This article will provide a general summary of real property foreclosure procedures, timelines and strategies for borrowers and lenders in California.
As a precursor, it helps to understand that the creditor typically has a promissory note evidencing the loan or mortgage, which is secured by a recorded deed of trust. The deed of trust identifies the trustor, trustee and beneficiary, as well as the property securing the note. The truster is the debtor, and the beneficiary is the lender. The trustee is a neutral third party instructed to cancel the note and reconvey the deed of trust upon payment of the obligation, or to foreclose on the property in the event of a default on payment of the note. Trustees will almost always require the original note to do either.
The beneficiary/lender holding a deed of trust may generally foreclose by two different methods in California: (1) judicial foreclosure, and (2) non-judicial foreclosure (power of sale auction). The latter method constitutes about 99% of all foreclosures in California, for reasons discussed below.
A judicial foreclosure requires court action (lawsuit before a judge), and is generally used only to resolve complex and subjective issues and disputes involving the chain of title, destruction of property (“waste”), and fraud. The other primary advantage to this method of foreclosure is the possibility of obtaining a deficiency judgment (i.e., a judgment against the debtor for the difference between the value of the foreclosed property and the amount of the debt).
The primary disadvantage to a judicial foreclosure, and the reason so few creditors choose this route, is that the court action typically takes 8-14 months, at substantial expense to the creditor. The foreclosing creditor usually must hire an attorney to prosecute the case, while the debtor continues to occupy the property (and sometimes intentionally damage and strip it) without making any mortgage payments. Further, the outcome of the lawsuit can be uncertain. For these reasons, very few creditors pursue this method of foreclosure.
A secured creditor may pursue a non-judicial foreclosure if the deed of trust includes a “power-of-sale” clause authorizing the trustee to sell the property for monetary default, as is common. This primary advantages to this method include expediency, relatively low costs, and a more certain schedule and outcome. A non-judicial foreclosure generally takes about 4-5 months to complete if handled by a qualified trustee. The primary disadvantage is the creditor’s inability to obtain a deficiency judgment against the debtor.
The non-judicial foreclosure process basically involves three stages: (1) recording a Notice of Default, (2) publication, posting and mailing of a Notice of Sale, and (3) the trustee’s sale.
In the first stage, the lender/beneficiary informs the trustee that the borrower/trustor has defaulted. The trustee then prepares and has the lender execute a Substitution of Trustee and a Notice of Default, which the trustee then records with the County Recorder and mails to the borrower and other parties who have recorded a Special Request for Notice. The trustee also orders a trustee sale guarantee from a title company. (For owner-occupied residential property, Senate Bill 1137, effective as of September 6, 2008, requires the lender/beneficiary make certain efforts to contact the borrower at least 30 days prior to recording a Notice of Default.) The borrower has a 3-month opportunity from the recording of the Notice of Default to bring the account current with the lender or to pay off the entire debt. (Senate Bill 7 and Assembly Bill 7, expected to become effective in May 2009, and expire on January 1, 2011, provide that for loans secured by a first deed of trust, recorded between January 1, 2003 and January 1, 2008, on the borrower’s principal residence, the reinstatement period is 3 months plus 90 days, subject to possible exemption for a lender with a “comprehensive loan modification program.”)
In the second stage, the trustee mails a Notice of Sale to the IRS and California Franchise Tax Board, if required, at least 25 days prior to the sale date; and at least 20 days prior to the sale date mails the same notice to the borrower and other parties requesting notice, and posts the Notice of Sale on the property and in a public place, usually the county courthouse. The trustee must also publish the notice for three consecutive weeks in a newspaper within the judicial district, the cost of which can be substantial in some areas. For owner-occupied residential property, Senate Bill 1137 also requires posting of a Notice to Residents and mailing of a Notice to Residents. The Notice of Sale is recorded with the County Recorder’s Office 14 days prior to the sale.
In the third and final stage, the borrower’s reinstatement right expires five business days prior to the sale date, and the property is sold on the sale date, usually on the courthouse steps, to the highest bidder. At the sale, the beneficiary gets a credit for the opening bid, in an amount equal to the monies due the lender plus foreclosure fees and costs. Anyone else bidding at the sale must have cashier’s checks (payable to the bidder in case they are not used). After the sale, the trustee records the trustee’s deed and disburses funds to the lender. The successful bidder cannot obtain title insurance with respect to the purchase, though subsequent purchasers can.
Under Senate Bill 1137, the party taking title at the trustee’s sale must also maintain the property, or risk a fine of $1,000 per day, and any tenants (other than the borrower/owner) must be given 60 days notice prior to being required to quit the property. Tenants can be required to pay rent during their occupancy.
