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.
