Whether the economy is booming or in recession, certain circumstances may
arise which cause a borrower to enter default on a mortgage. It can happen
to anyone at anytime. With many homeowners in America living paycheck
to paycheck, and businesses struggling to compete, even a slight ripple
in economic conditions can have a profound impact on the mortgage markets.
As with residential lending, there are also instances within commercial
lending where a default can occur. In these situations, it is imperative
that you understand, as a lender or beneficiary, exactly what your options
are for the best and quickest recovery of your assets.
Five Options to Remedy a Bad Loan
Here, we will touch on the five legal options available to lenders when
a loan goes bad. With each of these points, there is an extensive list
of information that supports the reasoning for each action, but we will
touch on just the fundamental aspects of each point of remedy and briefly
describe how it contributes to finding a beneficial solution for a loan gone bad.
Notice of Default Demand Letter
A notice of default letter is a demand letter that is sent to borrowers
to alert them that the terms of the loan have been broken in some way.
The default may occur if the borrower missed payments, alters the condition
of the property, burdens the property with junior liens, or otherwise
violates the terms of the loan document.
Issuing a demand letter is an important first step in the default/foreclosure
process. It essentially places the borrower on notice that the lender
intends to take action to preserve their interest in a property. A notice
of default does not always have to lead to a foreclosure action and sale,
but it is a crucial first step to begin the process of remedying a bad loan.
The demand letter also serves as a communication tool between the lender
and the borrower. The letter may urge the borrower to contact the lender
or servicer to identify the problems and find a resolution for the default.
This notice outlines the issues behind the default, provides an amount
needed to cure the default, and allows the borrower a legal opportunity
to fix the problem.
Issuing a demand letter also ensures the lender is in compliance with both
the judicial and non-judicial foreclosure processes.
Difference Between Loan Modification and Forbearance
Many times, it is beneficial for the lender to offer a workout solution
to the borrower rather than continue with a foreclosure process. In these
instances, a loan modification or forbearance can provide the borrower
with an option that allows them to maintain ownership of the property
and cure the default over a specified time period.
A forbearance is an agreement where a lender temporarily waives certain
rights to accelerate a defaulted loan in exchange for the borrower resolving
the issue. A forbearance allows a creditor the opportunity to work with
a borrower to remedy a default outside of an outright foreclosure action.
A loan modification is where a beneficiary changes the terms of the contract
to accommodate a borrower in some way. A loan modification can change
terms in favor of the lender or the borrower. For instance, a beneficiary
may choose to work out a deal with a borrower to add back-payments onto
the loan balance, increase the interest, or change the term of the loan
in order to lower the monthly payment amount.
It is not an “either-or” scenario with regards to a loan modification
and forbearance. There may be instances in which a lender issues a forbearance
while the terms of a loan modification are agreed to and implemented.
Judicial Foreclosure vs. Non-Judicial Foreclosure
Certain states allow a lender to conduct a foreclosure through the judicial
process - a civil lawsuit - or through the non-judicial process as outlined
by the state where the property is located. There may be instances when
it makes sense for a borrower to conduct both a judicial and non-judicial
foreclosure simultaneously, as some states provide for this type of remedy.
A judicial foreclosure is a process where the lender or beneficiary files
a civil lawsuit against the borrower to reclaim the property and any deficiency
owed. There are pros and cons that come with conducting a judicial foreclosure.
They typically take longer to complete than a non-judicial foreclosure
because you are at the whim of a judge and the court calendar. Another
issue of concern is borrowers often hire defense attorneys who can extend
the judicial foreclosure process for many weeks, depending on the fortitude
and patience of the borrower.
A non-judicial foreclosure is a process where the state has set forth the
guidelines required to take back the property outside of a civil suit.
The process is initiated with recording a notice of default, and followed
with recording a notice of sale, and is finalized through a sheriff’s
sale or auction.
Assigning a Receiver
There are instances where a lender will want to appoint a receiver to take
over a property in default. A receiver provides a service to the lender
by taking possession of the real property, investigates the finances,
reviews tenant lease agreements, determines the cash flow of the property
and prevents rental money from reaching a foreclosed borrower.
Appointing a receiver can only be accomplished through a judicial foreclosure
process. If the lender is undertaking a non-judicial foreclosure, they
will need to file a lawsuit to have a receiver take control of the property.
Filing a Lawsuit
Beneficiaries seldom want to resolve a defaulted loan with a lawsuit as
they are costly and time consuming. However, sometimes legal action becomes
inevitable for resolving the issue at hand. In some instances, a lender
will need to take a dual-track approach to default by forcing a non-judicial
sale action as well as filing a judicial suit. Filing a lawsuit allows
a lender to appoint a receiver or go after a deficiency judgment if warranted.
During all five of these options, communication is essential between not
only the lender and borrower, but also between the lender and servicing
agent. It makes smart business sense to inform your servicer of the steps
you are taking with your borrower to cure a default, including providing
a forbearance, offering a loan modification, or accepting reinstatement
payments. A servicing agent should also be kept in the loop as to payments
due, outstanding fees, title changes, or any other information that is
pertinent to the efficient servicing of the loan and ensuring the process
stays on track.
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