Junior Liens Who Choose to Foreclose
Written By: Edward Brown
Sunday, February 24, 2019
Many private lenders may choose to fund a junior lien where the first mortgage is >
In looking at a foreclosure, a lender has to strategize. In the case of the second mortgage, it is imperative that the first does not foreclose out the second as there is usually nothing left over from the foreclosure to pay the second. In California, the foreclosing party gets to ldquo;credit bidrdquo; its loan. This means that it can simply bid [at the auction/trustee sale] what it is owed. Non foreclosing parties need to come up with cashierrsquo;s checks in order to bid. This can be a potential hardship for the second mortgage if the first is the foreclosing party.
For example, if we look at a situation where the property has a value of 1,400,000, the first is 800,000 and the second is 200,000 and the first is the foreclosing party, the first would most likely credit bid its entire 800,000 [it does have the right to bid less than what it is owed, but, if the value is reasonably higher than what is owed to the first, it will normally credit bid what it is enti>
Any bidder at the auction/trustee sale would need to come up with 800,000 at the auction itself or more should any bid exceed 800,000 if the bidder wants to be the highest bidder. In this instance [where the first mortgage is the foreclosing party], the second is not allowed to credit bid its 200,000 balance. It would need to come up with the 800,000 to pay off the first and its 200,000 second mortgage in order to be made whole. True, the second would just get its 200,000 back because that is what it is owed, but, unfortunately, in this case, since it was not the foreclosing party, it has to come up with cash just as any other bidder. Only the foreclosing party is allowed to credit bid.
For this reason, it is important for the second to have a strategy in place. The second wants to be the foreclosing party in most instances, driving the bus, so to speak. Borrowers usually go into default for two main reasons.
First, they stop making payments to the lender. Second, the lenderrsquo;s loan is due, and the borrower has not refinanced or sold the property. In the case where payments have not been paid, junior lien holders have the right to ldquo;curerdquo; the first. One can usually do that simply by making the payments to the first. Since foreclosure in California normally takes three months and 21 days, one strategy is for the second to cure the first and start its own foreclosure.
However, this may be cost prohibitive, especially if the first is large and the arrearages on the first are a few months. When the first files for foreclosure, junior lien holders are to be notified. This gives them notice, so they can have the opportunity to cure the first. The second then files its own foreclosure [either because the borrower has probably also not made payments to the second mortgage or because most loan documents state that if a borrower is in default on any mortgage associated with the property, its loan is also in default whether or not the borrower has kept the second current with payments].
One strategy for the second lien holder is to cure the first as soon as possible to allow the second to be the foreclosing party. That way, the second would be allowed to credit bid its loan, but would not eliminate the first; it would have to take the property subject to the first and have to deal with them post foreclosure. However, what happens in the case where the second pays just enough to get the first to stop its foreclosure for the time being, the second starts its own foreclosure, and then does not make any more payments to the first and allow the first to start its own foreclosure?
Letrsquo;s look at an example and see how this might play out; in our previous example, the property was worth 1,400,000, the first was 800,000, and the second was 200,000. Letrsquo;s presume that the borrower stopped making payments on both the first and second mortgages. Both loans have a maturity date five years in the future. If the first files foreclosure, the second could cure the first by making only one mortgage payment to them. Now it is true that most lenders will not immediately file a notice of default after 30 days, but the point here is for the second to make the first mortgage cancel or delay [even temporarily] its foreclosure, so the second mortgage can start its own foreclosure for two main reasons; it puts the second in a situation wherein the first does not foreclose out the second, and it allows the second to credit bid its loan at the time of the trustee sale.
Now it is true that, if the second does not make any more payments to the first [other than the one to get the first to stop its foreclosure], the first may start a foreclosure again, but, the firstrsquo;s foreclosure will be after the second mortgage has completed its foreclosure, buying time for the second to deal with the first [or sell or refinance the property] if the second is ultimately the high bidder at auction. If another bidder outbids the second, the first would get paid, the second would get paid, and the owner [borrower who defaulted] would pocket the difference.
If there is enough equity in the property, either the property will receive a high enough bid to pay off all of the liens, or the second [the foreclosing party in our example] should be able to flip the property fairly quickly or decide to keep the property, as it would be the new owner. If the second chooses not sell the property, it should very quickly discuss with the first some sort of agreement to either refinance [a new loan to the second who is now the owner] or make payments for a period that will allow time for a new lender. The above information is for discussion purposes only and, as always, one is advised to discuss real estate >
Edward Brown is an investment expert and host of the radio show, ldquo;The Best of Investing.rdquo; He has multiple published works, including an interview with the Wall Street Journal, and has also served as a chairman of the Shareholder Equity Committee to protect 29,000 shareholders representing 500 million REIT. Edward is also a recipient of a prestigious MBA Tax Award.
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