Defaults & Foreclosures

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1. Name three common types of default. (See other

correct answers on screen 3.): Failure to meet an
installment payment of the interest and principal.
Failure to pay taxes when they are due.
Neglecting to pay hazard insurance premiums.

2. What does the Housing Act of 1964 require?:

Requires that lenders provide relief in circumstances
where the default is beyond the borrower's control.
3. What is a moratorium?: A temporary or permanent,
partial or full waiver of mortgage payments that the
lender grants to the defaulting borrower.

4. Define recasting.: A redesign of a loan by changing

the terms, either temporarily or permanently.
Lenders can change terms such as interest rate,
amortization period or payment amount.
5. A redesign of a loan by changing the terms, either
temporarily or perma- nently. Lenders can change
terms such as interest rate, amortization period or
payment amount.: The right to redeem property
between the time of the default and the foreclosure
sale is equity of redemption.

The right to redeem the property after the

foreclosure sale has taken place is statutory
redemption.
6. What is a deficiency judgment?: Any outstanding
debt remaining after foreclo- sure and sale of a
property.
7. With a judicial foreclosure, when is the Deed of
Conveyance issued and who issues it?: The sheriff
will issue a Deed of Conveyance if the debtor does
not redeem the property within the redemption
period.
8. What does the FHA expect a lender to do at the
foreclosure sale for an FHA-insured property if the
bids are less than the loan balance?: FHA expects
the lender to bid on the debt, take the title, and
present it to the FHA along with a claim for
insurance.
9. What kind of redemption rights does a defaulted
borrower have under a power-of-sale foreclosure?:
The borrower has the right to redeem the property
between the notice of sale and the actual sale
(equity of redemption). But there is no statutory
redemption period with a power-of-sale foreclosure.
10. In a nonjudicial foreclosure sale, the new
purchaser will receive a trustee's deed to the
property. But what potential problem exists?: There
is no guarantee that the title is clear. There may be
some outstanding liens still in effect, such as a
federal tax lien, real property taxes or assessments,
or a valid mechanic's lien.
11. What is the disadvantage of a strict foreclosure?:
There is no clearly estab- lished value for the
property because there is no public auction. The
lender's losses cannot be established and there are
no deficiency judgments with strict foreclosures.

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Ch. 10 - Defaults & Foreclosures

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12. Which form of bankruptcy is the least favorable

to a lender?: Chapter 11 bankruptcy is the least
favorable because the lender may find that the
security is tied up for years during the reorganization
process.
13. A default is a failure to carry out a contract,
agreement, or other obligation, especially a financial
obligation such as a note. A mortgage default can
result from any breach of the mortgage contract.

The most common default is the failure to meet an

installment payment of the interest and principal on
the note. Other defaults include:

Failure to pay taxes when they are due.

Neglecting to pay hazard insurance premiums.:
Failure to pay taxes or insurance premiums could
cause the lender to state that the full amount of the
loan is due and payable (acceleration). If the
borrower can't meet the requirement for full
payment, the lender can bring an action for
foreclosure.

Some loans also have stipulations regarding property

upkeep. In some cases, failure to keep the collateral
in repair may constitute what is called a technical
default.

The Soldiers and Sailors Civil Relief Act of 1940

protects military personnel and their dependents
from being harassed by creditors, if their ability to
pay their bills has been affected by military service.
The Act restricts the power of the creditor to sell,
foreclose on, or confiscate the property of a member
of the armed services for nonpayment without first
obtaining a court order.

Under The Housing Act of 1964, the FHA requires

that lenders provide relief in circumstances where
the default is beyond the borrower's control. The VA
also requests relief for a veteran borrower who
wants to pay but cannot. The VA itself may choose
to keep up the payments for the veteran in order to
keep the loan current. 14. The term workout is used
to describe the activities that a lender will undertake
to deal with a borrower who is in financial trouble.
There are a number of alternatives that a lender can
consider in a workout. They include:- : Forbearance
or moratorium - The lender may choose to waive
mortgage payments temporarily or even forgive all or
some of the payments. A moratorium is usually one
of these four types: waiver of principal payments,
deferred interest, partial payments or prepayments.

Restructuring the mortgage loan - The lender can

redesign the loan through re- casting (changing the
terms such as interest rate or payment amount) or
extension agreement (extending the amortization
period for the remaining principal).

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Ch. 10 - Defaults & Foreclosures

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Transferring the mortgage to a new owner - The

defaulted borrower may be able to find someone who
can purchase the property and either assume the
mortgage or take the property "subject to" the
existing mortgage.
Deed in lieu of foreclosure - The lender may make or
accept an offer to take the title to the property back
from the borrower (also called voluntary
conveyance). Friendly foreclosure - The borrower
accepts the jurisdiction of the court, gives up any
right to declare any defenses and claims,
relinquishes the right to appeal or argue with any
judgment that is given, and otherwise agrees to
cooperate with the lender in the litigation.
Prearranged bankruptcy - The borrowers and all their
creditors agree in advance to the terms on which
they will turn the assets over to the creditors in
exchange for the release from the liability.
15. A foreclosure is a legal procedure in which the
property that is used as security for a debt is sold to
satisfy the debt in the event of a default.

