Misconceptions About Foreclosure

There are a lot of misconceptions by the public and the real estate industry about foreclosure and the distress property market.

1.         The foreclosure market is unethical and takes advantage of people.  There are a lot of sharks out there.  The fact is that there are people who take advantage of others, but the majority of investors and agents are ethical and working to help homeowners in distress.  You need to have a thorough understanding of foreclosures and loss mitigation alternatives to be able to effectively help borrowers.

You will find when you are out there educating people and showing them their options that it is quite rewarding.  People will thank you ten times over.

2.         Foreclosure only happens to bad people in bad areas with bad properties.  Foreclosure happens to everybody in every economic situation with every type of property all the way from small run down properties to multi-million dollar mansions.  The fact is that there are people that do bad things from loan fraud and worse, and they end up losing their home, but the vast majority of people in foreclosure are families that have experienced a financial crisis and are not able to make their payments.

3.         A property must have equity to be sold.  In this wave of foreclosures, there will be a lot of properties that have little or no equity.  A foreclosure specialist will know how to contact the borrowers with no equity, be able to negotiate with their lenders for short sales, and know how to work with different lien holders to discount the liens.  Additionally, a foreclosure specialist will be able to purchase and sell properties “subject to” the existing financing.

4.         It’s too much work.  Real estate agents have been very spoiled lately.  More than 98% of the agents will be trying to get business from the 95% of the market that is not in foreclosure, of which only 2% of the people may be in the market to buy or sell a home.

Foreclosures historically represented a very small percentage of the market, but today it is growing rapidly.  Most agents that do not have the proper knowledge think it is hard to work the foreclosure market, that short sales are too hard and that there is too much competition.  Most agents have no system, no consistency in communication and ineffective marketing plans to work with foreclosures.

5.       Lenders want to foreclose. The reality is that lenders are in the business of lending money.  The last thing they want to do is foreclose on a property.  Lenders are very fearful about the coming wave of foreclosures.  When a loan is performing, it is an asset.  The last thing a lender wants to do is have a large number of non-performing assets, because it impacts their credit rating and they have to set aside their cash reserves.  Lenders are very receptive to professionals who can help them resolve their non-performing asset issues.

6.       Lenders make money on foreclosures.  In reality, lenders lose money – a lot of money – when they foreclose.  The average loss per loan was nearly $60,000 in 2005.  Today, the losses far exceed that amount.

7.         Foreclosure is hard to stop; it happens quickly.  There are two different types of foreclosure processes and each is different.  In reality, the foreclosure laws do not protect the lender, but protect the homeowner.  It is true that there is a clock ticking and it’s an urgency you need to convey to the homeowner in foreclosure, but there is usually sufficient time for a borrower to take the necessary steps to deal with the foreclosure.  In Idaho, the primary form of foreclosure is non-judicial, which takes about four months from the time the lender starts the process.  If you can get in front of the borrower early enough, there is adequate time for them to take the necessary steps to alleviate their situation.

Options to Stay in the Property

A.        General Options:

1.         Cure – Reinstate:   Once a borrower has been placed in default, they have an opportunity to cure the default (also called reinstatement), of their loan.  Borrowers have basically two separate time periods within which to cure a default.  The first time period is set forth in the note and deed of trust, and usually gives them about 30 days to cure before a notice of default can be recorded.  The second time period for reinstatement commences after the Notice of Default has been recorded (this time period is determined by state law).  In Idaho, the right commences upon the recording of the notice of default and is available only 115 days after the notice of default is recorded.  The right to reinstatement is an absolute right, which cannot be shortened or terminated by the lender.

2.         Redemption:  Redemption is defined as paying off the loan in full.  At all times, until the foreclosure auction actually takes place, the borrower has an absolute right to “pay off” the loan that is in default – the borrower can redeem the loan.  This right extends up until the gavel falls at the auction.  In most cases, this pay off of the defaulted loan occurs through a refinance of the property with a new lender providing a new loan to the borrower.

