That Awful ‘F’ Word: Foreclosure
By Gytis Nefas
Loan foreclosures of real property were at a peak following the financial crisis of 2008. During the COVID-19 epidemic, between 2020 and 2021, a federal moratorium on federally backed loans forestalled foreclosures and resulting owner evictions. Various states also passed similar restrictions on foreclosures during this unprecedented period in our nation’s history. But now in mid-2024, data sources are bubbling up which report that foreclosures are on the rise.
In January 2024, foreclosure starts in California, Florida, Illinois, New York and Texas were at their greatest levels since 2008. It seems now is the time to dust off our foreclosure skillset and revisit its impact on the insuring of title.
What is foreclosure?
Foreclosure is a legal remedy available to a creditor to terminate a borrower’s ability to repay the loan taken out on their property. The borrower loses the right to redeem property pledged as security for a loan when the borrower fails to repay the loan according to the terms of the promissory note they signed. That is a default and considered a breach of the terms and conditions of the loan. Following a foreclosure by a lender, the property is typically sold at a foreclosure sale to satisfy the outstanding debt.
The two most common financing documents used to secure debt are a mortgage or deed of trust. Mortgages are more typical in the Eastern United States, while deeds of trust are used in Georgia and most Western states. The terms are often used interchangeably, even though there are differences in their form and effect.
There are two types of foreclosure procedures: Judicial foreclosure and non-judicial foreclosure. In a judicial foreclosure, the lender files a court action and obtains a judgment allowing the sale of the secured property. A non-judicial foreclosure avoids the judicial process and allows for a sale according to statutory regulation. Foreclosure laws vary between all the states. Most states allow for either judicial or non-judicial foreclosure. A minority of states allow a creditor to collect their debt through a judicial foreclosure only.
Mortgages were a concept developed under the British system of common law, where property was pledged for the performance of a contractual agreement between a debtor and creditor. The mortgage imposes a lien on the property without any change of possession. Mortgages are enforced by judicial action. As we know, such a judicial action can take a long time to complete, allowing the property to decline in value – while the lender incurs attorney fees and costs to collect their money.
Deeds of trust (or trust deeds) were adopted in the 19th Century by creditors seeking to circumvent the delay and procedural red tape imposed by the courts. Trust deeds were developed to avoid the judicial process all together, creating a contractual agreement between the borrower and lender. The deed of trust typically contains a “power of sale” to allow for a non-judicial foreclosure sale, vesting title to the real property in the foreclosing lender. Non-judicial foreclosures are regulated by state statute. Unlike a judicial foreclosure, there is typically no right of redemption available to the borrower under this process. This is a valuable benefit many borrowers may want to take advantage of – particularly in cases of an absentee owner, who only too late learns the property has been foreclosed on by the lender.
Judicial vs. non-judicial foreclosure
What are some differences between a judicial and non-judicial foreclosure? There are tradeoffs for the creditor utilizing each procedure. A creditor may want to proceed by judicial foreclosure, which in some cases, will allow for a deficiency judgment against a borrower whose home has declined in value. If the secured property is worth less than the outstanding loan, some states will allow a judgment for the full amount of the loan, even though the property is worth less. This deficiency judgment allows the lender to pursue other assets of a solvent borrower. The borrower facing a judicial foreclosure is also given, sometimes up to a year after judgment, to redeem the property by paying off the judgment, and all lender costs, in full. Another reason for a judicial foreclosure would be if there was some technical issue with the deed of trust which needs to be “reformed” by court order, such as an incorrect legal description, which could prevent a non-judicial sale.
Under a non-judicial foreclosure sale, the creditor can proceed to sell the secured property to a third-party purchaser within a few months, rather than following a lengthy judicial proceeding. This timing issue is the main advantage of a non-judicial foreclosure. If the value of the property covers the amount owed, the creditor would not need a deficiency judgment. Depending on state statute, the debtor in default may be allowed to reinstate the loan prior to sale; that is, they may pay off the arrearages and stop the sale, continuing making payments as they were before. However, if the foreclosure sale is completed, the debtor has no right to redeem the property. The property is gone – forever.
Title companies and foreclosure
Title company involvement in the foreclosure process can occur in several ways. With respect to a non-judicial foreclosure, a title company can act as a trustee under the deed of trust and conduct the sale. However, with the rise of independent foreclosure companies, there are fewer title company operations conducting foreclosure sales. Title companies are still involved in the foreclosure process by providing necessary title information to the trustee or attorney conducting the sale.
In most Eastern states, the title agent may provide a foreclosure commitment, a title search report or an Owner’s and Encumbrances Report. These products provide the foreclosing lender and their counsel with the names of all parties in title, as well as all parties holding any superior or inferior interests, such as a second-position mortgage, a lien or a judgment which the lender will want to “foreclose out.” The foreclosure process will confirm the lender has a first-position lien on the property and can take title after foreclosure and sale, free and clear of any duly noticed and inferior positioned liens.
Two products are available in the Western states: A Trustee Sale Guarantee and Litigation Guarantee. Both these products afford the trustee of a deed of trust and/or their counsel conducting a non-judicial foreclosure with the names and addresses of all those entitled by statute to receive notice of the impending foreclosure. The information provided is also critical to publication of notices in local business newspapers for parties that are difficult to find. This is a wise investment, particularly if the lender returns to the same title insurer as their original loan policy.
In the case of a judicial foreclosure, the trustee or mortgagee, represented by legal counsel, would require the information and coverage provided by a Litigation Guarantee. Counsel would need to know all possible interest holders disclosed by the public records to properly name all necessary parties to the foreclosure action. This could even include the U.S. Department of Treasury if there are IRS liens against the property.
Insuring real estate owned (REO) property
Real estate owned, commonly known as REO, is the term used to identify foreclosed properties owned by institutional lender banks. Insuring real property following a foreclosure is considered an extra-hazardous risk on a national basis due to the risks associated with a failure to notify all interested parties and lienholders and provide due process in the foreclosure proceeding, whether judicial or non-judicial. Prior approval from your underwriting counsel may be needed, initiating a careful review of the process and notices. This will ensure that the lender (and their subsequent purchaser) do not later face challenges from third parties left out of the foreclosure through oversight or omission.
Remember: No two real estate transactions are identical as to facts, title chain issues, parties, lenders or prior parties in interest – whether they are disclosed or undisclosed in the title search, a search of public records, OFAC lists, court records, lien or mineral interest searches. Doma underwriting counsel are standing by to assist on these challenging files and ensure that your lender customers have a positive experience with the “F” word.
Gytis Nefas is Vice President and Senior Underwriting Counsel for the Western Region of Doma Title Insurance, Inc.