Across America, real estate investors and home owners alike are making real estate purchases made possibly by our system of real estate financing and mortgages. Rather than paying the entire cost all at once, credit-worthy property purchasers may place a fractional down payment on their real-estate investments. A lending institution will provide a loan – typically a mortgage – to pay the remaining balance.
When people are unable to live up to their commitments in a real estate financing arrangement, they often find themselves facing a foreclosure or a short sale. However, the rights and responsibilities associated with the different options facing real estate borrowers in default vary greatly. A good real estate lawyer can help mortgage borrowers manage their various options, each of which offer different degrees of legal and financial liability.
Mortgage and Foreclosure
When taking out a mortgage loan, a lender and a homeowner execute a promissory note that articulates the details of the rights and liabilities associated with both the debt and security of the loan. However, mortgages require more than just a contract between a borrower and a lender that outlines a conveyance of real-estate coupled with a legal assurance to pay a debt. In a mortgage agreement, the real estate acts as a security on the loan. If the mortgage borrower goes into default by either failing to pay or breaking any other substantive term of the lease, the borrower’s property may be at risk.
A promissory note will specify the payment amounts and the time allotted for the loan amount to be paid back in full, usually with added interest and fees. Promissory notes will also articulate any other requirements – such as insurance, maintenance, property use, and other mandates – necessary to maintain the agreement in good standing. If borrowers either fail to make payments as required in the note or violate other substantive terms, they will enter default. In this case, borrowers typically have two options: either pursue a short sale or await foreclosure.
Foreclosure is a legal process through which a lender invokes a number of rights against an underlying property after a borrower has allowed a mortgage loan to go into default. Foreclosure laws regulate the rights of both borrowers and lenders in the event a borrower fails to uphold his or her end of a mortgage agreement. In most jurisdictions, these laws empower mortgage lenders the to take legal and actual possession of mortgaged property when the borrower has allowed the loan to default.
Foreclosure can either be court ordered or achieved through contractual power of sale. Judicial foreclosures require lenders to demonstrate as a matter of law that the terms of a valid mortgage agreement have not been upheld by the borrower, and thus the loan is then in default. Only then may a lender assert its rights against the property that was purchased with the mortgage loan, and if the lender wins it will secure a court order will for the seizure and sale of the subject real estate. The real estate is sold – typically by public auction – and the proceeds of the sale is used to pay off the remaining balance of the loan.
In many cases, the capital recouped from the real estate liquidation is insufficient to cover the amount outstanding on the mortgage. In these cases, borrowers may be obligated to liquidate personal assets and forfeit any equity accrued in the property as a result of these unfortunate circumstances.
In many cases, foreclosure follow a major change in a borrower’s financial circumstances, such as a divorce, unexpected medical bills, the loss of a spouse, or loss of employment. Due to these and other challenging circumstances, thousands of American families end up facing foreclosure every day.
Despite how common it is, foreclosure is an extreme solution and should be treated as a last resort. Financial challenges can be daunting, and some homeowners and real estate investors facing default choose to bury their heads in the sand, avoiding the issue until it comes to its natural legal termination. In this case, a mortgage borrower is likely to end up in foreclosure. In many cases, however, borrowers facing default are able to negotiate short sales with their lending institution instead of moving forward with a foreclosure.
Short Sales Offer Important Benefits Over Foreclosures
Depending upon the terms of the mortgage agreement, borrowers in default may be able to move forward with a short sale. This avoids the potential consequences of a foreclosure, which can be enormous.
Under a short sale agreement, a mortgage lender will typically agree to discharge the debt underlying the mortgaged property regardless of how much the property sells for. Thus, even if the property sells for substantially less than what is owed, a borrower may be relieved of the underlying debt.
A short sale is often the preferred option for borrowers who can no longer afford payments on their mortgages, as it may offer meaningful financial relief. Short sales can be structured to release a borrower from a loan agreement for less than what was originally owed, and many lenders will accept the profits from a short sale rather than move forward with the costly and time-consuming process of foreclosure. This is particularly true when the difference between what is owed and what the property ultimately sold for is minimal.
The biggest difference between a short sale and a foreclosure is that under a short sale the lender agrees to accept compensation that is lower than what is still owed on the borrower’s mortgage. In these cases, when the borrower defaults on the mortgages and is compelled to sell the property for less than what is owed on the loan, the lender will accept the sales price as full repayment for the defaulted loan, no matter the amount.
Unlike a foreclosure, a short sale often does not impose any additional financial or legal liability on a borrower in default once the sale has closed However, some states require borrowers to be held responsible for the difference between what the property sold for and what was originally owed, even in a short sale. In these jurisdictions, borrowers should consult with a licensed real estate lawyer before taking out a mortgage loan.
Why Lenders Agree to Short Sales
Borrowers whose mortgages are in default, might attempt to negotiate a short sale with their lenders. However, anyone facing default on their mortgage should be prepared to face foreclosure, as whether lender decides to move forward with a short sale is often entirely a matter of the lender’s discretion.
Many lenders choose to accept short sales as compensation for a defaulted loan over a foreclosure because foreclosures can be a drawn out and costly process for all parties involved. Whether or not a lender will accept a short sale in the event of an impending or actual default on a mortgage agreement very much depends on the circumstances surrounding both the loan and property.
As the economy ebbs and flows, the real estate market does the same. Properties that come up for sale in an unfavorable market could easily sell for much less than what is owed on the mortgage. Often, lenders are willing to work with home owners who find themselves in these circumstances. Before moving forward with a short sale or a default, however, be sure to consult with a real estate lawyer licensed in your jurisdiction.