3.         Refinances:  A refinance can be total and act as a redemption like above or it can be a “partial” where only enough funds are borrowed to reinstate the defaulted loan.  The new lender would then place a junior lien on the property.  Refinances are considered conventional or equity.

a.    Conventional Refinance:    A conventional refinance is one that occurs in the ordinary marketplace.  Practically speaking, however, unless the borrower has substantial equity in the property, it is difficult to secure a refinance under today’s new tightened credit standards, because of the damage to the borrower's credit from the foreclosure filing.

b.    Equity Loan: Equity lenders are commonly referred to as “hard money” lenders.  A hard money loan is not based solely upon the equity in the property.  Most equity lenders will not lend beyond 70% or 75% of the value of the property.  This is because, in the event the loan is not be paid, it allows the equity lender enough of a cushion to foreclose on the property and resell it to recoup the amount of the loan at a minimum, and perhaps some equity as well.

4.      Loss Mitigation Options:   With this recent wave of foreclosures, lenders are using loss mitigation tools at very opportunity.  The word “mitigation” means to “reduce or lessen.”  Thus, when lenders engage in loss mitigation, they are trying to reduce the losses to their bottom line and, hopefully, return a non-performing loan back to performing status.  Because of the huge number of foreclosures being filed and the flood of REOs coming back to the lenders, they have never been so agreeable in providing loss mitigation options to borrowers that would allow borrowers to stay in their homes.

         The loss mitigation options, which follow, are the common ones that are made available from most lenders and are fairly similar in form and qualifying standards.  These options are based upon the general philosophy that for a lender to minimize losses, they must foreclose only as a last resort.  The five basic option structures that follow have been utilized in one form or another since the early 1990s when the Department of Housing and Urban Development (HUD) first published detailed rules for loss mitigation of delinquent loans.  Most lenders follow the same general rules and guidelines subject only to special regulations, internal policies, or restrictions in the pooling and servicing agreements of securitized loans.  The discussion, which follows, will look at the general rules and requirements and note differences in policies between lenders where it may be deemed important.  The general loss mitigation categories that allow a borrower to retain their home are forbearance, repayment plan, loan modification and advance claims.

a.  Forbearance:    If a borrower can demonstrate to a lender that temporary circumstances have resulted in the borrower’s inability to make loan payments, the lender may enter into a forbearance plan with the borrower wherein it agrees to forbear or delay from starting or continuing with a foreclosure as long as the borrower can cure the default within a set time.  If the borrower can show the lender how they will be able to cure the default, the lender may simply suspend payments for three to six months.  A forbearance can be granted when a borrower has proven to the lender that they will have a financial windfall, perhaps a large tax refund or inheritance in the near future, so that the lender will agree to suspend payments until that time arrives.

b.  Repayment Plan: A repayment plan is similar to forbearance in that the borrower must demonstrate to the lender that they have had temporary circumstances which have resulted in the borrower’s inability to make loan payments.  The difference is the borrower does not believe it will receive enough funds sufficient to reinstate the loan all at one time.  In this situation, the lender will frequently combine forbearance from beginning foreclosure with a repayment plan wherein the borrower will make extra payments each month over a set period of time until they can catch up.  For example, if the borrower is three months behind, the lender may allow them to make one and half payments each month for six months until the loan default is cured.  Many repayment plans fail because, unless the borrower’s circumstances substantially improve, they are less likely to be able to make larger mortgage payments than they were making before they went into default.  In the past, repayment plans were usually limited to 6-12 months in length.  Now lenders are extending the terms to up to 24 months.

c.  Special Forbearance: Some lenders or government agencies combine a payment forbearance and repayment plan as part of a single loss mitigation strategy for a borrower.  HUD/FHA has a program called a “special forbearance.”  This can include a temporary reduction or suspension of the mortgage payments until the borrower can re-establish financial stability and/or a permanent revision in the payment amount to reflect the borrower’s new financial status.  HUD does not require a “hardship” test to determine eligibility for this loss mitigation option.  Even though a hardship is usually required for a short sale, it is not usually required for a repayment plan.  Not requiring encourages more participation in these earlier loss mitigation options.

