Underwriting Manual: Mortgage Foreclosures

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Underwriting Manual Subtopic

In General

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A mortgage foreclosure is a legal procedure whereby property that has been pledged as security for the payment of a debt is sold to satisfy the debt in the event of default in the payment or violation of any term or provision of the mortgage instrument.

The purposes of any mortgage foreclosure action are the following:

  • To recover the lender's collateral.
  • To eliminate the mortgagor's equitable right of redemption.
  • To establish the validity of the mortgage.
  • To establish the amount due the mortgagee.
  • To eliminate the junior interests that affect the laws.

Foreclosure procedures can be judicial or nonjudicial and vary greatly from state to state.

Underwriting Manual Subtopic

Obstacles To Mortgage Foreclosure

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The most common impediments to the commencement of a mortgage foreclosure action are the following:

  • Lack of Default

    Foreclosure can commence only after an event or act of default of any term or provision of the mortgage.

  • Lack of Compliance with Special Requirements of the Mortgage Instrument

    The terms and provisions of the note or mortgage may establish that certain requirements must be followed or complied with prior to the commencement of a foreclosure action.

  • Lack of Compliance with Special Statutory Requirements

    State laws may provide that certain conditions must be complied with prior to the commencement of a foreclosure action.

  • Death of the Owner of the Property

    In certain jurisdictions, state law provides that no foreclosure action can take place within a certain period of time after the death of a person owing real estate on which there is an outstanding mortgage.

  • Bankruptcy Proceedings

    The filing of bankruptcy proceedings affecting the owner of real estate results in an automatic stay of the proceedings at any stage of the foreclosure action (11 U.S.C.A. sec. 362(a)). Proceedings may be commenced or continued upon the lifting of the automatic stay.

  • Servicemembers Civil Relief Act of 2003

    Formerly known as the Soldiers' and Sailors' Civil Relief Act of 1940, the
    federal relief statute, although of limited applicability, must always be considered as a possible temporary impediment to the foreclosure of a mortgage executed by parties prior to their entering into the armed forces.

  • Restraining Orders

    In certain situations, because of alleged defects in either the mortgage instrument or the foreclosure proceedings, an owner of mortgaged property may seek and obtain a temporary court order restraining the foreclosure action.

Underwriting Manual Subtopic

Types of Mortgage Foreclosure

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Foreclosure by Judicial Action

In the majority of jurisdictions, the foreclosure of mortgages is accomplished through judicial proceedings.

In general terms, a court action is commenced seeking a decree of foreclosure and an order for a sale of the real estate. The action must be brought in a court having jurisdiction over both the subject matter and land and all necessary parties must be made defendants and be served properly. Upon completion of the pertinent statutory proceedings, a decree of foreclosure and an order for the sale of the real estate is entered by the court.

Foreclosure by Power of Sale

In a number of states, nonjudicial foreclosure by exercise of power of sale is permitted. This type of foreclosure rests upon a power of sale clause included in the mortgage instrument. This clause provides for a nonjudicial sale conducted after advertising, serving, and posting of a notice of sale as specified in the mortgage and the applicable state law. Hence, it is sometimes referred to as "foreclosure by advertisement." Usually, the mortgage document is a deed of trust.

However, the existence of power of sale foreclosure in a given state does not prelude the right to resort to judicial foreclosure.

Judicial dicta indicate that, in the absence of a state statute forbidding foreclosure except by judicial proceeding, a power of sale is valid and foreclosure by exercise of power of sale is proper and expeditious.

Foreclosure by power of sale is much simpler in its process than foreclosure by action.

The statutory requirements and procedures regarding to the form and contents of the instrument containing the power of sale and the mechanics of the foreclosure by power of sale vary greatly from jurisdiction to jurisdiction.

Strict Foreclosure

This was the original method of foreclosure adopted by the English courts of equity under the early common law.

A strict foreclosure decree will determine the amount due under the mortgage obligation and order the payment of that amount to be made within a specified time and will further provide that in the event of default in making the payment, the mortgagor's right and equity of redemption is to be forever barred and foreclosed. The effect of the decree is to vest title to the property absolutely in the mortgagee without any sale of the property.

At the present time, very few states recognize strict foreclosure.

Foreclosure by Entry and Possession

Foreclosure by entry and possession is permitted under the statutes of a few New England states.

This type of foreclosure is effected by an entry by the mortgagee on the mortgaged subject property and the retention of the possession for a limited time, after which all right of redemption is barred. The provisions of the statute must be strictly observed. After the expiration of this time, the mortgagee takes an absolute estate and becomes entitled to all the rents and profits. The entry must be peaceable and in the presence of witnesses, who are to make a certificate of the fact, and the certificate is to be recorded.

