REQUIRED READING: The goal of every lender and servicer is to have each mortgage perform at its maximal potential. This means that every loan in a portfolio is paid in full each payment period and serviced in the most efficient and cost-effective manner.
Unfortunately, reality is more complicated than that. Lenders, servicers and their legal counsel always had a roster of loss mitigation techniques that could be applied in advance of taking a delinquent loan to foreclosure, whether judicial or nonjudicial. However, several factors have placed greater emphasis on alternatives to foreclosure. These include the following:
- The economic collapse that resulted in significant job loss and huge reductions in property values – foreclosure is no longer something that just happens to the ‘other guy’;
- Record numbers of loans that have become delinquent and the costs incurred by lenders in taking back those properties and maintaining them until they could be sold at markedly reduced valuations, if at all; and
- The interest placed by our nation's policymakers and the American public in restoring calm and renewed certainty to this key segment of the economy.
This last item has brought about government-sponsored programs to avert foreclosure for borrowers, as well as state legislative mandates addressing such areas as borrower notification, foreclosure mediation programs and foreclosure alternative reviews. We have also learned to distinguish among borrowers who are delinquent due to life events, borrowers who have a history of exploiting loss mitigation programs, and the strategic defaulters who have sufficient resources but have chosen to let their loans go into arrears. Thus, loss mitigation has become more prevalent – and more complex.
Moreover, recent reports suggest that the number of homes in or near foreclosure remains high. The reality is that many homeowners – those still current and those already delinquent on their loans – are not financially qualified, whether by income or current asset value of their home, to take advantage of today's historically low home mortgage interest rates.
The other road
Something different is needed, and it is being provided. A review of potential alternatives is now standard procedure for many foreclosure referrals.Â
The servicer, often in conjunction with the foreclosure attorney or trustee, will balance potential return (loan performance) of loss mitigation versus taking a loan to foreclosure. This loss mitigation appraisal is completed in accordance with established lender policies and strategies, as well as state guidelines.Â
Servicers should consider the following hierarchy of foreclosure alternatives:
Reinstatement. Not formally a loss mitigation technique, reinstatement – or bringing the note current – is the preferred result for lenders. At times, the final threat of losing his or her home does impel the borrower to look to other resources. This can include borrowing from relatives, using one's ‘rainy day’ funds, tapping into a 401(k) or other retirement monies, or even redirecting a tax return check.
Formal forbearance plan. A borrower is given some breathing room by arranging to make up the amount in arrears. In some cases, the borrower will pay extra each month (in addition to the regular mortgage payment), until the outstanding deficit amount is repaid.Â
These plans may be lender-negotiated, in which case the lender must determine the likelihood of the borrower staying on course going forward, or be court-ordered as part of a Chapter 13 bankruptcy proceeding. This foreclosure alternative works best when the borrower had a temporary financial impasse (job loss, large medical expenses, etc.) that has been remedied and stabilized.
Loan modification. A promissory note and deed of trust comprises a contract between the lender and borrower, which they are free to change, if both parties agree to the new contract. This alternative to foreclosure can follow an individual lender's guidelines or government-sponsored endeavors like the Home Affordable Modification Program.Â
This modification can consist of adjusting the loan's interest rate, forgiving some outstanding principal or changing the term. For example, the loan can be rewritten to a longer term, such that the borrower can now meet the monthly payment obligation and all carrying costs.
As with any form of loss mitigation, the lender, as advised by counsel, must balance the financial and, in today's world, the social expense of a modified loan versus what will be lost in carrying the defaulted loan to foreclosure.
Short sale. This solution has become more prevalent in recent years. In a short sale, the borrower sells his or her home to a third party, with the lender agreeing to accept less than the full loan amount outstanding at time of closing. This can be a private arrangement or a government-sponsored program like Home Affordable Foreclosure Alternatives.
From a lender's perspective, short sales are an acknowledgement of how far property values have declined in certain markets, as well as the total costs and uncertainties of carrying a foreclosed property through the real estate owned process. From the borrower's perspective, while the debt settlement is a matter of record, the borrower has avoided a foreclosure on their credit history. There is less social stigma attached to having completed a short sale, versus having one's home go through foreclosure.
Depending on the jurisdiction and results of negotiation between borrower and lender, the short sale may or may not clear the borrower against any future deficiency judgment; this being the difference between the loan amount outstanding and net result accepted by the lender through the short sale.Â
Deed-in-lieu of foreclosure. In this loss mitigation technique, the lender accepts the property back in full satisfaction of the mortgage debt, allowing the lenders to have full title and possession of a home. As with a foreclosure, the lender ‘takes the home back’ and must then maintain the home, keep taxes and insurance current, and then attempt to sell the home.Â
Unlike the procedures in other loss mitigation techniques, the lender now becomes the primary owner of the property. Programs are emerging in which the borrower ‘gives back’ the home, but remains in place, paying a monthly rent to the lender.
Overall, deed-in-lieu of foreclosure is a valuable tool in judicial foreclosure states where the foreclosure process is lengthy or where there is an activist, consumer-oriented judiciary. Furthermore, it is possible that more primarily nonjudicial foreclosure states will join Colorado in mandating a ‘quiet period’ or ‘time out’ for certain foreclosures, which further lengthens the process.Â
The deed-in-lieu of foreclosure can have other complications. For example, in some states, the deed-in-lieu lets junior liens survive, while foreclosure cancels all junior liens, clearing the property for lender take-back. In these cases, the foreclosure attorney may recommend against taking a deed-in-lieu approach to loss mitigation.
Also, each state has a different home valuation, procedural, legislative and even social climate through which we must navigate as foreclosure attorneys. In general, the longer foreclosure takes in a state, the more attractive loss mitigation/foreclosure alternatives become.
As the economy and home valuations improve, and as our experience with lender-based and government-based loan modification programs becomes better known, we expect the entire lending system to refine its approach to foreclosure alternatives. With each file we process, we get a clearer picture of which programs are best for both lenders and borrowers.
Overall, the default servicing community has developed an exceptional knowledge base, outstanding customer service and communications skills that are helping lenders mitigate their losses more quickly and more efficiently than ever before. In doing so, we are also keeping more borrowers in their homes and playing a meaningful role in helping to stabilize families and communities.Â
Kip J. Bilderback is a partner at Millsap & Singer LLC and can be reached at
kbilderback@msfirm.com. Aaron Waite is a managing attorney with The Cooper Castle Law Firm and can be reached at awaite@ccfirm.com.
