This is a four-part series all on my website, danharkey.com
Part I: When a real property borrower defaults
Part II: Reasons that constitute a default.
Part III: Actions possibly taken by a defaulting borrower.
Part IV: Actions the lender may take to recover their security.
Summary:
Real Estate borrowers willingly convey a security interest in their property as consideration for a loan. In non-judicial foreclosure states, they convey legal title to a third-party trustee. They will default with the lender when they fail to make payments, do not pay off their loan when it comes due, or fail to abide by their contractual obligations.
A piece of the puzzle is that during the COVID fiasco, borrowers, tenants, and owners got used to not making payments as part of the social engineering plot. This refers to the temporary relief measures and moratoriums implemented during the COVID-19 pandemic, which may have led to complacency among borrowers. We are now dealing with the fallout of the government's encouraged broker promises, which are back to pay-as-you-go, individual accountability, self-sufficiency, and merit-based advancement.
There are endless circumstances in which borrowers find themselves in trouble making payments, including over-extending, irresponsibility, family problems, medical and emotional problems, lack of employment, economic changes beyond their control, such as inflation, and the diminished purchasing power of the dollar.
This article addresses possible actions taken from the borrower's perspective after they default on the real property loans.
Article:
Defaulting borrowers hold the key to their future. Proactive communication with their lenders is not just a suggestion; it's a crucial step that can lead to a resolution and prevent further legal action. By initiating this communication, borrowers can take control of their situation and work towards a solution, feeling empowered and in control.
They should work directly or through an intermediary, such as their broker (fiduciary) or a lawyer specialist, who can provide valuable guidance and support.
If the property is a single-family, 1 to 4 owner-occupied property, there may be deferral remedies within the laws of the state or municipality. Extended notice provisions may allow the borrower to receive counseling.
Requesting an extension to solve the problem can give the borrower breathing space to address the issue.
Consider asking for a loan modification that places the arrears on top of the principal balance. This could provide a fresh start, like a mini-refinance. The lender may skip some accrued earned interest but will make it up because the modification allows the arrearages to become principal. Hence, the borrower now pays interest on the original loan and the arrears. This option can provide a glimmer of hope in a challenging situation.
Take a hostile position and do not communicate with the lender: It's never your fault, as you have become accustomed to after the COVID era. However, this approach can lead to a lack of understanding of the situation and may result in the lender taking more aggressive actions.
The lender or their hired foreclosure trustee will notify the borrower of the intent to file a notice of default if the loan is not brought current in a specified period. This notice of default becomes a matter of public record. At that time, the clock starts ticking, starting a foreclosure period.
The borrower will quickly discover that they have a notice of default filed against their property.
Non-Judicial vs Judicial Foreclosure states: various states have different procedures:
In non-judicial foreclosure states, there is a statute procedure. I am using California's system. The process allows the lender to handle the entire process outside a court jurisdiction and out of the hands of a potentially biased judge. Once the notice of default is filed, there is a calculated waiting period of about 90 days, plus 21 days for the notice of trustees' sale before the borrower's property is foreclosed on.
In a judicial foreclosure state, the lender, or the lawyer on behalf of the lender, must file a full-blown lawsuit against the defaulting borrower, which transfers the jurisdiction to the court. For those with experience, this is a long and arduous period fraught with expense and frustration. Judges and all those public employee labor union members in the court system seem to have no sense of urgency. If the defendants demand a jury, that selection takes a month or two. The jury pool is flawed because the most competent and employed parties will find a way out of serving in the charade. A judicial foreclosure can take one to three years, all the time while the defaulted borrower lives rent-free.
Remember, you may have the opportunity to attempt a last-ditch negotiation before deciding to lose your property in foreclosure. Don't give up hope. There are still options available, and you can work toward a solution with determination.
Another desperate option for the borrower is to file a Chapter 13, 11, or 7 in the Federal Bankruptcy Code. This can delay the foreclosure sale and transfer the property disposal jurisdiction to a Federal Court judge. However, it also means the borrower becomes subject to the decisions and whims of the court, and the process can be complex and lengthy.
During the stay period, the borrower may attempt to find a solution by refinancing or selling the property to salvage some of the equity dollars. However, one thing for sure is that the judge will choose a court-appointed receiver to oversee the entire disposition of the property. In many cases, the trustees' fees can eat up most of the equity, and the borrowers get little or nothing.
The lenders, or lawyers representing the lenders, will file a relief of stay motion to release the asset from the bankruptcy court so that they can complete the foreclosure. The borrower may have lawyers who argue against it by objecting based on numerous issues. The process could stall the foreclosure for 90 days up to 1 year or more. Bankruptcy judges routinely make decisions that benefit the consumer borrower, including contrary to established law. The lender will be the big bad wolf vs goldilocks (the defaulting consumers).
The courts are stacked with left-leaning judges, so successful arguments, no matter how rational and lawful, are nothing short of a crapshoot. The outcomes involve a high probability of stalling the foreclosure sale by finding something wrong with the lender's procedures. I have included my opinions above from experience.
After the foreclosure, the borrower is considered an adverse tenant. This legal term describes their status as tenants who have the property against the new owner's wishes, significantly limiting their rights and control over the property.
If the new owner of the property after the foreclosure cannot negotiate with the adverse tenant to vacate they will begin a procedure called an unlawful detainer action. This is a legal process that the new owner can initiate to evict the adverse tenant from the property. Knowing this possibility and understanding your rights in such a situation is essential.
Some criminal-minded borrowers will seek protection under the Squatter laws. They will find a third party, even an illusionary party, such as grandma, a cousin, or a newly manufactured tenant, to declare that they have an economic interest in the property, further complicating the process. The new party will claim that they have a right to occupy the property, and in crazy states like California, there are even laws called Squatters Rights.
My frame of reference here is similar to the Bolshevik Revolution in 1917, when squatters took over private properties as part of a socialist state reset. The Russian Socialist Democratic Labor Party, led by Vladimir Lenin, later became known as the Soviet Union and the Communist Party.
The ultimate day in the move-out process:
Foreclosed owners who are not adverse tenants must find a rental or someone to live with or be tossed out to dwell in their automobiles for a while.
During this time, an investor who foreclosed has become the new property owner. They must suffer the financial burden of loan payments, forced-order insurance, property taxes, legal expenses, and the degrading feeling of watching the court system appear as nothing more than a charade, an absurd pretence of reality and unfairness.
The process has become so onerous that many small investors abandon the income property strategy altogether.