HML actions in case of default
SFR Investor · Orange County, CA · Member since 2009 · 1k+ posts · 1k+ votes
Jon, sorry for the thread drift, but I've been wondering, when the lender (you, in this case) forecloses on a house, are you required to auction it off? Or can you just take the house (and turn into a rental, a vacation home, storage for your hub cap collection, etc.)? Thanks.
Split from this thread.
Thought this would be better to be in a separate thread.
There are two courses of action you can take when a borrower defaults. Strictly speaking, this is no different that any other pre-foreclosure deal, just that I (and my business partner, in this case) are the bank. So, deed-in-lieu, foreclosure, a short sale, or findinging a buyer and maybe having the borrower bring money to the table at all options.
In my case that's coming to a head as we speak, deed-in-lieu or a foreclosure are the best options. The fix and flipper/borrower had a buyer on the hook, but that deal fell apart. As we've all been noting, the new appraisal was WAAY below the original estimated ARV. I think the new appraiser is low, but there turned out to be permit issues and I think that had an effect. Original ARV, based on an appraisal was $213K, new one is $166K.
Now, some of the work wasn't the best, and some work was done without proper permits. We met with the city and some GCs last week and have an understanding of what needs to be done. I expect to start seeing bids this week and choose a contractor.
The borrower has offered to give it back deed-in-lieu. Taking it to auction is an option, but we're not required to do that, nor does it seem the best choice. We could move ahead with filing the notice, wait the mandatory time period, and the take it to the sheriffs sale. But that's almost five months and several grand in fees, and the most likely outcome is we get it back. So, that doesn't seem like the best choice.
Once we take possession, its ours to do with as we wish. In this particular case, resolving the permit issues, doing a bit more fixup and selling it seems like the best choice. Its entirely possible at this point we will end up with a loss when you compare the sales proceeds after all costs to what we will have invested into it. We did get eight months interest, so we don't think it will be a net loss. But certainly the returns will be less than we expected.
I'm sure we could rent it, but we will end up with about $160K into this deal and I doubt we would get much more than $1000-1100 in rent. As a fix and flip, this works. As a rental, its bad. We were fully aware of that going in, but did not expect this low value. Hopefully we can resolve the issues with the city and make the place nice and come out OK on the sale.
Sometimes posters ask why are HMLs such a bunch of jerks and want to see good credit, cash in the bank, and only 65-70% LTV. Well, here's why.
Split from this thread.
Thought this would be better to be in a separate thread.
There are two courses of action you can take when a borrower defaults. Strictly speaking, this is no different that any other pre-foreclosure deal, just that I (and my business partner, in this case) are the bank. So, deed-in-lieu, foreclosure, a short sale, or findinging a buyer and maybe having the borrower bring money to the table at all options.
In my case that's coming to a head as we speak, deed-in-lieu or a foreclosure are the best options. The fix and flipper/borrower had a buyer on the hook, but that deal fell apart. As we've all been noting, the new appraisal was WAAY below the original estimated ARV. I think the new appraiser is low, but there turned out to be permit issues and I think that had an effect. Original ARV, based on an appraisal was $213K, new one is $166K.
Now, some of the work wasn't the best, and some work was done without proper permits. We met with the city and some GCs last week and have an understanding of what needs to be done. I expect to start seeing bids this week and choose a contractor.
The borrower has offered to give it back deed-in-lieu. Taking it to auction is an option, but we're not required to do that, nor does it seem the best choice. We could move ahead with filing the notice, wait the mandatory time period, and the take it to the sheriffs sale. But that's almost five months and several grand in fees, and the most likely outcome is we get it back. So, that doesn't seem like the best choice.
Once we take possession, its ours to do with as we wish. In this particular case, resolving the permit issues, doing a bit more fixup and selling it seems like the best choice. Its entirely possible at this point we will end up with a loss when you compare the sales proceeds after all costs to what we will have invested into it. We did get eight months interest, so we don't think it will be a net loss. But certainly the returns will be less than we expected.
I'm sure we could rent it, but we will end up with about $160K into this deal and I doubt we would get much more than $1000-1100 in rent. As a fix and flip, this works. As a rental, its bad. We were fully aware of that going in, but did not expect this low value. Hopefully we can resolve the issues with the city and make the place nice and come out OK on the sale.
Sometimes posters ask why are HMLs such a bunch of jerks and want to see good credit, cash in the bank, and only 65-70% LTV. Well, here's why.
