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What is the process of foreclosure?

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The process of foreclosure can be rapid or lengthy and varies from state to state. Other options such as refinancing, a short sale, alternate financing, temporary arrangements with the lender, or even bankruptcy may present homeowners with ways to avoid foreclosure. Websites which can connect individual borrowers and homeowners to lenders are increasingly offered as mechanisms to bypass traditional lenders while meeting payment obligations for mortgage providers.

Strict foreclosure/judicial foreclosure

In the United States, there are two types of foreclosure in most common law states. Using a "deed in lieu of foreclosure," or "strict foreclosure", the noteholder claims the title and possession of the property back in full satisfaction of a debt, usually on contract.

In the proceeding simply known as foreclosure (or, perhaps, distinguished as "judicial foreclosure"), the lender must sue the defaulting borrower in state court. Upon final judgment (usually summary judgment) in the lender's favor, the property is subject to auction by the county sheriff or some other officer of the court. Many states require this sort of proceeding in some or all cases of foreclosure to protect any equity the debtor may have in the property, in case the value of the debt being foreclosed on is substantially less than the market value of the immovable property (this also discourages strategic foreclosure). In this foreclosure, the sheriff then issues a deed to the winning bidder at auction. Banks and other institutional lenders may bid in the amount of the owed debt at the sale but there are a number of other factors that may influence the bid, and if no other buyers step forward the lender receives title to the immovable property in return.

Nonjudicial foreclosure

Historically, the vast majority of judicial foreclosures have been unopposed, since most defaulting borrowers have no money to hire counsel. Therefore, the U.S. financial services industry has lobbied since the mid-19th century for faster foreclosure procedures that would not clog up state courts with uncontested cases, and would lower the cost of credit (because it must always have the cost of recovering collateral built-in). Lenders have also argued that taking foreclosures out of the courts is actually kinder and less traumatic to defaulting borrowers, as it avoids the in terrorem effects of being sued.

In response, a slight majority of U.S. states have adopted nonjudicial foreclosure procedures in which the mortgagee, or more commonly the mortgagee's servicer's attorney or designated agent, gives the debtor a notice of default (NOD) and the mortgagee's intent to sell the immovable property in a form prescribed by state statute; the NOD in some states must also be recorded against the property. This type of foreclosure is commonly referred to as "statutory" or "nonjudicial" foreclosure, as opposed to "judicial", because the mortgagee does not need to file an actual lawsuit to initiate the foreclosure. A few states impose additional procedural requirements such as having documents stamped by a court clerk; Colorado requires the use of a county "public trustee," a government official, rather than a private trustee specializing in carrying out foreclosures. However, in most states, the only government official involved in a nonjudicial foreclosure is the county recorder, who merely records any pre-sale notices and the trustee's deed upon sale.

In this "power-of-sale" type of foreclosure, if the debtor fails to cure the default, or use other lawful means (such as filing for bankruptcy to temporarily stay the foreclosure) to stop the sale, the mortgagee or its representative conduct a public auction in a manner similar to the sheriff's auction. Notably, the lender itself can bid for the property at the auction, and is the only bidder that can make a "credit bid" (a bid based on the outstanding debt itself) while all other bidders must be able to immediately present the auctioneer with cash or a cash equivalent like a cashier's check.

The highest bidder at the auction becomes the owner of the immovable property, free and clear of interest of the former owner, but possibly encumbered by liens superior to the foreclosed mortgage (e.g., a senior mortgage or unpaid property taxes). Further legal action, such as an eviction, may be necessary to obtain possession of the premises if the former occupant fails to voluntarily vacate.

Defenses

In some states, particularly those where only judicial foreclosure is available, the constitutional issue of due process has affected the ability of some lenders to foreclose. In Ohio, the federal district court for the Northern District of Ohio has dismissed numerous foreclosure actions by lenders because of the inability of the alleged lender to prove that they are the real party in interest. In June 2008, a Colorado district court judge also dismissed a foreclosure action because of failure of the alleged lender to prove they were the real party in interest.

In contrast, in nonjudicial foreclosure states like California, due process has already been judicially determined to be a frivolous defense. The entire point of nonjudicial foreclosure is that there is no state actor (i.e., a court) involved.The constitutional right of due process protects people only from violations of their civil rights by state actors, not private actors. A further rationale is that under the principle of freedom of contract, if debtors wish to enjoy the additional protection of the formalities of judicial foreclosure, it is their burden to find a lender willing to provide a loan secured by a traditional conventional mortgage instead of a deed of trust with a power of sale. The difficulty in finding such a lender in nonjudicial foreclosure states is not the state's problem. Courts have also rejected as frivolous the argument that the mere legislative act of authorizing the nonjudicial foreclosure process thereby transforms the process itself into state action.

In turn, since there is no right to due process in nonjudicial foreclosure, it has been held that it is irrelevant whether the borrower had actual notice of the foreclosure, as long as the foreclosure trustee performed the tasks prescribed by statute in an attempt to give notice.

Equitable foreclosure

"Strict foreclosure" is an equitable right available in some states. The strict foreclosure period arises after the foreclosure sale has taken place and is available to the foreclosure sale purchaser. The foreclosure sale purchaser must petition a court for a decree that cuts off any junior lien holder's rights to redeem the senior debt. If the junior lien holder fails to do so within the judicially established time frame, his lien is canceled and the purchaser's title is cleared. This effect is the same as the strict foreclosure that occurred at common law in England's courts of equity as a response to the development of the equity of redemption.

Title search and tax lien issues

In most jurisdictions it is customary for the foreclosing lender to obtain a title search of the immovable property and to notify all other persons who may have liens on the property, whether by judgment, by contract, or by statute or other law, so that they may appear and assert their interest in the foreclosure litigation. This is accomplished through the filing of a lis pendens as part of the lawsuit and recordation of it in order to provide public notice of the pendency of the foreclosure action. In all U.S. jurisdictions a lender who conducts a foreclosure sale of immovable property which is the subject of a federal tax lien must give 25 days' notice of the sale to the Internal Revenue Service: failure to give notice to the IRS results in the lien remaining attached to the immovable property after the sale. Therefore, it is imperative the lender search local federal tax liens so if parties involved in the foreclosure have a federal tax lien filed against them, the proper notice to the IRS is given. A detailed explanation by the IRS of the federal tax lien process can be found.


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