I know it hasn’t been that long since I last wrote about foreclosures, but since there is so much discussion, and frankly misinformation, currently circulating on the subject, I thought I would revisit it, with some personal perspective on what it all means today. Perhaps some political leaders could benefit from this information.
What is a foreclosure? In general, it is the legal process that a lender uses to repossess property that is collateral for a loan when the borrower doesn’t repay the loan. There are two methods by which this is done in Arizona, known as judicial foreclosure and trustee sale.
A mortgage and a deed of trust are the two common methods of placing a lien against a parcel of real estate to secure a loan, that is, making property collateral for a loan. When a mortgage or a deed of trust is recorded with the county recorder, the property described in the mortgage or deed of trust becomes collateral, or security, for the loan.
The deed of trust is far more common in present-day Arizona than the mortgage. In a deed of trust, the borrower is called the trustor, the lender is called the beneficiary, and a third party, either a title company or a lawyer, is the trustee. In both a deed of trust and a mortgage, the document contains the description of the property that is collateral for the loan and describes the rights granted to the lender.
Just as the deed of trust is much more commonly used than the mortgage, the trustee sale is by far the more common form of foreclosure in Arizona. The trustee sale starts when the person named as the trustee in the deed of trust signs a notice of trustee sale. The trustee records the notice of trustee sale with the county recorder, publishes a copy of the notice in the newspaper, posts a copy of the notice on the property described in the deed of trust and at the courthouse, and mails a copy of the notice to everyone who has a recorded interest in the property. The date of the sale must be more than ninety days after the notice is recorded.
The judicial foreclosure is the less common, and more old-fashioned, method of foreclosure. It is the only foreclosure method available for a mortgage, although it can also be used to foreclose a deed of trust. A judicial foreclosure proceeds in more or less the same manner as any other civil lawsuit up to the point where judgment is entered. How long a judicial foreclosure takes depends on a number of factors, but it usually takes longer than a trustee sale.
After a judgment has been entered in a judicial foreclosure, and at the time set for the sale in a trustee sale, an auction is held. Anyone can show up at the sale and bid to buy the property. The property is sold to the highest bidder. The highest bidder must be prepared to pay the amount of their bid within a day after the sale unless the highest bidder is the lender, in which case the lender gets a credit for the amount they are owed.
What happens if the highest bid is less than the amount the lender is owed? The answer depends on what type of property is being sold and the method of foreclosure. If the parcel of real estate is larger than two and one-half acres or is used for something other than one house or a duplex, the lender can obtain a judgment against the borrower (known as a deficiency judgment) for the difference between the amount owed (including the costs of the sale) and the value of the property.
If on the other hand the parcel of real estate is two and one-half acres or less in size and is used for one house or a duplex, the lender’s ability to pursue a deficiency judgment depends on what method of foreclosure was used and what type of loan was made. If the lender used a trustee sale, the lender cannot pursue a deficiency judgment. In other words, if the lender uses a trustee sale on a house or duplex on less than two and one-half acres, all the lender gets is either the property (if the lender is the highest bidder at the sale) or the amount of the highest bid (paid by the highest bidder).
If the lender used a judicial foreclosure, then the lender can pursue a deficiency judgment even if the property is a house or duplex on two and one-half acres or less, but only if the mortgage was not given to secure a loan that was used to pay all or part of the purchase price of the property. In other words, if the loan was made for something other than paying for the property, the lender can get a judgment against the borrower for any difference between the amount owed (including the costs of the sale) and the value of the property.
The foreclosure process is a subject that has unfortunately become relevant for a growing number of people. The process hasn’t changed much since I started my career over twenty years ago. Most of the people I talk to about it are surprised when I tell them that in my experience, you have to miss more than a payment or two before the actual foreclosure process even starts. People also often seem surprised when I tell them that even when real estate values have risen, but especially now when they have fallen, your lender doesn’t want to foreclose. The process of taking a property through foreclosure, marketing it, and reselling it is expensive and time consuming. The lender would much rather have you make the payments.
My observation recently is that lenders are increasingly reluctant to pursue foreclosures and are trying harder than ever to keep borrowers current on their payments, which makes sense given the current climate. From my viewpoint this makes the political chatter about a “moratorium on foreclosures” particularly nonsensical. It doesn’t make any sense that at a time when real estate values have declined, lenders need to be restrained from foreclosing. If there is a possibility that the borrower can get caught up, the lender should have ample incentive to work with the borrower without government intervention. If on the other hand there is no chance that the borrower can get caught up, it’s probably better for all parties, and better for the real estate and lending markets, that the property be resold at a price and on loan terms that are consistent with current market conditions.
Perhaps the most important thing for mortgage borrowers in Arizona to know is this: if a foreclosure occurs and the borrower ends up owing the bank more than the property is worth (which can happen, as some people are now realizing for the first time), the bank’s ability to collect the difference between the amount owed and the value of the property depends on the method of foreclosure (trustee sale or judicial foreclosure), the type of property (house or duplex on no more than 2 ½ acres, or something else) and the nature of the loan (a home acquisition loan or a home equity loan). It is not a situation you want to find yourself in, of course, but knowing the rules can help you make the right choices even if you never have to deal with a foreclosure.