Hi, maybe this was just a question to Jon, but I'll take a stab at it.
First, foreclosure laws vary state to state so check in your state and follow state law concerning notice and notice of demand, accelerating the note to matuiry.
You'll need to notify the trustee of the deed of trust or mortgage if you have the power of sale in your security agreements (some states don't and you'll need a judicial foreclosure depending on your security agreement, so contact an attorney.)
You or the Trustee will need to send your borrower a notice of demand for amounts due. You need to give the amount required to payoff the obligation plus the per diem interest so that if they attempt to pay it off 8 days later, they can pay the correct amount to do so (many trustees forget this). The soonest date to demand payment is set by statute, generally thirty days and that is the the last day the borrower can pay to stop foreclosure costs unless otherwise stipulated in the security agreement or note. Your trustee will probably take it from there.
When you go to foreclosure sale and if anyone bids in a higher amount than is required to payoff your note, plus costs, such amount will be due the borrower, not you and your property has been sold, you get your money. If sale proceeds go to you, the borrower can sue you for the amounts due them over what you were entitled to as that represents their equity.
If no other bid is made and your entry bid wins, most states have a period of redemption and the borrower has to follow certain proceedures, like posting a bond, saying they want to payoff the note. They may have one year to redeem the property, inwhich case it sits there while the muster their money together to pay you off. You could make repairs at your risk, but you can't covey with a general warranty deed as the notice to redeem the property places a cloud on title.
In some states, even after you take possession of collateral and sell the collateral, additional amounts over your costs may again go back to the borrower and they can sue you for it.
A security agreement is not the keys to the house, it represents a way for you to get the amount of money you are entitled to and excess equity is due the owner (borrower).
If the property after foreclosure sale sells for less than the bid amount, the lender may seek a deficiency judgment to collect amounts remaining due, if it was a cash loan, if the loan proceeds were made as an amount of equity based on a particular sale price, it is an installment sale and receiving the property back terminates the sale. No deficiency judgment is obtained from an equity funded note unless there are other circumstances, like cash advances to make repairs.
In order to avoid all this, you can ask for a deed-in-lieu-of-foreclosure. If a borrower deeds a property back to you, it is giving you the property for the full payment of the outsatnding debt. There is no deficiency allowed since you accepted the property as full payment.
As you know, a quit claim deed is used to convey the property to the lender and such conveys only that interest the grantor may have in the property, so if there are other liens, the property was granted to you is subject to the liens and encumbrances at that time. That's why you need to check title before accepting a DILF.
If you receive the property as full payment of the obligation, then you own the property. You can move in, rent it, leave it vacant, fix it, whatever, it's yours. When you accept the deed as full payment, for tax purposes, you are deemed to have received the full face amount as if it were cash, so you may have a tax liability.
If you have a mortgage/note, there will be a Trustee and the address should be listed on the document as well. Contact them or your attorney for the actions to be taken. Good luck, Bill
LOL, Jon types faster than I!
Thanks gentlemen. So the keyword here is "deed-in-lieu". If accepted, the borrower Quit Claim deeds the property back to you (or your company) and then you "tear up" the Trust Deed somehow, correct?
How do you handle "tearing up" the Trust Deed? Do you need to record some kind of re-conveyance that the debt has been settled? Thanks again.
jon, sorry to hear the deal didn't work out....will this destory the investor's credit, just like a normal foreclosure??? i've always wondered what happeend when a private investor took a property back
Here is Colorado you file a "release of lien" document to close out any deed of trust. This is no different.
Its a risk you take on these sort of deals, Bryan. It remains to be seen exactly how this one plays out.
Sorry to hear Jon, but we have all had it happen. I have also been lucky to have the borrower agree to DIL's, but I have often how I can structure the loan/mortgage to ensure that the DIL is offered.
My attorney doesn't say this is not possible but has not been comfortable with this idea; and I wondered if anyone has any strategies they have used.
Obviously not allowing other liens is one thing you have to do but how else could you structure an advance agreement to do a DIL in case of default?
Thanks
could you not have them sign one at the closing, and the attorney holds it in case you have to use it??
That seemed simple and was my original idea but my attorney feels that is too aggressive. Although he can't say it is illegal, he feels it is trying to circumvent the borrowers rights under the FC laws.