     On the following pages you will find a summary sheet from HUD outlining the special forbearance program in more detail and a checklist loss mitigators are to use to determine someone’s eligibility for the special forbearance program.  Additionally, you will also find the loss mitigator’s guide to special forbearance for USDA loans along with the special forbearance checklist for loss mitigators to utilize in determining the borrower’s eligibility for its program.

d.  Special Considerations for Forbearance and Repayment Plans for Securitized Mortgages: Remember, as we discussed earlier, that sometimes-special considerations must be made for those loans which have been securitized and sold.  FNMA, in Announcement #06-27 on December 29, 2006, amended some of its guidelines for forbearance and repayment plans for loans that are part of mortgage-backed securities pools.  In order to comply with those pooling and servicing agreements, temporary forbearance, which they define as a temporary suspension or reduction in borrower payments, may be made for no more than four consecutive months.  Thereafter, for a mortgage loan to remain in a MBS pool, the mortgage loan must become current or have been placed in a repayment plan, be in bankruptcy, or referred for foreclosure.

With regard to repayment plans on MBS loans, they have to provide for all delinquent or past due payments of principal and interest to be brought current within a period of not more than 18 months calculated from the first effective date in the repayment plan.  However, if the delinquency involves fewer than three monthly payments, repayment plans can be made through oral agreements with the borrower.  Formal written agreements are required if the delinquency is three months or longer; each agreement clearly stating the amount in arrears, the due date of each payment and the final due date by which the delinquency must be cured.

e.    Loan Modification: When a borrower’s circumstances require more than a forbearance or repayment plan because their income has not increased, a loan modification might be the best solution.  If the borrower can demonstrate to the lender that they will be able to commence making the regular loan payments in a specified amount in the near future, the lender may enter into a loan modification with the borrower.

What a loan modification can do is to amend the terms of the loan.  Some common modifications extend the term of the loan by either putting the missed payments on the back of the loan or taking the arrearages as a lump sum and adding it to the principal and re-amortizing the loan over the same or a longer term.  Loan modifications are quite flexible in order to allow the borrower to keep their home.  In some instances it may be something as simple as reducing the interest rate to a lower rate so that the monthly payment is lowered to an amount that the borrower can afford to make.  In essence, this has the same effect as a refinance, but the borrower is getting a lower interest rate than they could have on the open market, and do not have to incur the costs and expenses of a new loan.  To deal with the problem of all the ARMs resetting today, many lenders are extending the term of the fixed rate loan for an additional two or three years.

Loan modifications have not been used very extensively in the past.  However, in the new foreclosure cycle that is beginning, lenders have started using this tool more and more to decrease the number of loans that are short sold or returned to the lender through REO.  This is an especially easy solution when you consider the number of sub-prime loans that are going into default simply because the loan interest rate has reset, making the monthly payment unaffordable for the borrower.  By modifying the loan to temporarily fix the interest rate at more reasonable level keeps the borrower in their home and keeps a loan performing that was current before the payment shock when the ARM reset.

A problem with loan modifications is that many of the pooling and servicing agreements limit the services’ ability to modify a loan.  In fact with all FNMA loans, loan modifications are not permitted in the pools that they sell, rather FNMA is required to repurchase each loan and then FNMA can enter into a modification agreement with the borrower.

Loans that have been pooled into securities and sold to investors worldwide often are controlled by rules and restrictions governing the changes that may be legally permissible.  Some bond structures limit the number of loans inside the pool that can have their terms or payment requirements changed in any way.   Others strictly limit the types of modifications that can be made.  Federal tax and securities rules also restrain bond trustees from permitting wholesale modifications, however, well intentioned, within the pool.  A movement is currently afoot to get these restrictions relaxed.