Underwriting Manual Subtopic

Title Acquired By The Purchaser At A Mortgage Foreclosure Sale

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If all the necessary parties have not been named as defendants and redemption is not made or if no redemption period is allowed by law, the purchaser at a foreclosure sale takes title to the property as of the date of the mortgage by the "doctrine of relation back." Hence, the general rule is that the purchaser's title is that which the purchaser would have obtained had the purchaser acquired the property from the mortgagor at the time the mortgage was executed.

Underwriting Manual Subtopic

Reacquisition Of Title By Mortgagor

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According to a number of court cases in some jurisdictions, in the event the mortgagor under the mortgage or deed of trust foreclosed subsequently reacquires title to the property, it is possible that such a reacquisition may effectuate the revival of the junior liens and encumbrances that were cut out by the foreclosure action. State law must be properly researched in order to determine any possibility of revival within a specific jurisdiction. In this respect, nonjudicial foreclosures represent areas of extreme risk.

Underwriting Manual Subtopic

Deficiency Judgment

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In many states, if the foreclosure sale of the real estate secured by a mortgage or deed of trust does not produce a sufficient sale price to pay the loan balance in full after deducting expenses and accrued unpaid interest, the mortgagee may be entitled to a personal judgment against the maker of the note for the unpaid balance. Such judgment is called a deficiency judgment. It may also be obtained against any endorsers or guarantors of the note and any owners of the mortgaged property who may have assumed the debt by written agreement.

The existence of the right to a deficiency judgment depends upon the jurisdiction where the land is located, the manner in which the foreclosure is conducted and the kind of mortgage being foreclosed, and the particular type of property, i.e., single family residential property.

Deficiency judgments are enforceable in the same manner as any other judgment or decree. Deficiency judgment questions are often closely related to the one form of action rule in effect in several states. In general, this rule establishes that in the event of a default, the mortgagee's sole remedy is a foreclosure action and that any deficiency claim must be sought in that proceeding.

Underwriting Manual Subtopic

Redemption Rights Of Borrowers

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Most states confer upon defaulting borrowers the right to redeem their properties. In such cases, redemption takes one of two forms: equitable redemption or statutory redemption. The latter, in some cases, is also made applicable to inferior lienholders and other parties in interest.

Equitable Redemption

Historically, the right of redemption is inherited from the old common-law proceedings in which the court sale ended the equitable right of redemption. Carried over to statutory law, this concept provides that, if during the course of a foreclosure proceeding but before the foreclosure sale or the decree in strict foreclosure, the borrower or any other person who has an interest in the real estate (such as another creditor) pays the lender the amount currently due, plus costs, the debt will be reinstated as before. In some cases, the person who redeems may be required to repay the accelerated loan in full. If some person other than the mortgagor or trustor redeems the real estate, the borrower becomes responsible to that person for the amount of the redemption.

Statutory Redemption

Many states allow defaulted borrowers and some other parties with interest a period in which to redeem the real estate after the foreclosure sale. During the statutory redemption period, which may be as long as one year, the court may appoint a receiver to take charge of the property. The mortgagor or party with interest may redeem the property within the statutory period of time by paying into the court the amount of money determined for that purpose by the judgment decree of foreclosure.

State law provides the parties entitled to redemption rights and the time and conditions for their exercise. It also provides the cases and circumstances in which redemption rights may be waved.

Redemption periods and conditions for redemption vary greatly among the states.

United States as a Mortgagee

When the mortgage is one in which the United States has an interest, as where the mortgage is FHA insured, VA insured, or a Small Business Administration mortgage, some court decisions hold that the state redemption law is inapplicable and that a federal court may order such redemption period as it deems appropriate.

United States as a Party Defendant

Section 2410(c) of the U.S.C.A. governs the period within which the United States may redeem from a judicial sale made to satisfy a lien superior to that of the lien of the United States. As amended by the Federal Tax Lien Act of 1966, this section reads in part as follows:

"Where a sale of real estate is made to satisfy a lien prior to that of the United States, the United States shall have one year from the date of sale, within which to redeem, except that with respect to a lien arising under the internal revenue laws, the period shall be 120 days or the period allowable for redemption under State law, whichever is longer..."

Elective Statutes

In some states, a mortgagee can choose a mode of foreclosure that eliminates the right of redemption.

Underwriting Manual Subtopic

Mechanics' Liens Affected By A Mortgage Foreclosure

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Mechanics' and materialmans' liens should not be ignored on the assumption of their possible elimination as a consequence of a foreclosure action unless the claimants were parties to the proceedings, or, in the case of nonjudicial foreclosure, until it is clearly established that the priority of such claims is inferior to the priority of the security instrument foreclosed.