Maybe time for a new attorney? :-)
I've not tried to do this up front, so I can't speak to the legalities. I do think it would be a circumvention of the borrower's rights. The borrower and lender have to agree to the deed-in-lieu. Otherwise, foreclosure is the main recourse for the lender.
In this particular case, transfer will be via warranty deed, not quit claim.
In installment transactions it is customary to have the buyer execute a QC to be held in escrow in the event of default at the time of settlement. The installment agreement as the default provisions with the QC being used in lieu of foreclosure. I guess this was moved from another form post so the front end of this deal is missing, whay not post a little background so that readers might follow what it was and where it is going....Bill
The original thread was asking for a hard money loan to buy a pretty house for an OO. I mentioned my repo to explain why I thought a HML in the OP's situation was a bad idea and then Mitch asked his question. Rather than taking that thread off course, I split this apart.
The background to my situation is that my partner and I did a HML to a fix and flipper last October. The deal looked fine, and we did a 70% LTV based on ARV. ARV determined by the $213K appraisal mentioned above. The borrower did some of the fixup, some parts well done, some not so well. Some permitted, but some not, and the inspectors noticed the extra work. Pretty tough to miss new windows when you're called for a siding inspection. My first post above, which came right at the same time as yours, Bill, explains the situation as of now.
Thanks for the update, yes, new windows might be a hard thing not to notice....the inspector might not be happy, doubt you'll have to tear them out, hope not! Sorry that one disdn't work out as planned. I never let owners do work, unless they are in the trade and then limited to that trade unless I'm there. Bill
The inspector OK'ed the windows, providing we get permits for the work that's been done and get everything inspected. We're going to have to cut open some drywall to let them inspect the plumbing and electric. May have to remove some tile, too. And there's a possiblity we will have to cut and remove some concrete in the basement to inspect some work. Nothing that was done with this rehab, but work that was done after the house was built.
So, there's another lesson, folks. When you start down the rehabbing path, you end up taking responsibility for old but unpermitted work. Just because "it was like that when I got here" doesn't mean the inspector won't want a look.
Could you be more specific in naming some of these states? I find this difficult to swallow, that a lender takes a property as REO and then upon selling it possibly has to return funds to a defaulted borrower.
Steve, It might be easier to look for the exceptions, if there are any. Actually, I think it's in all states, but I didn't go that far because I'm not sure that is the case, so I said "some". By now, I would think many that like to sharp shoot me would catch on and realize that I usually tyr to allow room for such possible error since I'm not an attorney and not familiar with every law in every state. But, in MO., LA., AR., and OK. states that I examined banks in as a FDIC Bank Examiner, I'm pretty sure that's the case. So, consider this;
Whose property is it? The owners.
What interest does a lender have in it? A Security Lien to secure a loan amount.
What is the lender entitled to?
His money!
So, ya think if I pledge a 500K property to make sure you get your 25K loan amount, that you can declare default, foreclose, take the property, sell it for 400K and keep the whole thing? Does that even make sense? It won't in court either, I guarantee it won't. The concept of collateral security that we use is contained in federal UCC, statutes and precedence cases, as well as state laws, I'm not looking up state laws for fifty states and the UCC. So, see if you can find it, that will be a good learning experience.
Not too many borrowers are aware that they don't have to give the farm away to repay a debt. Many banks foreclose, sell and make a profit, off of repos, cars, boats, equipment, MHs and real property. If the borrower never brings it up, makes a claim or asks for the overage, if they just walk away, the lender will likely keep (steal) the money. SO, what you are accustom to seeing might be from poor or preditory practice and arising from unaware borrowers.
A lender is a lender, not an owner, they are entitled to the repayment or indemnification of the loss arising from the loan, no more, no less. States may limit the time a borrower has to redeem excessive equities and some may not even address it, that's what judges do, provide equity in law.
Once they become the owner though, it's my understanding that the owner of the property (i.e. REO) is entitled to all proceeds from sale.
Consider this example as a perspective on this. Property goes to foreclosure auction (sheriff sale or trustee sale). "Buyer" obtains property at that foreclosure sale for the winning bid amount. "Buyer" now becomes the new owner of that piece of real estate. "Buyer" now re-sells that real estate for some amount over the winning bid amount from that earlier foreclosure auction. "Buyer" is entitled to keep all proceeds from that re-sale, including the "excess" profits over the winning bid amount - correct?
