judicial or Non-Judicial Foreclosure
Foreclosure proceedings in most states are either Judicial or Non-Judicial at lender’s discretion. Unlike mortgages, Trust Deeds give the lender the Power of Sale at public auction if the borrower fails to repay the debt. With a Trust Deed, a lender can exercise this right without a court order using the faster and less-expensive non-judicial foreclosure.
The lender may sue the borrower for repayment of property debt in a judicial foreclosure and obtain a Deficiency Judgment which they can record as a blanket lien against all borrower property in a given jurisdiction. Lenders often will pursue judicial foreclosure and Delinquency Judgment if the amount is large and the borrower has other liquid assets the lender can take or illiquid assets the lender can encumber (look out Coastal California). Lenders greatly weaken — but do not extinguish — their claim to borrower assets in the non-judicial process. Without a judgment, lenders are merely unsecured creditors similar to credit card companies hoping to squeeze life from the insolvent.
Once a lender has decided to obtain a judicial foreclosure — a relative rarity in California so far — it enters a court process ultimately leading to a Trustee Sale and Deficiency Judgment. The non-judicial process is of most interest to us because it is a process we can follow, it is the most common, and it is a process hundreds of thousands of California borrowers are enduring.
The step-by-step Non-Judicial Foreclosure process
The Non-Judicial Foreclosure process, established by the Legislature and encapsulated in the Trust Deed, begins when a lender records a Notice of Default. There are three events, (1) Notice of Default, (2) Notice of Trustee Sale, and (3) Trustee Sale, which cannot occur quicker than the prescribed timeframes; the speediest is one-hundred fifteen (115) days with one-hundred twenty (120) being typical — assuming no delays.
The law makes no time requirement on lenders after default before lender has option to record a Notice of Default. By custom lenders give borrowers ninety days, but they can give as many or as few as they like; lately, lenders like delay. The lender is never required to issue a Notice of Default, but unless the property is worth less than the loan balance — a common occurrence of late — the lender will issue a Notice of Default as quickly as possible to move the process along and regain their stranded capital.
After the Notice of Default is recorded, the borrower is granted a ninety-day redemption period to bring the loan current before the lender has option of Trustee Sale. Historically, this period was the only period in which the borrower was allowed to bring the loan current; the Notice of Trustee sale being a point of no return. This law was changed, and now the borrower has unrestricted right to reinstate the loan up until five days prior to a Trustee Sale.
Once a Notice of Trustee Sale is recorded, the Trustee must send notification via certified mail to all known borrower addresses of the scheduled sale, and the Trustee must publish Notice of Sale in a newspaper or other prescribed media (1) three times (2) one week apart. If the Trustee publishes the day after the Notice of Trustee Sale is recorded, and published again on the next two weeks, the entire process can be completed in about three weeks.
The Trustee Sale occurs at a public site determined by the Trustee, often at the County Courthouse, but sometimes in front of the Trustee’s office. Since these auctions are often held at the County Courthouse, many people incorrectly believe the Courts are involved in the process in some way; courts are not involved in the process here in California unless the lender specifically chooses to pursue a Judicial Foreclosure.
Black hole of payment default
In 2010, payment default is akin to crossing the event horizon of a black hole never to return. The singularity sucks in and spaghettifies every troubled borrower with the relentless tug of equity-squashing financial gravity. The black hole feeds continuously on the unemployed and overextended and cleanses the universe of toxic mortgages in its purifying crucible.
The first public problem disclosure, our detection of loan particles passing the event horizon, is the TransUnion report on 60-day delinquencies, and this data is supplemented by the First American CoreLogic report of 90-day delinquencies (Irvine 90-day delinquencies.pdf). In the aftermath of The Great Housing Bubble, lenders by choice to maintain their capital ratios or by force through Government moratoria chose not to issue Notices of Default: they chose to amend, extend and pretend. Impact of these delays, besides the multi-month extension to the process, is accumulation of vast Shadow Inventory.
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Once a Notice of Default is issued, properties move from Shadow Inventory to Visible Inventory where they are tracked by Foreclosure Radar and other companies. At this point in the process, borrowers are usually at least 3 payments behind, but they are given another 90 day period to reinstate the loan through (1) bringing payments current, (2) selling the property for a net greater than the loan balance (no shorts), or (3) negotiating a loan modification. Since most borrowers are also underwater and since short sales are very difficult and take months to get approved, few have option of a market sale, and loan modification or foreclosure become the only available paths.
Loan modification recycling
Loan Modification programs have consistently proven to fail. The first of these programs floundered back in 2007, and now in 2010, they continue to writhe and flail. The entire fiasco resembles a rancid meat grinder where toxic loans are ground and reground with the fetid meat-debt stuffed in a paper sarcophagus printed at the Federal Reserve (The FED program to buy GSE debt is printing money).
The loan modification recycling will continue for the foreseeable future as lenders prefer to defer; lenders, and US taxpayers insuring GSE debt, are praying for appreciation to save them. Lenders must wait a decade or more to be successful, and practicality suggests more properties will grind through the foreclosure process.
When loan modifications are completed, the lender issues a Notice of Rescission announcing the borrower has reinstated the loan. This resets all statutory timeframes, and if the borrower were to default again — something they do with great regularity — then the process starts all over.
Restarting the process removes a property from both Shadow Inventory and Visible Inventory, and although these properties are no longer measured in our statistics, most will ultimately go through the foreclosure process. Consider properties in the Loan Modification Recycling process as Shadow Shadow Inventory (or double-secret probation).
Lenders hope to recycle the toxic mess until values come back.