Lender Strategic Recommendations
Contact a reputable trustee to handle the entire foreclosure proceeding. The California Civil Code generally allows for either the trustee’s fees or attorney’s fees to be passed on to the borrower through a non-judicial foreclosure, but not both. The trustee’s fees are fixed by statute at 1% of the debt balance, so unless the attorney can handle the entire foreclosure proceeding for less, it will be more economical to retain the trustee as soon as possible.
After the sale, make sure any former owner-occupants receive a 3-day notice to quit, and any other tenants receive a 60-day notice to quit (assuming the city in which the property is located has not imposed a moratorium on evicting tenants of foreclosed residential properties). Because it can be tough to identify all of the occupants, and a defective notice has no legal effect, a 60-day notice is always safer. A plan to reasonably maintain the property should also be promptly implemented to avoid potential fines. In this regard, some lenders may find it economically prudent to offer the occupants approximately $1,000 to turn over the property in good and undamaged condition, along with the keys at the time of sale.
Borrower Strategic Recommendations
A borrower in default or on the verge of default should promptly contact the lender to discuss options, including: (1) forbearance or restructuring of the loan, (2) a short sale, and (3) a deed-in-lieu-of-foreclosure. Often lenders would rather modify the loan (e.g., lower the interest rate, re-amortize the loan over 40 years, reduce or defer a portion of the principal balance, etc.) and forgive late fees than take the property back. However, assuming the borrower and the lender cannot agree on a loan modification or forbearance, the borrower should ask the lender if it will agree to a short sale or a deed-in-lieu-of-foreclosure.
In a short sale, the lender agrees to accept less than the amount owed on the loan because the loan amount exceeds the property value. Before signing a purchase and sale agreement contemplating a short sale, the seller should get the lender’s approval, or condition the sale on the lender’s approval within a specific timeframe. If more than one lender is involved, both will have to be consulted, and the holder of the first deed of trust will usually need to agree to give the holder of the second at least a small portion of the sale proceeds in exchange for cooperation.
A deed-in-lieu-of-foreclosure only works if the lender desires to take back the property. If so, the borrower can offer to deed the property back to the lender, and pay for the lender’s title insurance policy (to protect against junior liens), for the purpose of avoiding the expense and embarrassment of foreclosure and, possibly, preserving a better credit rating. The lender will also want to make sure commercial property or vacant land has not been environmentally contaminated, and may even require the borrower’s indemnification against this risk.
If the lender will not cooperate with the above three strategies, and the foreclosure sale appears imminent, the borrower can possibly delay the sale by: (1) asking the lender to postpone the sale to allow more time for reinstatement, (2) filing for bankruptcy protection, (3) seeking a court injunction, and (4) requiring the lender to produce the original promissory note (which sometimes gets lost in the packaging and bulk-selling of loans). However, employing any of these tactics will simply delay the trustee’s sale, not prevent it. Filing a homestead exemption, transferring title, leasing the property, and even death, will not likely avoid or delay the inevitable.
As stated above, the debtor has no personal liability for the deficiency in the event of a trustee’s sale. However, this difference between the balance of the mortgage and the sale price has generally resulted in taxable “phantom income” to the borrower in the form of forgiveness of debt, causing the lender to send the borrower a 1099-C. The recent Mortgage Forgiveness Debt Relief Act of 2007, now excludes from gross income any amounts attributable to discharge of indebtedness incurred to acquire a principal residence, up to $2,000,000, until January 1, 2010. California’s Franchise Tax Board has adopted similar provisions. This benefit only applies to taxpayers who lose their homes in 2007-2009, and does not apply to investment properties or second homes, or to mortgages incurred subsequent to the home purchase.
Summary & Conclusions
Foreclosures have grown at such an alarming rate in recent years that law makers have attempted to stem the tide with recent legislation designed to force lenders to slow down the process and work with borrowers for alternative solutions. Lenders have been encouraged to adopt loan modification programs intended to help borrowers stay in their homes. Such programs typically include some combination of an interest rate reduction, extended amortization period, deferral of a portion of the principal amount until loan maturity, and reduction of principal, in order to target a ratio of the borrower’s housing-related debt to the borrower’s gross income of 38% or less.
In those situations where the borrower simply cannot or will not cure the default or reach a loan modification agreement with the lender, or the lender will not agree to a short sale or a deed-in-lieu-of-foreclosure, then the lender will likely commence a non-judicial foreclosure, which will take at least four months to complete (while the borrower is not making any payments). Upon such foreclosure, the borrower loses his or her entire ownership interest in the property, but will not be liable for the deficiency; and the lender now has a distressed property on the books to maintain and sell. Therefore, the borrower and the lender might both have been better off if they had successfully negotiated an alternative solution with the help of an objective, qualified professional.
This article is for general informational purposes only, and should not be considered legal advice for any particular matter. Each situation is unique in some respect, and the law is constantly and rapidly changing, such that the information in this article might not apply to a particular situation, or may no longer be current and accurate at the time of reading.