Now rewind a bit and change "Buyer" in that example to "Bank" - why should that lead to any change in how the proceeds are handled?
Now, if at the foreclosure auction the winning bid exceeds the amount owed to the bank (and all other lien holders in turn), then there is a requirement to pass along those excess funds to the defaulted borrower (former owner) as the accrued equity that they held. But once it gets past that stage, and the property becomes owned by new ownership (whether REO or privately held owner) - I can't see why that defaulted borrower is owed anything further at that point. That defaulted borrower could have held their own sale prior to the conclusion of the foreclosure to receive the "excess" proceeds - but they chose not to.
As some may know, I got into some transactional loans on here with another BP member. I provided 90% of the funds. Turns out, there are a lot of problems in that arena.
1. lack of due diligence
2. crooked borrowers
3. usury laws
4. difficulty in foreclosing.
I had 3 defaults, 1 which I resolved myself and 2 others pending. In MO, the actual TRUSTEE that did the note and trust deed would not handle the foreclosure due to exorbitant interest rates. I had to travel th MO, work with the borrower to get property back, by means of quit claim. Listed property, found a buyer and was ready to close. Because of the way that note and TD were drawn, title company wouldn't accept it. I had to go back to borrower a SECOND time to have a DIL signed. I had to throw in a Cancun week to buyer and borrower to make deal go.
I have received the deed on a second default in NJ, which is unsold and I will go after borrower for fraud and deficiency. The 3rd default was on AZ property and not resolved yet.
I will do some sort of lending in the future, but no extended terms without borrower having skin in the game. I urge all you wannabe transactional lenders to be careful and REALLY know the laws. Rich
Read what I said carefully. Lender has a collateral interest, they take the property, they have the right to sell for the amounts lost, as collateral and amounts pay off the bank, excess amounts are equity from THAT SALE. NEW OWNER bought at the auction, it's his house, he can sell it for whatever and is entitled to all the proceeds, so is the next buyer and the next buyer and the next buyer, etc.
The property is IN TRUST until sold at foreclosure, banks may act like owners but they do not hold title, it is sold under the trust agreement held by the trustee. The bank does not give a deed, the sherriff does.
When the entry bid by the lender is the highest bid, the lender wins the auction and the sherriff's deed is issued. The lender now owns the property. I said the borrower MAY be entitled to excess proceeds, and the old owner may seek amounts received by the LENDER upon the final disposition of the property when it is sold for cash.
A bank is a lender, they did not obtain any title to the property as a buyer, but as a creditor arising from an agreement to allow only for the cure of a default. The bank is entitled to be indemnified, made whole again, according to the terms of the agreement, which is the basis for the bank acquiring the title under the sherriff's deed.
At a sale, a third party as a buyer, acquires the property as a buyer, the interest acquired in the property is an ownership interest, not a collateral interest.
While time periods may be limited by states for a civil suit to be brought by a borrower against a lender, basically for reaping greater rewards than originally agreed to, at the expense of the borrower/owner, borrowers may seek such remedies. As I implied before, most borrowers walk away. This is going to be an area where an equitable compromise will prevail, how much is in excess, what's the costs involved in holding the property, management, repairs, etc. if it's not really significant, and since courts rule generally in favor of lenders over borrowers, the borrower may not win small sums, but if amounts are excessive, beyond what is reasonable to compensate for the collateral interest, the borrower will be getting a check. A suit maybe required if there is no specific right afforded in this area by state statute. Been there, done that.
I hope you see the equitable difference is between buying a property as a buyer and lending money and accepting property as collateral, it's not the same thing. If that's what was intended to be structured, the bank would buy the property and lease it back over time until all amounts disbursed were repaid and then return the property. A purchase-lease-repurchase agreement instead of a loan and collateral assignment.
Excess amounts received from a sale are a contingent liability as well as a cash asset until any statutory waiting period expires, form a borrower to bring claims, it's a hold your breath, they might not inquire about what we got, then, wheeew, now it's all ours without any problems.
Banks are probably held to a tighter standard here than an individual, IMO, don't know, but I have seen this in cases where a HML was made and the lender attempted to retain all proceeds from the sale, it didn't work for the lender, he got his money back, but he did not get the entire proceeds of the ranch. My guess would be too, that when this issue is not addressed by state law, how it washes out may lean toward lenders in conservative business minded states and toward borrowers in more consumer minded liberal states, that's a guess. But it happens and is done.