See Foreclosure Considerations: Sometimes, "Walking Away" is the best option.
Foreclosure is defined as follows:
To shut out; to bar; to terminate (Black's Law Dictionary).
It is a legal process by which the debtor's property becomes the absolute property of the lender (bank, individual, business, or other).
There are two types of foreclosure proceedings in California, to wit:
Judicial Foreclosure (also called Strict Foreclosure) and
Non-Judicial Foreclosure (also called Trustee's Foreclosure or Trustee's Sale).
Judicial Foreclosure contemplates the filing and service of a law suit in the Superior Court.
At trial, the lender (or creditor) will need to either reserve or waive the right to a potential deficiency judgment against the borrower.
The judgment (called a decree) will order a lien on the property foreclosed by sale to be overseen by the Sheriff, or by a Court appointed receiver.
The actual sale will take some months after the trial in the matter.
If a deficiency is reserved at trial, a second proceeding (called "fair value" proceeding) will be required after the property is sold.
The "fair value" proceeding determines the value of the property without restrictions of the . Basically, the evidence is determined by appraisal.
The deficiency is based on the higher of the winning bid at the foreclosure sale (which could be the amount due on the loan) or fair market value of the property on that date.
However, if the creditor reserved the right to a deficiency when the property is sold by the Sheriff, the sale is not final.
The debtor (homeowner or owner) will have the post sale right to redeem the property for a period of three (3) months up to a year depending on whether the winning bid was enough to pay the debt in full.
During this period, the debtor retains the right to possess the property.
The process will take up to 18 months to complete with significant legal costs.
Because of the above and the lender's ability to actually collect a deficiency judgment from a debtor who has lost his/her property, a Judicial Foreclosure is rarely used.
Due to the conditions imposed by law, there are three main reasons why this type of foreclosure is rarely used:
The process takes time;
The process is costly; and
The debtor will probably not have the ability to pay a deficiency judgment and faced with a large judgment, may elect to file for Bankruptcy.
Non-judicial Foreclosure is the most common type of foreclosure used in California.
To use this option, the security instrument (mortgage or deed of trust) must have a "power of sale" in the document (all have such language).
The foreclosure process starts with the lender (called a beneficiary in the deed of trust), recording and mailing to the debtor a Notice of Default (NOD).
The NOD must describe the default and be in the form as required by law.
The debtor can reinstate the loan by paying the amount in the default.
Three (3) months after the NOD is recorded and mailed, the lender may record a Notice of Sale (NOS).
The NOS is also served on all interested parties, published in a newspaper of general circulation in the County where the property is located, and posted at a public location (typically the local Court house).
The sale (sometimes called an Auction Sale) can take place twenty days thereafter. Note that the sale can be postponed at the discretion of the lender (such as to allow debtors to cure the default or pay-off the loan).
Anytime up to five (5) business days before the sale date, the debtor can reinstate the loan.
The reason this type of foreclosure is used is that it can take place in four (4) months as opposed to a Judicial Foreclosure, which can take up to 18 months or more.
THIS IS IMPORTANT - the price the lender pays for using this procedure is that the lender will be barred from collecting a deficiency judgment (Cal. Code of Civil Procedure §580d).
New Changes in the Law: New foreclosure rules have been enacted by California Legislature in response to the foreclosure crisis. The changes affect loans on homes (1-4 family dwellings) made from 1/1/03 through 12/31/07 (SB 1137). The rules affect the time when a lender can file a NOD or when a NOS may be noticed.
A NOD cannot be recorded or served on a borrower until "Initial Contact" has first been made by a lender on a borrower "...to assess borrower's financial situation and explore options..." (CA Civil Code 2923.5). This applies to all loans on "homes" (1-4 family dwellings).
After a default, the lender must "contact" borrower (CC 2923.5 sets forth the method of "contact"). Thereafter, the lender can record a NOD. This adds an additional 30 days to the foreclosure process.
The following applies ONLY to homes (owner occupied 1-4 units) secured by a 1st mortgage.
A NOS cannot be given until 90 days after the lapse of 3 months after a NOD is recorded (CC 2923.52).
This new law extends the time of foreclosure by an additional 3 months (presumably to allow borrower to complete a loan modification).
A non-judicial foreclosure "wipes out" the security of any junior liens.
A non-judicial foreclosure has no effect on senior liens.
The determination of whether a lien is senior or junior depends on when the lien was recorded. As a general rule, "first in time is first in right". A loan recorded on 4/1/xx is senior to a loan recorded 4/2/xx (junior loan).
For example, a homeowner purchases a home for $500,000. The homeowner puts up $100,000. cash and obtains a loan for $400,000. when the property closes escrow on April 1, 2005 (Loan 1). The home appreciates in value, so that on April 1, 2006, the owner obtains a home equity line of credit (HELOC) and draws down the sum of $100,000. (Loan 2). The home again appreciates in value and the homeowner again borrows money from the private lender on April 1, 2007 (Loan 3).
All of the loans are secured by Deeds of Trust (mortgages) on the property.
Scenario 1: Homeowner is in financial trouble and fails to make payment on Loan 1. The lender files a NOD and three months later, a NOS. The foreclosure sale takes place with the lender owning the property.
Result Scenario 1:
Lender on Loan 1 owns the property.
Lender on Loan 2 has no security in the home.
Lender on Loan 3 has no security in the home.
Scenario 2: Homeowner is in financial trouble, but in this instance, the lender in Loan 2 forecloses.
Result Scenario 2:
Lender on Loan 1 is still good and is secured on the home.
Lender on Loan 2 owns the home, subject to the lien of Loan 1.
Lender on Loan 3 has no security in the home.
The junior liens in Scenario 1 (Loan 2 and Loan 3) and Scenario 2 (Loan 3) are "wiped out" by foreclosure of a senior loan.
Can those "wiped out" lenders pursue the debtor? The answer depends on whether the loans are recourse or non-recourse and whether the lender is the same institution that has the senior loan (see discussion below).