Prerequisite: Deed of Trust with Power of Sale
Contrary to popular belief, banks can’t just take back a property when an owner stops making payments. In non-judicial foreclosure states, the right to foreclose and sell the property actually lies with a 3rd party, known as the trustee; who has a responsibility to both the lender and the borrower.
When you purchase a property, ownership is transferred to you using a document known as a deed. When you take a loan (in a non-judicial foreclosure state), you sign a deed of trust, which gives this third party trustee the right to sell the home if you fail to make payments. This power of sale is what makes non-judicial foreclosure possible.
The Notice of Default
The foreclosure process is first triggered when the lender notifies the trustee that the owner is not paying their loan, as agreed. Upon receiving that notice from the lender, the trustee will issue a Notice of Default, which is typically published in the local paper, posted on the property, and recorded at the County Recorder’s office. This notice provides the borrower with a period of time (varied by State), in which to either dispute the lender’s claim that the borrower has defaulted on their loan, or to pay the loan current prior to the house being sold. Here are some of the common features of a Notice of Default:
•Puts owner and public on notice that the foreclosure process has started.
•State statutes define when a Notice of Default can be issued.
•Typically lists the default date and default amount. The default amount can be more than the loan amount in the case of a loan with both payments in arrears and a balloon payment that is past due for the remaining balance.
•Provides lender contact information to the borrower.
The Notice of Trustee Sale
Once the owner has received the notice of default and has been given an opportunity to bring the loan current, the trustee will proceed with scheduling the auction date and time if the owner has not yet brought the loan current. The Notice of Trustee Sale sets forth the auction date, time, location, and in some States, the opening bid amount. Here are some of the common features of a Notice of Trustee Sale:
•Sets date, time and location of foreclosure auction.
•State statutes specify the required information, format, and procedures for Notices of Trustee Sale, as well as how the trustee sale must be conducted.
•Provides a published bid amount that usually equals the principal balance + past due payments + late fees + foreclosure fees. The actual opening bid at the auction may be lower, sometimes considerably, at the lender’s discretion.
The Trustee Sale Auction
On the date and time of the trustee sale auction, one of four things may occur with the property:
- The auction for the particular loan may be cancelled. This may occur because the property was sold before the auction, and therefore the loan was repaid (or partially repaid in the case of a short sale); the owner was able to refinance the loan; the owner came up with the cash to bring the loan current; or, there may have been an error made in the sale process, and the trustee has decided it would be better to restart the process.
- The auction may be postponed to a later date and time. Common reasons for postponement include: mutual agreement, trustees discretion, bankruptcy, and operation of law.
Reasons for Postponement
- Mutual Agreement. The most common postponement reason it simply indicates that the homeowner and the lender have agreed to postpone the sale. This may be the result of a simple call by the homeowner requesting a little more time, or a more formal agreement like forbearance. Many homeowners do not realize when they enter a forbearance agreement that the foreclosure process continues; and if they miss an agreed upon payment, the property can be sold on the next scheduled sale date with no further notice.
- Bankruptcy. When a homeowner files for bankruptcy protection, it puts an automatic stay on all debt collection actions, including foreclosure. Note that bankruptcy does not stop foreclosure, as many believe. Instead, it simply delays the sale of the property until the homeowner resolves the debt, or in many cases, the lender gets approval from the bankruptcy court to continue the sale – an order granting motion for relief from stay. The bottom line is that a home is a secured debt, and the lender has the right to take the security (the home) if the homeowner lacks the ability to pay the debt as agreed. Bankruptcy is only an effective tool against foreclosure if the homeowner will have sufficient income to pay their home loan and make up past due amounts once the bankruptcy plan is completed.
- Beneficiary’s Request. A simple decision by the lender (beneficiary) to postpone the sale. Could be for any reason, including that they simply aren’t prepared to take the property to sale, or because they have reason to believe they are about to be paid (a closed escrow for which they have not yet received payment, for example).
- Trustee’s Discretion. A simple decision by the trustee to postpone the sale. The most typical reason is that they are unable to reach the lender for sale instructions.
- Operation of Law. Fairly rare, but used when a court orders the postponement of the sale. The most likely reasons for a court to make such an order would be in cases where there is a plausible allegation of fraud against the lender, or there are questions of material fact around the right of the lender to foreclose.
No matter what the postponement reason, a new notice of trustee sale must be posted and filed if the sale is postponed for more than 365 days.
- The property may be Sold to a 3rd Party. The loan being foreclosed on was offered for sale by the trustee, and a bidder (other than the lender) ended up purchasing the loan. These 3rd parties are typically an investor, but may be a sophisticated homebuyer or a junior lienholder protecting their interest in the property.
- The property may be Sold to the Bank. Remember that it is the trustee, not the bank, that sells the home. Since the lender clearly has the most to lose in the transaction, and because they are the beneficiary of any funds received from the sale, they are allowed to place the first bid, and are allowed to credit bid (bid without bringing cash to the sale), up to the amount they are owed.
Before bidding at auction it is important to consider the following factors:
- Auctions are open to the public—Typically held on the courthouse steps.
- Payment requirements will vary from state to state, but generally the property must be paid for, in full, at the time of the auction, and bidders are usually required to show proof of payment, typically cashier’s checks or cash, in order to qualify for bidding. Some states, like Arizona, only require a down payment.
- Generally, you are not able to perform any inspections on the property, other than a visual inspection from the street or neighbor’s yard. Hidden work can be extensive, so auction investors need to be prepared to suffer losses from time to time.
- Foreclosure auctions are subject to existing liens and encumbrances. Remember that properties aren’t sold at foreclosure auction—loans are. One of the great things about foreclosure auctions is that it wipes out loans that came after the one being taken to auction (except in the case of subordination). This can help clear up excess debt on the property, allowing it to be resold at an affordable price point. The flip side is that the buyer is responsible for any loans or liens on the property prior to the loan being taken to auction. For example, delinquent property taxes, which are typically a senior lien on the property and therefore the responsibility of the new owner.
- No title insurance. One of the things that can help buyers sort out what debt they might get stuck with after buying a property at a trustee sale, is a preliminary title report; which would show which existing loans and liens the buyer would be responsible for. One important thing to note is that even the best title companies make mistakes, and occasionally miss items that can have a dramatic impact on the amount owed on the property. To reduce or eliminate this risk, title companies offer homeowners and lenders a title insurance policy which agrees to defend against or pay any claims that their preliminary title report failed to show. Unfortunately, such insurance is generally not available for purchase at trustee sales.
The Trustee's Deed
Once the property is sold at auction, the property has been foreclosed. Ownership of the property is transferred to the new owner (whether the bank or a 3rd party bidder) with a Trustee’s Deed, and any secured interest in the property held by junior lienholders is wiped out.
Even though the bank or 3rd party bidder now owns the home, they may have to evict the current occupants. Eviction processes vary from state to state, and can also vary depending on whether the property is occupied by the former owners, or a renter. Lease agreements recorded after the foreclosing lien, are wiped out by the foreclosure, just like other liens and encumbrances, however, some states have added protections for renters allowing them to stay through the end of the lease anyway.