Mortgage Foreclosure
Q. First things first - what is a "mortgage"?
A. A "mortgage" is a legal process by which the owner of property (we'll limit our discussion to real estate) gives another party (typically a lender) specified rights in the property. The process varies from state to state, but typically the rights involved include the right to take title to the property or to sell it. In some states, a "Deed of Trust" is used instead of a mortgage, but the process works basically the same way. The lender obtains certain rights, but they can be exercised only upon the occurrence (or lack of occurrence) of specified subsequent events. The property owner, by meeting his/her/its obligations, can terminate the lender's rights. This ability to terminate the lender's rights by meeting specified obligations is referred to as "redemption" or "right to redeem."
Q. What is a mortgage "foreclosure"?
A. Basically, a "foreclosure" is a process through which the owner's right to redeem is terminated. As long as the owner can redeem the property (or sell the right to do so to someone else), the lender is limited in terms of its recourse to the property to satisfy the obligation owned to the lender. Long ago, it was recognized that at some point, if the property owner failed to fulfill the owner's obligations, the right to redeem would need to be terminated so that the property could be sold and the obligation to the lender satisfied. All states provide a process through which this can be achieved.
Q. What is the process used for a mortgage foreclosure?
A. Foreclosure procedures vary greatly from state to state. All states provide a procedure through which a lawsuit can be brought in a court of general jurisdiction by the lender to foreclose on the property. In some states, such as Illinois, this is the only way that foreclosure can be achieved. But many states provide for a non-judicial procedure alternative. Credit unions that have plans to make mortgage loans need to keep in mind that real estate and mortgage laws vary from state to state much more widely than just about any other area of the law of interest to credit unions, and guidance from local counsel is definitely needed.
Q. Can the credit union handle its own foreclosures?
A. This would be unwise unless the credit union has its own attorney. There are many complications that could arise if something is not handled properly. Keep in mind that the debtor's right to redeem will exist and can be sold at any time. If a purchaser decides to challenge the credit union's position, the purchaser could post a bond and force the credit union to release its mortgage (the bond would be a cash substitute) and bring suit on its note. If the credit union has done something wrong in handling its case and this sort of circumstance arises, the credit union might walk away empty-handed. The credit union's attorney can take the needed steps to avoid such problems.
Q. Once the credit union has decided to foreclose on the member's mortgage, what type of foreclosure should be utilized - judicial or non-judicial?
A. This is a decision that should be made based on the credit union attorney's recommendation. Each foreclosure process has different advantages. Foreclosure by advertisement (non-judicial foreclosure) is usually less expensive and less time consuming than a judicial foreclosure. It may also help to avoid problems, since the onus is on the mortgagor to start a lawsuit if he or she disputes the foreclosure. However, the member’s mortgage must contain a "Power of Sale" clause in order to foreclose by advertisement.
The judicial foreclosure may be helpful if the credit union intends on pursuing a deficiency judgment when the value of the home is less than mortgage debt. The credit union's attorney may also elect to use judicial foreclosure if the attorney believes that title problems may occur.
Q. How long does the judicial foreclosure process take?
A. Generally, the lender doesn’t begin the process until the homeowner is three to four months behind in mortgage payments. Until that time, and even after the lawsuit is filed, the credit union attempts to get the defaulted homeowner to make good on the loan, most likely by selling the property. The process, from the first filing until the final judgment (when the court orders the home to be sold), typically takes a few months. However, it is not unusual for complications, such as the bankruptcy or death of one of the property owners, to drag this process out even longer.
Q. If the credit union forecloses on a member's real estate, will the sale satisfy the secured obligation in full?
A. That depends on how much the property can be sold for, as compared to the amount owed. It's always possible that the property can't be sold for enough to cover the secured obligation. In this case, a deficiency will remain.
Q. How are the proceeds of the sale of the mortgaged property applied once the foreclosure process has been completed?
A. The proceeds of the sale of the mortgaged property are applied first to the indebtedness secured by the mortgage and the foreclosure expenses, and if any funds are available the balance is paid to the property owner.
Q. What foreclosure process is proper if the member is in the military and on "active duty"?
A. The mortgage must be foreclosed by judicial action if the mortgagor is in the military and the mortgage was originated prior to the start of "full time duty in the active military service of the United States". Even if the judicial foreclosure is proper and the appropriate court order is entered as required, the redemption period may be tolled in the event the mortgagor signed the mortgage before entering military service. It will often not be possible for the attorney to complete the foreclosure while the member is in the service. Federal law gives the courts much discretion under these circumstances. The credit union attorney, in this situation, should endeavor (if title is clear) to try to convince the mortgagor to resolve the matter by agreement. The key in negotiation is to be flexible. It may be that the credit union would be best off just to buy the property from the member (by paying him/her $10,000 for the member's equity, for example) and releasing the mortgage. That way, the credit union would have full ownership rights and could sell the property as it pleases. The member, in turn, may value being free of any potential future obligation related to the property.
Q. Can the credit union foreclose by advertisement if a mortgage was entered into with a member after the member has started "active duty"?
