Chapter 40
Default and Foreclosure
DEFAULT AND FORECLOSURE DEFINED
Default occurs when the borrower fails to keep the promises he or she made in the promissory note or the security deed. The borrower’s principal promises are the following:
| (a) | to make the periodic principal and interest payments specified in the note; | |
| (b) | to make the property tax and hazard/liability insurance payments directly or to place funds for those payments into the lender’s escrow account; | |
| (c) | to keep the property in good physical condition by proper maintenance and repair; and | |
| (d) | to retain all structures and site improvements unless allowed by the lender in writing to demolish and remove any of them. |
The result of a failure to keep these promises is default. The lender’s options under a default appear in the default clause of the promissory note and in the acceleration clause in non-uniform covenants of the security deed. Briefly, upon default the lender receives the right to call for the full and immediate repayment of the remaining loan balance. The acceleration clause identifies the procedure by which the lender must give notice to the borrower of the lender’s actions. If the borrower is unable to repay the remaining loan balance, the lender has the right of foreclosure which is the right to end the borrower’s ownership or other legal interest in the real property.
FORECLOSURE OPTIONS
Each state establishes the foreclosure procedure for loan defaults in that state. The first major distinction in foreclosure approaches is between judicial and non-judicial. Georgia uses non-judicial foreclosure, which means that the lender does not have to sue the borrower and obtain a court decree before foreclosing.
The equity of redemption period is the period between the default and the foreclosure when the borrower can correct the default and stop the foreclosure process. He or she can redeem the property by paying off the loan and compensate the lender for all expenses incurred because of the default. If the default occurs for some reason other than nonpayment of the monthly mortgage payment, the equity of redemption period is the time during which the borrower corrects all deferred maintenance and repair. Some states provide for statutory redemption by which the debtor can redeem the property even after foreclosure. Georgia allows redemption after foreclosure only for tax sales.
There are two non-judicial foreclosure procedures. The first or “entry and possession” procedure gives the lender the right to inform the defaulted borrower that the lender will take possession on a given date. If the borrower does not peacefully give the property to the lender, the lender goes to court to have the borrower removed from the property. The second or “power of sale” procedure gives the lender the right to advertise the property and then hold an auction to sell the property. The latter is the non-judicial foreclosure procedure used in Georgia.
GEORGIA FORECLOSURE PROCEEDINGS
The security deed in Georgia passes title to the lender upon the borrower’s default. However, lenders normally use the non-judicial power of sale which gives the lender the right to sell the property to receive the unpaid loan balance. The borrower gives the lender this right by signing the security deed which contains a power of sale clause. Although this procedure does not require a court judgment, Georgia real estate law strictly regulates the method and frequency of advertising and the timing and conduct of the sale.
| (a) | THE PARTY ENTITLED TO SELL THE PROPERTY – The only person or financial institution allowed to sell the property of a borrower in default is the party identified in the security deed as the lender. The lender can use an agent, an attorney, or a representative. If the original lender sold the security deed, the power of sale right transfers to this “successor.” If the original lender is a deceased individual, the security deed transfers to the heir to the lender’s estate the power of sale. | ||
| (b) | NOTICE OF THE SALE – Once the lender notices the default, he or she notifies the borrower as provided in the acceleration clause. At the appropriate time, the lender advertises the property in the newspaper that is “the official organ of the county.” This designation simply means that the citizens of the county and/or the county officials accept a particular newspaper as the source of legal notices such as foreclosure sales. In some counties that organ is a private legal publication; in others, a general circulation newspaper. The advertisement must appear in the newspaper once a week for four consecutive calendar weeks preceding the week in which the sale will occur. A sale in the same week as the last of the four notices is legally invalid. |
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| (c) | FORM AND CONTENT OF THE ADVERTISEMENT – The published advertisement must contain: | ||
| (1) | the complete legal description of the property; | ||
| (2) | the name of the lender; | ||
| (3) | the name of the attorney who will conduct the sale; | ||
| (4) | the place of the proposed sale which by custom is the steps of the county courthouse, but can be another location if ordered by a superior court judge and that new location is applicable to all such public sales; | ||
| (5) | the day and starting time of the sales for that day (the advertisement cannot identify the exact sale time of a specific property because the number of sales for that day are unknown); and | ||
| (6) | the application of any proceeds of the sale to special purposes such as the payment of taxes or another lien. | ||
| The advertisement also typically states the terms of the sale as “cash” but does not have to contain this provision. Even if the advertisement states “cash,” the highest bidder can make a deposit. A cashier’s check is as good as cash. However, a bidder who fails to provide cash can be passed over in favor of another bidder who can give cash. The advertisement is supposed to contain the name of the person who possesses the property (the borrower in default), but this requirement is largely ignored. The advertisement does not require information about the unpaid loan amount or the cause of the default. Great care goes into the construction and the printing of the advertisement since mistakes or misleading statements involving the required elements of the advertisement can invalidate the sale. |
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| (d) | THE CONDUCT OF THE SALE – Both state statutes and the principle of fairness govern the conduct of the sale. Since there is no requirement for the auctioneer to be a disinterested third party, the lender or the lender’s agent can conduct the sale. However the person conducting the sale must act fairly and impartially. The lender must withdraw the property from sale if unfavorable circumstances prevail and offer it for sale at another time. The purpose of the foreclosure sale is to obtain the “fair market value” of the property. However, in actual circumstances, the usual interpretation of this legal requirement is an “adequate price.” | ||
