Foreclosure Alternatives for Lenders: Considering Modification, Short Sale, Deed In Lieu of Foreclosure, and Consent Judgment
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Foreclosures can be a lengthy, expensive process for both lenders and borrowers. There are several foreclosure alternatives lenders can consider that often achieve more effective resolutions, which are acceptable to both parties. When both the lender and borrower believe the borrower should remain in possession of the property, modification is certainly the best foreclosure alternative to consider. When borrowers are ready to turn over the keys, there are additional foreclosure alternatives for lenders to consider, such as a deed in lieu of foreclosure, a short sale, or a consent foreclosure judgment.
Modification
Modification can be an advantageous foreclosure alternative for lenders to consider when lenders believe changing the terms of the loan will allow them the best chance to recover amounts owed, such as when the mortgage is undersecured. Mortgage modifications are different from mortgage refinancing. Mortgage refinancing involves replacing an existing mortgage with a new mortgage on different terms. In a mortgage modification, the lender and borrower mutually agree to modify existing loan terms by entering into a modification agreement that provides for a restructuring and continuance of the existing loan. Mortgage modification can occur before a foreclosure, such as when a borrower has missed several payments or voices concerns about their ability to make future payments. The modification agreement will provide new binding loan terms and can allow for provisions such as lower interest rates, extended payment periods, or waiver of interest and penalties. Lenders have flexibility with regards to structuring modification terms and can make any changes temporary or permanent depending upon the circumstances giving rise to the modification. However, lenders must be cautious because mortgage modifications will be treated as a new loan and may require specific qualifications in certain instances.
For lenders considering modification as a foreclosure alternative, the key issue is often identifying whether there are junior liens existing on the property, as modifications may affect lien priority. When there are no junior liens on the property, lenders have tremendous flexibility with their modifications and are not at risk of losing their lien priority. In such instances, modifications can include terms that increase the principal balance or interest rates. However, when junior liens exist on the property, lenders who wish to preserve their lien priority must pay careful attention to not prejudice the junior lienholders. If the modification prejudices the rights of the junior lienholder, then the modification may cause the original loan to lose priority in favor of the junior lienholder. According to Restatement (Third) of Property: Mortgages section 7.3, mortgage modifications such as extending the maturity date or “stretching out” payments are believed to be acceptable modification terms that do not prejudice a junior lien holder.
Short Sale
A short sale is a foreclosure alternative for lenders to consider when the borrower does not wish to keep the property, and the lender does not want to take possession. A short sale occurs when the collateral is sold for an amount less than the amount remaining on the debt. Before a short sale can occur, the seller and lender must agree in writing to the terms of the short sale in an agreement.
For lenders considering a short sale as a foreclosure alternative, the key issue is often drafting a strong short sale agreement. Whatever terms are included in the short sale agreement will be the terms that control the sale of the property and release of liability for the remaining debt, if any. Lenders may only be able to recover any deficiency resulting from the short sale from the borrower personally if such term is specifically included in the short sale agreement. Lenders have tremendous flexibility when drafting a short sale agreement and can always ensure that short sales only occur on their terms. For example, a lender will often reserve the right to make acceptance of a short sale contingent upon their approval or identify the time which the sale of the property must occur. Lenders are wise to consider a short sale when they can obtain favorable terms in the short sale agreement and do not wish to acquire title to the property.
Deed in Lieu of Foreclosure
A deed in lieu of foreclosure is an agreement where the lender cancels some or all of the borrower’s debt in exchange for the borrower voluntarily conveying legal title to the property.
For lenders considering a deed in lieu of foreclosure as a foreclosure alternative, the key issue is whether other liens exist on the property. Since lenders are acquiring legal title to the property, they will acquire title to the property subject to any junior liens or other encumbrances that may exist. Upon consideration of a deed in lieu of foreclosure, lenders should perform a title search on the property to ensure there are no junior liens. If lenders wish to extinguish junior liens, they will need to proceed with a foreclosure. Additionally, when the lender holds an FHA loan, attention will need to be given to Title 24 of the Code of Federal Regulations Section §203.357, to ensure their agreement will satisfy all statutory requirements. Lenders are wise to consider a deed in lieu of foreclosure because they can acquire title to the property immediately and avoid spending unnecessary time and money initiating a foreclosure.
Consent Judgment Foreclosure
A consent judgment foreclosure is a foreclosure alternative for lenders to consider when junior liens exist on the property, such that a deed in lieu would not suffice, or when they are already engaged in a foreclosure proceeding, and the borrower is cooperative. A consent judgment foreclosure occurs when the parties mutually agree to the foreclosure terms in a legally-binding agreement and ask the court to enter a foreclosure judgment against the borrower according to the terms of the agreement. Because a consent judgment foreclosure requires an agreement between the lender and borrower, lenders should specifically identify all material terms surrounding the foreclosure or risk waiving them.
For lenders considering a consent judgment foreclosure as a foreclosure alternative, the key issue is the presence of junior liens existing on the property and the cooperation of the borrower. When junior liens exist on the property, only a foreclosure judgment entered by a court will allow the lender to acquire legal title to the property free and clear from all junior liens and encumbrances. Additionally, only when a borrower is willing to cooperate and consent to the terms of the foreclosure judgment will the lender be able to obtain an uncontested foreclosure judgment from the court. Lenders are wise to consider a consent judgment foreclosure because it allows them to acquire title to property free and clear from all junior liens and encumbrances, and both the lender and borrower will save time and legal expenses resulting from a long drawn out foreclosure proceeding.
Conclusion
Lenders have numerous foreclosure alternatives available at their disposal. Modification can be an attractive option for lenders to consider when changing the terms of the loan will provide the best chance to recover amounts owed and without losing lien priority. Lenders are wise to consider a short sale when they do not wish to acquire title to the property and can obtain favorable terms in the short sale agreement. Otherwise, if the borrower is cooperative and wants to surrender the collateral, lenders can execute a deed in lieu of foreclosure to acquire title to the property, or obtain a consent judgment foreclosure when the property is subject to junior liens and encumbrances. Regardless, lenders are wise to consider foreclosure alternatives as they can save time and money by avoiding a long drawn out foreclosure process.
Authors:
- Austin B. Calhoun, Esq.
- Joseph R. Luna, Esq.
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