This is a four-part series all on my website, danharkey.com

Part I:    When a real property borrower defaults

Part II:   Reasons that constitute a default.

Part III:  Actions possibly taken by a defaulting borrower.

Part IV:  Actions the lender may take to recover their security.

Summary:

Real Estate borrowers willingly convey a security interest in their property as consideration for a loan.  In non-judicial foreclosure states, the lender conveys legal title to a third-party trustee.  The borrower defaults with the lender when they fail to make payments, do not pay off their loan when it comes due, or fail to abide by their contractual obligations.

A piece of the puzzle is that during the COVID-19 pandemic, borrowers, tenants, and owners became accustomed to not making payments as part of a social engineering plot.  This refers to the temporary relief measures and moratoriums implemented during the COVID-19 pandemic, which may have led to complacency among borrowers.  We are now dealing with the fallout of the government’s encouragement of broker promises, which are shifting back to a pay-as-you-go, individual accountability, self-sufficiency, and merit-based advancement model.

There are numerous circumstances in which borrowers find themselves in trouble making payments, including overextending, irresponsibility, family problems, medical and emotional issues, unemployment, economic changes beyond their control, such as inflation, and the diminished purchasing power of the dollar.

This article discusses potential actions taken by borrowers after they default on real property loans.

Article:

Defaulting borrowers hold the key to their future. Proactive communication with their lenders is not just a suggestion; it’s a crucial step that can lead to a resolution and prevent further legal action.  By initiating this communication, borrowers can take control of their situation and work towards a solution, feeling empowered and in control.

They should work directly or through an intermediary, such as their broker (a fiduciary) or a specialist lawyer, who can provide valuable guidance and support.

If the property is a single-family, 1- to 4-unit owner-occupied property, there may be deferral remedies available under the laws of the state or municipality.  Extended notice provisions may allow the borrower to receive counseling.

Requesting an extension to solve the problem can give the borrower breathing space to address the issue.

Consider asking for a loan modification that places the arrears on top of the principal balance. This could provide a fresh start, similar to a mini-refinance. The lender may skip some accrued interest, but will make it up because the modification allows the arrearages to be included in the principal.  Hence, the borrower now pays interest on the original loan and the arrears. This option can provide a glimmer of hope in a challenging situation.

Take a hostile position and do not communicate with the lender, as it’s never your fault, a mindset you may have become accustomed to after the COVID era.  However, this approach can lead to a lack of understanding of the situation and may result in the lender taking more aggressive actions.

The lender or their hired foreclosure trustee will notify the borrower of the intent to file a notice of default if the loan is not brought current in a specified period.  This notice of default becomes a matter of public record. At that time, the clock starts ticking, marking the beginning of a foreclosure period.

The borrower will quickly discover that a notice of default has been filed against their property.

Non-Judicial vs Judicial Foreclosure states: various states have different procedures:

In non-judicial foreclosure states, a statutory procedure exists.  I am using California’s system.  The process allows the lender to handle the entire process outside a court jurisdiction and out of the hands of a potentially biased judge.  Once the notice of default is filed, a calculated waiting period of approximately 90 days, plus 21 days for the notice of trustees’ sale, precedes the foreclosure of the borrower’s property.

In a judicial foreclosure state, the lender, or the lawyer acting on behalf of the lender, must file a lawsuit against the defaulting borrower, which transfers jurisdiction to the court.  For those with experience, this is a long and arduous period fraught with expense and frustration. Judges and all those public employee labor union members in the court system seem to have no sense of urgency. If the defendants demand a jury, that selection takes a month or two. The jury pool is flawed because the most competent individuals often find ways to avoid being in the charade.  A judicial foreclosure can take one to three years, all the time while the defaulted borrower lives rent-free.

Remember, you may have the opportunity to attempt a last-ditch negotiation before deciding to lose your property in foreclosure.  Don’t give up hope.  There are still options available, and you can work toward a solution with determination.

Another desperate option for the borrower is to file a Chapter 13, 11, or 7 in the Federal Bankruptcy Code. This can delay the foreclosure sale and transfer the property disposal jurisdiction to a Federal Court judge.  However, it also means that the borrower becomes subject to the court’s decisions and whims, and the process can be complex and lengthy.

During the stay period, the borrower may attempt to find a solution by refinancing or selling the property to recoup some of the equity.   However, one thing is sure: the judge will undoubtedly appoint the court receiver to oversee the entire disposition of the property.  In many cases, the trustees’ fees can consume most of the equity, leaving the borrowers with little or nothing.

The lenders, or their lawyers, will file a motion for relief from stay to release the asset from the bankruptcy court, allowing them to complete the foreclosure.  The borrower may have lawyers who argue against it by objecting on the basis of numerous issues.  The process could stall the foreclosure for up to 90 days, 1 year, or more. Bankruptcy judges routinely make decisions that benefit consumers, including those contrary to established law.  The lender will be the big bad wolf vs Goldilocks (the defaulting consumers).

The courts are stacked with left-leaning judges, so successful arguments, no matter how rational and lawful, are nothing short of a crapshoot.  The outcomes involve a high probability of stalling the foreclosure sale by identifying an issue with the lender’s procedures.  I have included my opinions above based on my experience.

After the foreclosure, the borrower is considered an adverse tenant.  This legal term describes their status as tenants who have the property against the new owner’s wishes, significantly limiting their rights and control over the property.

If the new owner of the property, after the foreclosure, cannot negotiate with the adverse tenant to vacate, they will begin a procedure called an unlawful detainer action.  This is a legal process that the new owner can initiate to evict the adverse tenant from the property. Knowing this possibility and understanding your rights in such a situation is essential.

Some criminal-minded borrowers will seek protection under the Squatter’s Law. They will find a third party, even an illusory one, such as a grandparent, a cousin, or a newly manufactured tenant, to declare that they have an economic interest in the property, further complicating the process.  The new party will claim that they have a right to occupy the property, and in crazy states like California, there are even laws called Squatter’s Rights.

My frame of reference here is similar to the Bolshevik Revolution in 1917, when squatters took over private properties as part of a socialist state reset. The Russian Socialist Democratic Labor Party, led by Vladimir Lenin, later evolved into the Soviet Union and the Communist Party.

The ultimate day in the move-out process:

Foreclosed owners who are not adverse tenants must find a rental or someone to live with, or they may be forced to dwell in their automobiles for a while.

During this time, an investor who has foreclosed has become the new property owner. They must suffer the bearable burden of red-tape insurance, property taxes, legal expenses, and the degrading feeling of watching the court system appear as nothing more than a charade — an absurd pretense of reality.  The process has become so onerous that many small investors abandon the income property strategy altogether.