Defaults on notes secured by real estate give you, the note holder, more avenues to pursue than you may realize. Few note holders welcome a default. It is important to be aware of practical and legal choices you have, when faced with a payor who is not paying your note. While the pros and cons of all of these options will be detailed, understand that the laws vary dramatically throughout the country. Be sure to check with your attorney to be certain which of these methods of dealing with defaults are open to you.
A few basics may be useful before exploring your legal options. The note you hold is an “I Owe You”: a promise and an obligation of the payor to pay the debt owed to you for financing the payor's property. The Deed of Trust, or Mortgage on the property, is the security for that debt. If your payor has been neglectful about paying your note, or is no longer willing or able to make the payments, you may be facing a default situation.
Be aware that, if the payor is having a problem, it's always better to try to work out a practical solution. There are numerous ways in which creative problem-solving may come into play. A first step would be to communicate clearly with the payor. You need to listen carefully to be aware of the payor's perceptions of the problem and compare them to your own. This process assists in finding a solution to cure or prevent a default. It is possible that you may consider alternatives such as eliminating balloon payments, waiving unpaid payments, getting additional security or a new guarantor on the note, or, even increasing the interest rate and lowering the payments. Amending your agreement with the payor may allow you to realize your debt more quickly. If you do amend your agreement, it is critical that you have a competent attorney document the changes. If you are a senior lien holder, it is prudent to get junior lien holders' permission for these changes, to protect your lien's seniority.
The best solution to a default situation could be, surprisingly, to do nothing at all. Sometimes, if you ignore the situation, time has a way of healing and the problem will solve itself. Keep in mind that your lien on the property will usually remain intact until you release it voluntarily, or your lien is eliminated by a senior lien foreclosure. Your lien is a cloud against the title and eventually must be dealt with if the property is sold or refinanced.
If you choose the option of doing nothing, it's imperative to be aware that there are often legal limits to the amount of time you can wait. This is called the Statute of Limitations. Some legal action may be required within this time period so you don't lose your right to collect or foreclose. If you are a junior lien holder, you must stay informed of the status of the senior lien holder; so your security is not lost.
It's wise to investigate the physical condition of the property. If the property is deteriorated, you might be liable for injury to others by doing nothing.
If you want to get out of the picture, you can possibly sell your delinquent note for cash. However, you must realize there is a narrow marketplace for such a sale. In addition, you will be offered very little cash, so be prepared to take a substantial loss. Further, when you sell the note, it's important that you sell it “without recourse” to avoid guaranteeing the note payments.
Pursuing the following legal remedies are the final options toward enforcing your rights. When a default on your note is at hand, your legal choices in dealing with this default are:
- to sue on the note only,
- to foreclose in-court,
- to foreclose out-of-court, or
- to take the Deed to the property.
Let's look at each alternative in more detail.
Sue On The Note
You may choose to sue only on the note. There are several reasons for this choice. The payor may have other assets that could be attached. Maybe, you don't want the property. Perhaps, the note you hold is no longer secured, due to completion of a foreclosure superior to your position.
In this case, you are instituting a lawsuit in court against the payor, asking the court to require the payor to pay all money owed to you. A judgment may be obtained in court, stating that the full amount of the note is payable to you immediately. This judgment attaches all non-exempt assets owned by the payor and allows you to take those payor's assets which satisfy the amount of the judgment. Exempt assets are those necessary for the payor's livelihood and are specified by state or federal law.
Some states do not allow you to sue on the note. In many states, if you choose to sue on the note, you can never foreclose on the Deed of Trust or Mortgage. Other states require you to foreclose first, before you may sue on the note.
A suit on the note is not a foreclosure on the property. This alternative is the least utilized. Normally, the secured property is your favored source for satisfying the note.
An in-court foreclosure is called a judicial foreclosure, another form of a lawsuit. The in-court foreclosure laws vary a great deal from state to state; therefore, an attorney is crucial in this process. The in-court foreclosure allows you to institute a lawsuit calling the entire note due (accelerating the note) and requesting a court ordered sale of the property to satisfy the note. Usually, bringing the payments current is not enough to stop the foreclosure and, therefore, the entire note must be paid off. Judicial foreclosure is the only type of foreclosure available in some states.
Another form of judicial foreclosure permits you to call the note due, taking both the property to satisfy your debt and, also, gaining a Deficiency Judgment against the payor. The Deficiency Judgment demands that, if you do not get all your money from the foreclosure sale of the property, the rest of the debt should be paid by the payor. In essence, this type of judgment lets you sell the property to satisfy part of the note and obligates the payor to pay the difference. Sometimes, a Deficiency Judgment is only allowable on certain types of properties, and often is not allowed for personal residence foreclosures.