Trustee sale postponements
Besides the delays creating Shadow Inventory, Trustee Sales are postponed for a variety of other reasons — but mostly because the lender doesn’t want to either take a loss or buy the property. These postponements add weeks or months to the process, and there is no knowing if an auction will occur as scheduled. The frequent postponements make purchasing at Trustee Sales difficult for the few all-cash novices making the attempt.
Foreclosure Suffering Flow Chart
Another way to conceptualize the foreclosure process is to look at borrower circumstances and outcomes. Above we defined the timelines of events that occurs once borrowers enter the whirling vortex of mortgage debt, but we have not discussed the ramifications of this process on the borrower both short- and long- term.
I last covered this topic in The Financial Implications of Short-Sales and Foreclosures. That post referred to an attorney’s post on the subject: The California Foreclosure Rules or “So What Happens If I Let My California House Go Back To The Bank?”.
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Bad Credit is best result
All borrowers who default on their loans endure credit problems because credit scores are impacted by delinquencies; no defaulting borrower avoids this fate. Beyond that, the range of possibilities ranges from (1) complete freedom from further financial obligation to (2) complete liability for every penny of lost lender funds and legal judgments to obtain same. Obviously, most prefer the former to the latter, and unfortunately, many believe they can and have escaped the bills, but the system is not finished with them quite yet.
Many who become delinquent lose their homes and become renting-former-owners; they snobbishly will never identify with being a “renter.” Renting-former-owners believe they will own real estate again in a year, eighteen-months tops.
Not going to happen.
The GSEs and FHA have guidelines preventing them from loaning to anyone who discharged mortgage debt over a five-year lookback period, and few private lenders extend such loans. Many have suggested the large number of renting-former-owners are a pent-up-demand that lenders will gush over. Perhaps so, but the borrower pool has proven default, so why would a lender want that business? — except perhaps to obtain huge fees, charge usurious interest, and go back to subprime lending-as-usual. Do we want that again? Really?
The borrower has four major options when in delinquency: (1) make up missed payments, (2) sell in resale market, (3) enter into a loan modification agreement with the lender, or (4) do nothing and wait for the Trustee Sale.
The best outcome for everyone is for the borrower to make up the missing payments, and sometimes they borrow from Peter to pay Paul and cure the mortgage delinquency through other borrowing, but this outcome is rare because borrowers are in financial distress.
If the delinquent borrower attempts a sale, they are giving up their house, so this isn’t a pleasant outcome, but if they have equity, they can sell the property, pay off the loan, and obtain their cash equity to move on with life. If they do not have equity, they must wait for approval from the bank for a short payment on the sale of collateral (short sale) or acceptance of a deed-in-lieu legal abandonment. This has serious negative credit repercussions, and few borrowers bother to read the onerous terms of the short sale agreement where lenders often make the borrower personally guarantee the shortfall.
A common outcome lately has been a delay; loan modifications are the rolling loans gathering no loss, an attempt by both parties to avoid dealing with a problem that isn’t rolling away.
Lenders Captain the Titanic
No matter what option a borrower chooses, lenders push forward with the process leading to Trustee Sale. The Titanic is heading inexorably toward the iceberg with lenders at the helm, and it is up to borrowers to divert its course. If borrowers do nothing, a Trustee Sale is assured.
If a property goes to Trustee Sale and borrower loses legal title, they must vacate the property and the ramifications of their previous decisions become apparent; good or bad, they reap what they sow. If the borrower bought at the peak and borrowed too much, but they never refinanced or took any mortgage equity withdrawal money, they have a Purchase Money Mortgage, and they have no further financial responsibility to the lender or to the IRS. They endure the credit hit, but they are rewarded for their small modicum of restraint and prudence with debt forgiveness; this is the best possible outcome.
Recourse sucks for borrowers
If the borrower adds to or refinances a purchase money mortgage — even if the refinanced balance is the same size or smaller — they give up their recourse protections, and lenders gain several options borrowers find unappealing: (1) seek deficiency judgement, (2) become unsecured creditor, (3) charge off debt and issue borrower a 1099 creating a tax liability. There are no good outcomes for borrowers who lost their recourse protections.
In the best case scenario — remember these people already lost their homes and their credit is trashed — the borrower is reported to the IRS and ends up with a major tax liability because forgiveness of debt is considered income (that HELOC money was income after all). This point is critical: borrowers who have not received a 1099 have not had their debt discharged.
Many think that because lenders are not badgering them that somehow the lender forgot they are owed money. Lenders haven’t forgotten, they just haven’t put the systems in place to chase down payment on mountains of unsecured debt. Many bright attorneys are working to create this debt collection doomsday machine to slice people to rubble. Look for this to be a developing story over the next several years.
The worst possible outcome is reserved for those borrowers with assets. If lenders believe they can obtain more money than it will cost them to pursue the borrower, they will opt for a Judicial Foreclosure to obtain a Deficiency Judgment. I recently attended a meeting of the Turnaround Management Association, a group of turnaround specialists. Many of the assembled attorneys, investors and consultants derive their livelihood from pursuing borrowers who personally guaranteed defaulted debt. This group is going to be very busy.
California Legal Code Pertaining to Foreclosure
The links below lead directly to the State of California code where you can wade through the legalese for yourself.
Start of foreclosure process. Initial notice recorded after borrower fails to meet the terms of their loan.
Sets auction date. Can be recorded 3 months after Notice of Default
CC 2924 c. (b)(1)
Initial auction date can be just 14 days after Notice of Trustees Sale is recorded.
CC 2924 f. (b)(1)
Auctions can postpone for up to one year.
CC 2924 g. (c)(1)
Transfers property to winning bidder. By default this will be the lender if no bid higher than the lender’s opening bid is received.
CC 2924 h. (c)
The links provided by ForeclosureRadar.com are supplement to today’s post.