One concern has always been that if there are re-defaults on modified loans, it will result in higher ultimate losses to the lender.  In other words, the lender has just delayed the inevitable and made their situation worse by approving a loan modification.  Due to the significant increase in foreclosures and, now, REOs, however, servicers have been more lenient in this analysis in approving more modifications.  Some of the criteria and checklists for loan modifications programs for HUD loans and USDA loans that are used by the loss mitigators follow this section.

f.   Partial Claims:   Another option that was not frequently utilized in the past, but is   now becoming more common, is the “partial claim”.  Depending on the lender offering this position, it goes by several other names: Claims Advance, Pre-Claim Advance, and PMI Advance Claim.  What this option usually involves is the mortgage insurer or mortgage guarantor making an interest free or low interest loan to the borrower in an amount sufficient to bring their mortgage current and remove them from foreclosure.  Repayment of this new loan may be delayed for several years or not even due until the property is resold.

     Under this type of program, a one-time payment is made by the mortgage guarantor or insurer to the lender to cover all or a portion of the default.  The borrower then is required to sign a note and a deed of trust securing the property for the amount of the claim payable to the party advancing the money.  The repayment terms of this type of note is usually structured based upon the borrower’s ability to repay the note at some point in the future if possible.  If it appears to the party advancing the claim that this may be difficult to determine, they may not make the not due until the property is sold.

     The eligibility of borrowers for this program varies greatly among the mortgage insurers and guarantors.  If someone truly wants to stay in their home and has not utilized this option before, it is one that should be seriously considered.  This type of program allows the borrower to secure a junior loan on the property to stop the foreclosure when they would not have been able to qualify for a loan in the open market because of the pending foreclosure.  In some instances these advance claim programs do not even required any equity in the property.

     To qualify for this type of program, the borrower must be able to prove that the hardship that caused him to miss the mortgage payments has ended, and that if the lender does bring their loan current; they will then be able to again start making their mortgage payments on a regular basis.  Further if the pre-claim advance required them to make any payments on the new sum that has been loaned, they will also have to show positive cash flow sufficient to make this payment well.

     One important point is that some of the insurers, such as HUD, will not pay any late charges, foreclosure fees or costs in the pre-claim advance.  They are limited only to the PITI payments that are in arrears.  HUD expects either the borrower to come up with the difference or the lender to waive the charges.  Following this section are the program standards and a loss mitigator’s checklist for determining eligibility for a partial claim along with a model security instrument and promissory note forms that lenders utilize for partial claims.

5.    Options to Sell the Property:  In instances where the borrower is unable to qualify for any of the programs above that would allow them to stay in the property, they must consider selling the property in order to resolve their financial difficulties.  Sometimes borrowers need to realize that it is in their best interest to sell the property and get out from under the defaulted loan.

a.    Conventional Sale: In this circumstance, the defaulting borrower will list the property with an agent or sell it themselves on the open market hoping to recoup enough funds to pay off the defaulted mortgage and other liens on the property.  In some states, California for example, if an agent is listing a property that is in foreclosure, whether or not there is enough equity to pay off the loan; the agent will need to be familiar with specific state laws that govern the sale of property that is in foreclosure.  This is true whether or not there is any equity in the property.

b.    Seller Carry Sale:  In situations where time may be short and there is equity in the property, but the seller is not attracting any buyers, the property can be advertised a “seller carry” sale.  This means that the seller of the property is willing to carry back some of the financing in a junior deed of trust in order to facilitate a sale.  Because seller carry back financing can act as a down payment for sub-prime borrowers, it opens up a pool of additional buyers for the property that would not have been otherwise been available.  For a seller carry back to work in today’s lending environment, it is usually necessary there be a sufficient real equity cushion in the property to cover the amount that the seller is carrying back.

c.    Sell “Subject To”:     As has been discussed earlier, selling a property “subject to” means that a property is being sold to a buyer subject to the existing financing.  This means that the existing loans on the property will not be paid off at closing, nor formally assumed, but the buyer agrees to assume responsibility for payment of those loans and relieve the seller of the obligation.  When this type of sale occurs, usually one of the requirements of the subject to transaction is that the buyer will come in with enough funds to cure the amount of any defaulted loans.  The buyer may also pay the seller for any remaining equity or have the seller carry back a note for the seller’s equity.

