I've seen a couple of conversations here on BP about what happens to any remaining equity in the event that a NPN holder forecloses on a property. The assumption for many seems to be that the investor would get all remaining equity, though others have corrected them explaining that you're only able to collect on the equity up to the value of the note.
Until this came up here on BP this is something that I haven't come across or honestly even wondered about. But now it has me thinking and I was hoping I could get a little clarification.
Let's use an example with simple numbers. A first-position note with a face value of $60K is purchased for $35K. For simplicity sake there are no other liens of any kind. The FMV is $200K. The note investor forecloses and recoups the $60K owed them. At what point is the remaining equity addressed? If as an investor I sold the property below FMV (let's say $150K) to get a quick sale, when does the former homeowner receive the equity and how much?
In this example would he/she be entitled to the full fair-market equity of $140K or the remaining equity post-sale of $90K? What incentive do I have then to sell the property for anything reasonable?
Or what if I decided to rent out the property (particularly during the redemption period)... when would the former homeowner be due their equity?
I'm interested to hear the replies on this one :)
If you buy a note with an unpaid balance of $60K as in your example, the most you can receive is $60K, or title to the property. If you foreclose, and no one bids at the foreclosure sale, you now own the property and all of the equity is yours. If the property is worth $200K, it is highly unlikely that no one will bid higher than $60K at the foreclosure sale. More likely is that competitive bidding brings a bid in the low to mid $100s. If that happens, you get your $60K unpaid balance, junior lien holders get whatever is left up to their unpaid balances (if any), and the former homeowner gets the rest.
Common misconceptions. Once a lender, always a lender.
There are two legal theories at play, one is title theory the other is laws of equity.
State laws vary, but the Uniform Commercial Code addresses collateral matters with installment sales.
Cash funded loans are secured to indemnify the lender or note buyer up to the financial interest acquired under the security agreement, the lender holds an equitable financial interest they do not acquire title in ownership.
After foreclosure title may be obtained however laws of equity still apply and apply in all states. Laws of equity are applied when (as in this case) one party attempts to cure their financial loss in to an unconscionable extent that fairness no longer applies, that the cure exceeds what a note holder is reasonably entitled to. Again, this applies in all states regardless of being a title or equity state.
Security is granted to secure the financial position or risk a lender accepts, the equity of ownership not title. Look to rights of ownership as a pie, half the pie represents equity rights, the other half represent ownership rights. When a security interest is granted by an owner they give or assign a lender a slice of the equitable title rights, that is all the lender is entitled to.
The misconception that a lender is entitled to ownership rights beyond those to cure a financial loss or be indemnified is long standing in reality. Lenders sell collateral, even as ORE/REO, and may or may not be required to give notice of the sale to a borrower, regardless, the borrower needs to make a demand for equity in most states, in some states a lender may be required to pay excess equities to a borrower. In reality, most borrowers walk away and though up their hands, The lender keeps the money. It's been such a long standing practice that attorneys seem to think a lender is entitled to ownership failing to look at the equitable side.
This issue has surfaced since the bubble burst and rash of foreclosures. Laws of equity have been applied and lenders lose. The chance of being sued is much higher when there is significant equity.
Notes from installment sales are different as they are not cash loans but funded by equity based on a sale price. The default of an installment sale terminates the sale and collateral reverts back to the seller with all rights in title of ownership, states may require foreclosure and excess proceeds paid to the buyer, if not then the sale is still subject to an equitable settlement through the courts of equity. The court can decide what is equitable.
Once a lender, always a lender means that any lender loaning money is only entitled to receive their money back, principal, interest and expenses allowed by law, that is all they are entitled to. A lender does not purchase a property and sell back the rights of ownership. The purchaser of any note only assumes those rights of the lender, noting more.
Additionally, when you are dealing with higher valued homes keep in mind you may not have an idiot as a borrower. These folks probably travel in different circles among informed people and they may be able to afford an attorney. Actions can usually be brought for 3 years.
I suggest you buy notes for the financial interest in the note and not go into predatory schemes trying to turn collateral into a rental property. :)
Bill Gulley, General Real Estate Academy | https://generalrealestateacademy.com
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