During the period after a default and before a

foreclosure sale, the borrower has a right to reclaim
the property that was forfeited due to the mortgage
default. The borrower can claim the property by
paying the full debt, plus any interest and costs.The
right to redeem property between the time of the
default and the foreclosure sale is called the equity
of redemption right.

Once the foreclosure sale has taken place, any right

to redeem the property is known as the right of
statutory redemption.: There are three types of
foreclosure proceedings:

Judicial foreclosure
Nonjudicial foreclosure
Strict foreclosure
A judicial foreclosure allows a property to be sold by
court order after sufficient public notice. Most
lenders will seek a judicial foreclosure when they
want to get a deficiency judgment, which is any
outstanding debt remaining after the foreclosure and
sale of a property.
The judicial foreclosure procedure can be used with

Conventional mortgages Conventional insured

mortgages FHA-insured mortgages

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VA-guaranteed mortgages
Junior mortgages
16. A nonjudicial foreclosure is also known as a
power of sale. With this type of foreclosure, a lender
or a trustee has the right to sell the property without
spending the time, effort and money involved in a
court foreclosure. This form of foreclosure
eliminates the statutory redemption period that is
allowed in the judicial foreclosure process.

The deed of trust gives the trustee the power of sale

in the event of a default. If there is a default, the
lender will notify the trustee in writing of the
borrower's delinquency and will instruct the trustee
to begin the foreclosure process. However, the
trustee has the option to foreclose judicially if there
is the possibility of getting a deficiency judgment,
since California does not allow a deficiency
judgment on a power-of-sale foreclosure.: At the
sale, the property will go to the highest bidder. The
new purchaser will receive a trustee's deed to the
property, but there will be no guarantee that the title
is clear. There may be some outstanding liens still in
effect, such as a federal tax lien, real property taxes
or assessments, or a valid mechanic's lien.

The power-of-sale process can be incorporated into a

standard mortgage contract. Several states that do
not use the deed of trust allow this process to be
used for mortgages.

Using the strict foreclosure method, a lender could

get ownership to a property that has a value above
the loan balance. The problem with strict
foreclosure, however, is that there is no clearly
established value for the property because there is
no public auction. In this case, the lender's losses
cannot be established. There are no deficiency
judgments with strict foreclosures.

17. Many people believe that if they lose their home

in a foreclosure, they will owe no taxes. This is not
necessarily true. As far as the IRS is concerned, a
foreclosure is considered a sale. If the amount of the
defaulted loan exceeds the tax basis of the property,
the IRS considers that there has been a gain.
The potential for bankruptcy under Chapters 7, 11
and 13 of the Bankruptcy Code affects the value of
real estate as collateral.

The objective of a Chapter 7 bankruptcy is to

liquidate the debtor's assets and distribute the
proceeds among the various creditors. A lender will
normally be paid in full if the value of the property is
more than the balance due under

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Ch. 10 - Defaults & Foreclosures

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the mortgage.: A Chapter 11 bankruptcy is available

to owners of a business and looks to safeguard the
debtor's assets while putting together a plan of
reorganization. Chapter 11 bankruptcy proceedings
should be a great concern to lenders who may find
that their security is tied up for years during the
reorganization process.

A Chapter 13 bankruptcy is known as a "wage earner

proceeding." This plan is designed for the
rehabilitation of the debtor. The funding of the plan
is designed to come from future wages and earnings
of the debtor. During the period covered by the plan,
creditors must accept payments as they are
provided in the plan and may not seek to collect
their debts by other means.

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device: Chapter 10 Summary
18. Most private mortgage insurance companies
consider a default to be nonpayment of the mortgage
for how long?: 4 months

19. After a nonjudicial foreclosure sale, to whom do

the proceeds go first?: To the trustee to pay
expenses
20. Which is the most common type of default?:
Failure to make mortgage payments

21. What is it called when a lender chooses to waive

some or all of the defaulted mortgage payments?:
Forbearance
22. Which legislation requires lenders to provide
relief when circumstances are beyond the borrower's
control?: Housing Act of 1964
23. How does the title usually transfer in a voluntary
conveyance?: Quitclaim deed
24. What is the term for the right of a defaulted
borrower to buy back the property before the
foreclosure sale?: Equity of redemption
25. What document gives constructive notice that an
action affecting a partic- ular property has been
filed?: Lis pendens
26. Which of the following is not an example of a
moratorium?: Full payment of arrearages
27. Which of the following statements is not true?: A
deed of trust allows three months after the sale for
the debtor to reinstate the loan by bringing payments
current and paying any expenses.