What You Should Know about Foreclosures for the Real Estate License Exam
The Real Estate License Exam will have basic foreclosure questions. Foreclosure is the process by which the lender takes over ownership of the property and sells it for nonpayment of the debt. Mortgages may contain an acceleration clause that enables the lender to declare the entire balance due after the borrower is declared in default.
Declaring the loan due in full makes the foreclosure process easier, because the entire debt is due right away and must be satisfied by sale of the property unless of course the borrower wins the lottery and pays off the loan. Any funds left after all the debts associated with the property are paid go to the borrower.
If your state has a homestead act in place, the borrower may be entitled to only a certain amount of money, the rest going to pay unsecured debts like credit card bills.
Foreclosure can occur in one of several ways:
Judicial foreclosure, which is where the court orders property to be sold as a result of a foreclosure action brought by the lender. This type of foreclosure is the most common. And you can remember it by relating the word judge as in judicial.
Nonjudicial foreclosure, which only some states permit, can apply to both deed of trust situations and mortgage loans. Nonjudicial foreclosure involves filing a notice of default in the county recorder’s office and providing appropriate public notice, usually through the newspapers. After that, the property is sold to pay off the debt.
Strict foreclosure, which is an action that is permitted in some states, and requires that appropriate notice be given to the borrower and a period of time established by the courts during which the borrower may pay off the debt. If the borrower fails to meet the deadline, title to the property transfers to the lender. In this case, the sale of the property isn’t required by the court.
Many people mistakenly believe that whenever the lender forecloses on a property for nonpayment of the loan, the borrower automatically is off the hook. If, however, the lender cannot sell the property at a price that covers the entire debt, the lender can go to court and sue the borrower for the remainder of the debt.
If the lender’s suit is successful, the court enters a deficiency judgment against the borrower, who must then cover the portion of the mortgage loan debt that the property sale didn’t cover. In the case of VA and FHA insured loans this may not be true because insurance is in place to pay off the loan.
In the event of a default for nonpayment of the debt, depending on the state, the borrower may have a right of equitable redemption, a right that exists after foreclosure but before the sale of the property.
During a specified time frame, the borrower may pay off the debt and reclaim the property. In other states, another similar time frame is effective just after the sale. During that time, the borrower can pay the debt and reclaim ownership of the property. This right to redeem the property after the sale is called a statutory right of redemption.
Sometimes a buyer voluntarily signs the property over to the lender by executing a deed to avoid a foreclosure action. This deed in lieu of foreclosure, or a friendly foreclosure, has a major downside from the lender’s point of view. In a regular foreclosure action, all junior or subordinate liens, or liens on the property that are paid after the mortgage lien, effectively disappear.
However, in a deed in lieu of foreclosure, junior liens remain in place and can become the responsibility of the next buyer. To make matters worse, the lender usually also loses any rights to FHA, VA, or private mortgage insurance. The deed in lieu of foreclosure is not a particular type of deed but rather is whatever type of deed to which the borrower and the lender agree.
When an existing mortgage loan on a property is not being paid off and a lender is making a new loan on the property, that lender will require the first mortgage (the first lender) to execute a subordination agreement to protect itself from all other mortgage lien holders. This allows the new loan to move into first position for payment if a foreclosure becomes necessary.