Most of us understand that when we borrow money to buy real estate we sign a document that requires us to pay back the money over time to the bank. Most borrowers loosely refer to that debt as a “mortgage.” When our most recent market bubble burst many Americans, unfortunately, became intimately familiar with what happens when they don’t make their mortgage payments – Foreclosure.
The Foreclosure process is different depending on the state in which you reside and the two different foreclosure processes have very different impacts and time lines. For instance, when JP Morgan Chase and GMAC Rescap announced they would be halting foreclosures, the decision only affected 23 states; the reason, only 23 states require court approval to amend foreclosure affidavits. These differences find their roots both in the mortgage laws our country inherited after the split from England, and later common law changes which occurred in some states after legal challenges.
Background – Title Theory vs. Lien Theory
Simply put the foreclosure process your state follows can depend on whether the state laws subscribe to the idea that a loan is simply a lien against your property “lien theory” or that a loan is a conveyance of title to the lender until the borrower pays back the loan in full “title theory.” English mortage law follows title theory, therefore when our country began, the mortgage laws required title “ownership” of the home be transferred to the lender until the debt was paid off.
In 1791 attorneys in the state of South Carolina argued successfully that a mortgage, despite its wording, simply created a lien against title giving lenders the right to acquire title only after the proper foreclosure proceedings had been followed in a court of law. Thus with the Act of 1791 South Carolina became the first state in the Union to subscribe to lien theory with regard to mortgages. Since then 33 states have adopted the lien theory, while nine states continue to subscribe to title theory. Nine other states, and the District of Columbia, use an intermediary theory where the mortgage is treated as a lien unless the borrower defaults, at that time title is conveyed to the lender to pursue foreclosure.
Mortgage vs. Trust Deed
Although many Americans call the loan against their property a mortgage, many of them actually agree to a different instrument with their lenders – a Trust Deed. The differences include both the number of parties involved in the transaction, who technically holds title to the property, and ultimately how the foreclosure process will proceed.
A mortgage is an actual document that borrowers sign and convey to their lender in order to secure a debt on their home. It involves two parties, the borrower (mortgagor) and the lender (mortgagee), and creates a lien against the property that is normally recorded in public records. This lien prevents the borrower from transferring title or ownership until the debt (mortgage) is paid in full and the lien released.
The title holder during the loan period can be either the borrower or lender depending on which custom is practiced in the state where the property is located “ œtitle theory or œlien theory. As discussed above, the borrower conveys title to the lender during the loan term in a “title theory” state and continues to hold title in “lien theory” states. When a mortgage is the security instrument, the lender usually has to go through a court action to foreclose. This is called a judicial foreclosure.
Unlike a mortgage, a trust deed (aka deed of trust) involves three parties “ the borrower (trustor), the lender (beneficiary), and the trustee. The purpose of the trustee is to act as a neutral third party holding title until the debt is paid in full. Who is eligible to be a trustee varies from state to state although most often trustee services are provided by either a title company or an attorney. Actually, trust deed agreements include two documents, the trust deed which conveys title to the trustee and the promissory note between the lender and the borrower, outlining the terms of the agreed upon loan.
Another significant difference is in the foreclosure process. When a deed of trust is involved, foreclosure is faster, less expensive, and less complicated than when a mortgage is the security instrument. If the loan becomes delinquent, the trustee has the power to sell the home (as conveyed in the trust deed itself). As protection to the borrower, the lender must first provide the trustee with proof of delinquency and request that foreclosure proceedings be initiated, then progress according to law and as dictated by the deed of trust. This type of foreclosure does not have to go through the court system and is commonly referred to as a non-judicial foreclosure.
Judicial vs. Non-Judicial Foreclosure
Perhaps the most vexing position to hold as a lender is to be plaintiff in a lawsuit against the unfortunate family, in financial hardship, facing the prospect of losing their family home. In many states across the country foreclosure proceedings still take place in a court of law, sometimes in front of a jury, to decide whether or not a lender can take back real estate in the foreclosure process. Limited to lien theory states, the timely and arduous process provides defaulted borrowers opportunity to defend their ownership and requires lenders to meticulously follow procedural laws.
The judicial foreclosure process begins with the lender filing a complaint and recording a notice of Lis Pendens (it’s important to note both the predure and form will vary by state). The complaint will state what the debt is (amount and the real estate by which it’s secured), and why the default should allow the lender to foreclose and take the property pledged as security for the loan.
The homeowner is given a notice of the complaint (NOC) either by mail, direct service, or publication of the notice, and will have the opportunity to be heard before the court. If the court finds the debt valid and in default, it will issue a judgment for the total amount owed, including the costs of the foreclosure process. After the judgment has been entered, a writ will be issued by the court authorizing a sheriff’s sale.
The sheriff’s sale is an auction, open to anyone, and is held in a public place, which can range from in front of the courthouse steps, to in front of the property being auctioned. Sheriff’s sales usually require cash to be paid at the time of sale, however they may sometimes allow a substantial deposit with the balance paid later that same day or up to 30 days after the sale. At the end of the auction, the high bidder will be the owner of the property, subject to the court’s confirmation of the sale (another key difference between judicial and non-judicial sales). After the court confirms the sale a sheriff’s deed is prepared and delivered to the highest bidder, when recorded, the high bidder becomes the new owner of the property.
Non-judicial foreclosures, on the otherhand, are processed without court intervention, in accordance to the foreclosure procedures established by state statutes. When a loan default occurs, the homeowner will be mailed a default letter, accompanied by the filing of a Notice of Default (NOD). If the homeowner does not cure the default within the time-lines specified by the state where the property is located (in California the time period was 90 days from delivery of NOD prior to 06/15/2009 new laws have added 90 days to that process see ABX2 7 and SBX27), a Notice of Trustee Sale (NOTS) will be mailed to the homeowner, posted in public places, recorded at the county recorder’s office, and published in area legal publications.
After the legally required time period has expired (21 days in California), a public auction called a Trustee Sale will be held the highest bidder becomes the owner of the property, subject to their receipt and recordation of the deed. Auctions of non-judicial foreclosures will generally require cash or a cash equivalent either at the sale, or very shortly thereafter.
Although each state dictates their own foreclosure procedures, all foreclosure actions follow either a judicial or non-judicial method. Which method typically depends on the legal theory (lien or title) practiced in the state and which instrument (mortgage or trust deed) is used to secure the debt. The implications of these actions can determine other key factors in the foreclosure process such as deficiency judgements or rights of redemption. For detailed information in your state consult an experienced real estate attorney licensed in your state.
charts courtesy of James L. Wiedemer – The Home Owner’s Guide to Foreclosure