| (e) | THE BIDDERS AT THE FORECLOSURE SALE – The bidders at the foreclosure sale can include third parties, members of the public, or the lender and the borrower, who have an interest in the proceedings and in the property. The lender or the lender’s agent or attorney can bid for the property but to the greatest extent possible, cannot act to injure the borrower or any junior lien holders. The borrower in default or his or her agent or representative, if bidding for the property, must also not act to injure the junior lien holders. | ||
| (f) | CONFIRMATION OF THE SALE – Georgia law does not require a judicial confirmation of the non-judicial foreclosure sale except under the situation in which the lender seeks a “deficiency judgment” against the borrower because the sales price of the property is less than the unpaid loan balance and expenses of sale. A deficiency judgment is a request made by the lender to the judge to issue a court order to have the borrower make up the difference between the sales price of the property and the unpaid loan amount plus any expenses of the foreclosure sale. To confirm a sale, the lender files a report of the sale with the judge of the superior court within thirty days of the sale. The judge schedules a hearing in which the borrower in default can provide evidence about the legality of the advertisement, the fairness of conduct at the sale, and the adequacy of the sales price. The judge evaluates the evidence from both sides and makes a ruling either to confirm the sale or to set it aside. |
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| (g) | DISTRIBUTION OF THE PROCEEDS FROM THE FORECLOSURE SALE – The person conducting the foreclosure sale is responsible for the proper distribution of the proceeds from the sale. When he or she receives the funds from the foreclosure sale, the first payment goes to cover the costs of the sale including the attorney fees. The second payment goes to the lender holding the first lien on the property. If funds remain from the sale, the junior lien holders receive payment. Lastly, the remaining funds, if any, go to the borrower who defaulted. If the total payments to the lien holders and for the expenses exceed the sales price, a deficiency exists. Then the lien holder affected by the deficiency can request the confirmation of the sale and a deficiency judgment. | ||
ALTERNATIVES TO FORECLOSURE
When a borrower defaults on a loan, the lender can foreclose under the power of sale provision, or the parties to the loan can choose an alternative to foreclosure. These alternatives are very often the preferred courses of action because they may be more direct and less expensive solutions to the default problem, and they may consume less of the lender’s and/or the borrower’s time.
| (a) | THE BORROWER SELLS THE PROPERTY – Facing a foreclosure and sale, the borrower can attempt to sell the property to a buyer who can pay cash; obtain a new loan; or with the approval of the lender to whom the borrower is in default, assume the existing loan. At the closing the borrower/seller pays off the loan and keeps any equity that remains. | ||
| (b) | DEED IN LIEU OF FORECLOSURE (VOLUNTARY CONVEYANCE) – The simplest solution for the parties involved in a default is a voluntary transfer of the property from the borrower to the lender. The borrower simply deeds title and possession of the property to the lender. Depending on the circumstances, the borrower’s deed to the lender could be a full warranty deed or even a quitclaim deed. The lender must seek legal advice concerning the appropriate deed to accept. One complication of voluntary conveyance is the issue of the borrower’s equity. If the market value of the property is equal to the unpaid loan balance, the equity is zero and the borrower simply gives the property to the lender. However, if the equity is positive, the lender can take the property and compensate the borrower for the equity at 100% or at a lower negotiated rate. If the market value is less that the unpaid loan balance, the lender could absorb the loss to avoid the foreclosure process, or the borrower could promise to pay the difference at some time when he or she is able to make the payments. |
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| (c) | FORBEARANCE OR MORATORIUM – Upon default of the loan, the lender can choose to be lenient and forgive the missed payments if the borrower has resumed making the required payments on time; or the lender and borrower might negotiate a new agreement. For example, the lender might add the unpaid interest to the loan balance and extend the term of the loan so that the borrower can resume the payments at the same level or at a lower and more affordable level. | ||
| (d) | EXTENSION AGREEMENTS – Borrowers very often recognize in advance that they will default on the loan because of a job layoff or a termination. At this point the borrower could approach the lender and inform them of the impending default. They might then work out an arrangement in which the lender agrees to a suspension of monthly payments until the borrower goes back to work or finds a new job. The extension agreement in its simplest form states that the lender will defer, but not cancel, mortgage payments for an appropriate time. The borrower and the lender might agree to a six-month’s extension during which time the lender will charge the borrower interest for the six months at a reasonable rate (the same rate as in the note or the current market rate) with this interest to be added to the loan balance. At the end of the extension the borrower will resume making payments in the same amount, but the term of the loan will increase to allow time to pay off the larger balance. | ||
| (e) | RECASTING THE LOAN AGREEMENT – A different solution might address the problem of a borrower who recognizes that he or she will default on the loan because of a job change that results in a lower salary or, in the case of income property, the loss of anticipated income because of high vacancy rates. At this point the borrower could approach the lender and inform him or her of the impending default because of a change in his or her ability to continue making the loan repayment. The borrower and the lender might agree to recast the original loan. Recasting involves a major modification of the original loan terms. To avoid a foreclosure resulting in a loss that could not be recovered through a deficiency, the lender might agree to reducing the amount of the monthly payments by either changing the term of the loan or lowering the interest rate or both. The original loan is recast; the lender cancels the original note; and the borrower signs the new note. In commercial transactions, a recasting of the loan may be accompanied by a reduction of the original loan amount. The lender’s reason for accepting such a loss involves the lesser of two evils. The lender’s choice is to agree to a loan reduction or to take a troubled property through foreclosure and then sell it at a loss and try to get a deficiency from a firm in financial trouble. |
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| (f) | SALE OF THE LOAN – The lender can avoid the problem of foreclosure by selling the security deed at a discount to an individual who is willing to deal with the borrower in default and to take the risk regarding the sales price at the foreclosure sale. Their relative positions in the negotiation rest on their knowledge of the market. |