A. The foreclosure by advertisement is proper if the mortgagor entered into the mortgage after the commencement of "active duty". The credit union's attorney needs to advise specifically on this issue; there is still some room for discretion on the part of the courts if the member seeks to stop the process. Independent of any legal considerations, of course, the credit union faces a risk to their reputation by taking such actions.
Q. Is foreclosure the best solution for the credit union or the member to take?
A. For the credit union, foreclosure is a costly and time-consuming process. Foreclosure, or a deficiency judgment, could seriously affect the member’s ability to qualify for credit in the future. There are alternatives to foreclosure that should be considered first. The member hopefully will contact the credit union and explain his/her situation before it’s too late; however usually the credit union needs to take the initiative. A credit union employee who can convince the member that it's time to sell the property can save everyone much money and grief; and the credit union may want to give employees some ability to negotiate as part of the process. Keep in mind that an overriding focus on covering a book position as opposed to incurring some costs could in the end be a costly course of action. Picking up half of the real estate commission, particularly if there isn't much equity in the property could be a very good move from an ultimate recovery perspective. Foreclosures usually hurt both the credit union and the member; therefore it is best to try to avoid the situation if at all possible.
Q. How can the credit union and the member work together to reduce the likelihood of foreclosure when the loan is originated?
A. At the outset, advise the member to borrow only what he/she can afford. Draw up a budget and work with the member to figure out whether the mortgage payment fits into his/her monthly budget. Use caution if the member seriously considers tapping into available home equity for excess cash.
Q. How can the credit union assist the member with a workable plan to avoid foreclosure?
A. Some options include the following:
1. Special forbearance. The credit union may be able to arrange a repayment plan based on the member’s financial situation. The credit union may even provide for a temporary reduction or suspension of the mortgage payments.
2. Mortgage modification. The credit union may be able to refinance the debt or extend the loan to bring the payments to a more affordable level.
3. Deed-in-lieu of foreclosure. As a last resort the member may be able to voluntarily give back the property to the lender, maybe in return for a cash payout of the member's equity and a release of any deficiency rights.
Q. What about second mortgage situations?
A. It frequently happens that a member with a first mortgage with the credit union will take out a second mortgage somewhere else. And sometimes, a member with a first mortgage somewhere else will take out a second mortgage with the credit union. When a first mortgage holder forecloses, the rights of the second mortgage holder are eliminated as well as the rights of the owner. A second mortgage holder can foreclose, but the first mortgage holder's rights will continue in place after the foreclosure. Thus a second mortgage holder can never give clear title as part of selling the property.
Q. Our credit union, due to payment default, wants to foreclose a first mortgage on property that also has a second mortgage. Does the existence of the second mortgage add any complications?
A. The credit union's attorney may need to be consulted, but it may actually provide some additional options. When the first mortgage is foreclosed, the second mortgage will be wiped off the title to the property - That's the essence of being in a superior lien position. Second mortgage holders are very aware of this. If the credit union's mortgage goes into default, it may want to contact the second mortgage holder, alert the second mortgage holder to the situation, and ask if it would care to buy out the credit union's first lien position. If it agrees, the credit union may have just cleared up its position with minimal effort and no loss. There should be no privacy issues - By granting a lien to a second mortgage holder, the member gave the second mortgage holder the right to know all information affecting title to and rights in the property.
Q. Our credit union is in a second mortgage position on a defaulted loan? Can the credit union foreclose? What about the first mortgage holder?
A. The credit union can foreclose a second mortgage, but it will be unable to give clear title because of the first mortgage. This will affect the purchaser's ability to find financing. The credit union should consider approaching the first mortgage holder and buying out its position if there is enough value in the property. That way, it can foreclose both mortgages and give clear title. If there isn't enough value in the property to cover the first mortgage, the credit union may end up having to walk away from the situation or just pursuing its remedies under its note in the unlikely event that the member actually has the ability to pay.
It's also possible that circumstances will arise that will cause the first mortgage holder to foreclose. If it does so judicially, the credit union should receive a formal court notice. But if it does so non-judicially, the first mortgage holder only is required to publish notice generally. Although the first mortgage holder may, as a courtesy or hoping to get a buyout, notify the credit union personally, it has no obligation to do so. The credit union needs to monitor legal notices and keep in contact with the first mortgage holder to make sure that its mortgage isn't wiped out without it ever knowing about it. Because payroll deduction is so frequently used by credit unions, their second mortgages may be current even when first mortgages held by other lenders are in default. If a credit union is ever asked to subordinate its mortgage, such as when a member chooses to refinance a first mortgage with a new lender, it should seek to contract for personal notice of defaults and foreclosure as part of the subordination agreement.
This article is designed to provide general reference information only. It has been prepared with regard to the subject matters covered and is solely intended to be an informational guide. This information should not be considered as legal advice nor relied upon as a substitute for professional services for specific fact situations. This Web site and the credit union league and affiliates it represents will not be liable for any direct, indirect, or consequential damages resulting from the use of the information.