It should be noted that in most subject to transactions there is never a formal assumption of any of the loans by the buyer.  Because of this, the primary responsibility is still upon the seller to see that the loans are timely paid if the buyer quits paying them.  One reason for this is that there are really no easily assumable loans left in marketplace today.  For most loans to be assumed, it would require formal qualifying by the buyer, which is not something that most buyers would want to go through to purchase a foreclosure property.  This is because the subject to transaction allows someone to buy a property with little money down, usually only the amount required to cure the existing default.

Of course the risk in this is, because the buyer has not having formally assumed the loan, the seller is still on the hook for the monthly payments and full payment of the mortgage obligation.  Thus, any missed payments by the buyer can further damage the seller’s credit.  These types of transactions should be entered into with caution; with the advice of a professional, or the seller may find that they have left themselves with no recourse if the property enters into foreclosure at some period in the future.  Rather than having solved the problem, they have simply delayed it.

A final issue to always keep in mind in subject to transactions is that the transaction will most likely be a violation of the “due on sale” clause of the loan.  This topic will be discussed at length later on.  The primary advantage of selling subject to is that, again, it greatly expands the pool of available buyers for the property by offering no-qualifying, flexible financing terms.  Also, subject to transactions can be completed very quickly.  So if time is of the essence, they can be a very useful tool for a defaulted borrower to solve a foreclosure.

d.   Short Sale:   This is the sale of a property by the borrower for less than the amount necessary to pay off the loan in full wherein the lender agrees to accept the net proceeds from the sale to be applied toward the debt and release its lien on the property.

      A short sale also has several other names, depending upon which agency is involved in the transaction.  For most conventional lenders, this type of transaction used to be referred to as “short pay” or “pre-sale”, but now the most universally used term is “short sale”.  If you are dealing with a FHA property insured by HUD, it is called a “pre-foreclosure sale”.  All of these terms mean essentially the same thin; the only difference between them is some of the qualifying standards or requirements of the lender.

      Because a short sale can occur when there is little or even negative equity in a property, a short sale has the ability to create a transaction where previously one was not possible.  In essence, by reducing the amount of the debt to an amount sufficient to close the transaction, equity is created out of thin air.  The lenders are motivated to allow short sales because it reduces their total loss from foreclosure, they can liquidate a property quicker and they don’t risk acquiring the property later as a REO.  Because the short sale is the subject of this certification course, the details and procedures of the short sale process will be discussed throughout it.

e.   Deed-in-Lieu:    A deed-in-lieu of foreclosure is when a lender agrees to allow the borrower to simply deed the property back to the lender in exchange for extinguishing the loan obligation.  This allows the lender to acquire title to the property quickly.  For the borrower, it simply brings the whole foreclosure to an end sooner.

      In an effort to prompt more borrowers to execute deeds-in-lieu of foreclosure, some lenders are now offering cash incentives to borrowers.  Lenders have determined it is far cheaper to pay a small incentive now than going through the foreclosure process and possibly even paying for a post-foreclosure eviction.  In the past, making a payment to the borrower would have been unheard of, but in today’s market with the astronomically increasing foreclosures, lenders are being more practical and recognizing the value of getting a property back quicker.

      HUD offers an example of these programs.  For HUD-insured loans, their deed-in-lieu program allows the lender to take the property back and, in exchange, forgive the balance of the debt from the borrower.  Generally, however, HUD requires that the borrower must first attempt to sell the home for its fair market value for 90 days before the lender will consider this option.  This requirement also means that, because it being marketed for its fair market value, it includes short sales.  HUD will pay inventive for a deed-in-lieu of foreclosure in an amount up to $2,000.  This $2,000 can be used as funds to be paid to the borrower upon vacating the property or it can be used to pay off junior liens in order to clear the title.  However between the junior liens and the borrower, the total amount cannot exceed $2,000.