There are many reasons for a judicial foreclosure. Your particular state may not allow out-of-court foreclosure. Possibly, the payor has disputes with you or a former owner of the note. You may also want to have a receiver appointed to collect revenues. Or, you may want a Deficiency Judgment. You may usually want a Deficiency Judgment for two reasons: your payor has other assets which you think can be used to pay the debt; or the property has become devalued, due to lowering of the real estate value or destruction of the property.
Be sensitive to the disadvantages of this option. A difficult reality of judicial foreclosure, is the possibility of resulting Redemption Rights of the payor. Through the Redemption Rights, the payor may pay off the debt within a specific time period, after the court ordered sale of the property. Moreover, the legal process can be lengthy, which is costly to you, both in fees and delayed or reduced payments.
The most popular choice in a default situation is the foreclosure which takes place out of court. This is called a non-judicial foreclosure, usually performed by an attorney or a foreclosure professional. If this is an alternative in your state, you may re-take the property without getting any other compensation from the payor. However, some states do allow a Deficiency Judgement after the property foreclosure is completed. In most states, the payor has the option to bring the payments current, prior to foreclosure. Otherwise, a foreclosure sale of the property takes place, whereby you are either paid off or end up with the property yourself.
This type of foreclosure is chosen ordinarily when the payor apparently has no other assets or ability to pay, when the property is worth more than what is owing on the note, or when language in the documents dictate this as the only legal option. The advantages are that courts are avoided; thereby decreasing the waiting time, costs, and attorney's fees. In some states, the Redemption Rights are also eliminated. This process is generally the simpler choice.
There are distinct disadvantages to an out-of-court foreclosure, though. The payor can choose to bring the payments up to date, in which case, the note may not have to be paid off. You may then find yourself going into the non-judicial foreclosure proceedings with the same payor again and again. Also, a payor with disputes may force you into court to get out of paying all or part of the note.
Both in-court and out-of-court foreclosures may incur the resentment of the payor. The payor may pocket revenues from the property, occupy the property during the proceedings without paying, and/or destroy the property. Eviction may also become necessary, after completion of the foreclosure and/or Redemption Rights.
Deed In Lieu Of Foreclosure
The fourth method of dealing with defaults is to take the Deed in lieu of foreclosure. While this method is the fastest and least expensive, the payor must choose to cooperate. Usually, the payor is then “off the hook” for the debt, and you are possessor of the property. The payor frequently believes this is the appropriate or most honorable way to deal with a default. However, the payor may be trying to avoid a Deficiency Judgment. When a payor is pressing you to take the Deed, the ultimate choice is yours. Many times, the payor may decide to give you the Deed after foreclosure proceedings have begun.
Taking the Deed gives you immediate control over the property, so the property can provide revenue and deterioration can be minimized. Be aware that you may be anxious at this point to take the Deed. Take the time to make a careful title search, scrutinizing all the liens on the property. Then, have your attorney word the Deed properly, to maintain your rights to foreclose against junior lienholders.
The drawback to taking the deed is that you only get the property and nothing else. However, there are times when, to avoid a Deficiency Judgement and a poor credit rating, the payor may agree to owe you a portion of the note, in addition to giving you the deed.
The challenge with all of the legal methods of dealing with defaults is the possibility of the payor declaring bankruptcy. Bankruptcy creates many delays, and is the situation you most want to avoid. If you sue on the note, you may not be able to collect. Your foreclosure in and out of court may be stalled for some time, costing you money. In rare cases, part of your security may be taken away, if the property has greatly diminished in value. This is called Cram Down or Lien Stripping. You may also lose substantial interest, late charges, and attorney's fees. Although uncommon, it is possible the entire note may be rewritten to your disadvantage. If you accept a Deed in lieu of the payment, the bankruptcy court may reverse it, citing preferential treatment to you. Since bankruptcy is an option for the payor, you must be aware of the problems you will face in that instance.
When the payor is having problems, remember creative problem-solving or doing nothing. It is always in your best interest to work something out with the payor, if you are facing a default. You have the opportunity at that time to create an agreement which avoids legal procedures. If, however, the payor is unwilling or unable to accommodate you and selling your note is not feasible, it is useful to consider your legal options. Suing on the note allows you the right to be paid for the money owed, without taking the property.
In-court foreclosure may be the only option in your state, and may entitle you to be paid for a property which has diminished in value. Out-of-court foreclosure is cheaper, faster and simpler; although the payor may be able to bring the payments current at any time in the process. The payor can agree to give you the Deed in lieu of payment, so long as you have some protection from other lienholders. Be cautious about pushing the payor into declaring bankruptcy, which could delay or restrict your being compensated for the debt. It is most important that your attorney examines the state and federal laws applicable before dealing with a default situation.