      A limitation with this option is that, if there are any other encumbrances against the property, whether a junior loan, judgements, tax liens, or anything else clouds the title, the deed-in-lieu of foreclosure may not be doable because those liens would remain on the property’s title when it is deeded back to the lender.  If the junior lien holders are unwilling to do so, then completing a foreclosure would be the only legal way to remove the liens from the title to the property.

      HUD generally limits the acceptance of a deed-in-lieu from owners who occupy the property.  HUD states that decisions to accept a deed-in-lieu for non-owner occupied properties must be considered carefully, especially if the properties are being used for rental purposes.  HUD has stated the purpose of a deed-in-lieu is not to provide a bailout for builders, investors, or even some that took title through the foreclosure of a junior lien obligation.

      A couple of additional points with regard to the deed-in-lieu are that if there is a loan deficiency that will result from taking the property back, the deficiency of debt forgiveness must be reported to the Internal Revenue Service as income received by the borrower.  It is also questionable whether there is a benefit to the borrower from executing a deed-in-lieu of foreclosure versus allowing a foreclosure to be completed.  HUD implies on its website that there is a credit benefit to borrowers for executing the deed-in-lieu of foreclosure.  It states, “This won’t save your house, but it is not as damaging to your credit rating as a foreclosure.”  In a separate section of HUD’s website, the following statement also appears:  “This is a negotiated settlement wherein the borrower deeds the house back to the lender, saving the FHA insurance funds some legal costs and the borrower all of the credit ramifications of a foreclosure.”  That is a bold statement to make unless HUD is reporting deeds-in-lieu of foreclosure to credit agencies in a way that leaves the inference that the borrower paid the loan off in full according to its terms.

      On the following pages you will find sample deed-in-lieu of foreclosure criteria from the USDA, including the loss mitigator’s checklist to be utilized in considering a borrower for a deed-in-lieu, and a simple checklist from HUD for loss mitigators.

f.    Assumption of Loans:   Approximately 30 years ago, many loans were non-qualifying assumable loans, which made transfer of properties subject to existing financing via a simple assumption a fairly common practice.  Since the mid-1080s, these types of loans have pretty much disappeared.  However, one type of additional loss mitigation method now starting to be used more is loan assumption.  In some instances, a new buyer for a property may not be able to qualify to completely refinance the property and pay off the loan.  However, they may have better credit or better income than the current borrower and, thus are more likely to be able to pay the loan as agreed.

      In these situations, lenders are now considering the use of assumptions as an additional loss mitigation tool when there is a stronger, more qualified buyer available to assume the delinquent borrower’s obligation on the loan.  Thus, a new buyer who would not normally qualify for an assumption of the loan under ordinary circumstances may qualify for an assumption in a loss mitigation context.  Whether or not the original borrower is released from liability on this loan when it is assumed remains a negotiating point with the loss mitigator.  Obviously a seller trying to have his loan assumed by the buyer would want to be released from liability from the loan, if at all possible.

      Thus, as an agent, this may be an additional way to create a transaction where you believed one was not possible before.  If you are listing a property and having trouble finding a qualified buyer, advertising the possibility of loan assumption in your listing may bring additional buyers to the table.  This is especially true because of the tightening of the lending standards in the sub-prime market.

      The lender may approve someone who has already been turned down for a loan.  The same opportunity is present if you are a buyer’s agent representing an individual who is having trouble qualifying for a loan – you could approach sellers in distress or foreclosure to see if a loan assumption might be possible.

6. File Bankruptcy:     The filing of a bankruptcy by a borrower automatically and instantly stops the foreclosure.  This tactic can be used to buy the borrower time to close a transaction or may even allow the borrower to retain their home while repay the default over a period of up to five years.  This option is discussed in more detail at the end of this section of the course.

7. Using Military Status:     If a borrower is a member of the armed services on active duty and extended deployment, they can request a court to temporarily postpone a foreclosure or eviction and even reduce the interest rate on their mortgage payments.  These rights are contained in the “Soldiers and Sailors Civil Relief Act of 1941.”  This act is now called the “Servicemembers Civil Relief Act (SCRA).”