Successful investing in trust deeds involves answering the often asked question of what to do should the borrower stop making monthly payments on the note. While the possibility of losing principal is remote, even the most well-secured trust deed investment provides no guaranties that the borrower will make all their payments on a timely basis. Having a well-defined plan and taking quick decisive action by a lender will typically minimize a depletion of protective equity in the trust deed investment and thereby keep your loan more secure in the event a delinquency should occur.
Know The Foreclosure Process
It is important to know how the foreclosure process works and the individual parties in the foreclosure process. Besides the lender and the borrower, the other important party is the trustee listed in your deed of trust. Know how to contact the trustee and who specifically handles the foreclosure process. Additionally, it is important to have copies (or know where they are) of your note, the recorded deed of trust, and any other applicable recorded documents that are part of your trust deed investment.
Most lenders will commence foreclosure within 60 to 120 days of the borrower’s first delinquency in payments. Once the decision to foreclose on the property has been made, the best and fastest way to recover your investment is via a prompt commencement and processing of the foreclosure. This will shorten the time of delayed cash flow as well as result in a much lower risk where damaged property or unoccupied property is involved. If the trustee is handling the foreclosure process, ask them to outline the costs involved in beginning the foreclosure process through to the foreclosure sale so you can plan.
If your trust deed investment is secured by an income-producing property, you can separately move to recover a portion of your investment by electing to continue receiving rents and profits as the foreclosure process occurs. This can be a tricky process so you will want to speak to your legal advisor.
If you have funded junior liens, the foreclosure process has a few more issues involved. Again, moving quickly will lessen the amount you may have to pay to reverse the default on senior liens as well as allowing you time to maintain or service those senior liens without causing further delinquency until the foreclosure sale on your junior lien has concluded. It is not uncommon for a junior lien holder to start foreclosure while continuing to pay the monthly cost of the senior lien during the pendency of the foreclosure sale. One important consideration to keep in mind during the loan origination process involving junior liens is that the junior lien’s due date on the promissory note should occur prior to the due date of the senior lien’s promissory note.
Loan Modifications or Forbearance Agreements
Another way to increase the possibility of recovering your investment is to give the borrower an extension on the maturity of the loan or to modify the terms of the loan. There are many different types of agreements that can be reached with the borrower and lender, and all of these agreements will have to be reduced to writing which are called loan modifications or loan forbearance agreements. You will want your trustee or legal representative to review and approve of any such documents.
Negotiating A Deed-In-Lieu
An alternative to foreclosure can be negotiating a deed-in-lieu of foreclosure between the lender and the borrower. When the agreement and the deed-in-lieu have been property created and delivered, it will cause the transfer of the property’s title from the debtor to the lender. While there are important tax considerations to review with your tax professional ahead of time, this method can benefit the lender in a few ways under the right circumstances. First, any fees associated with foreclosure are eliminated. Second, control and ownership of the property to lender is very quick compared to foreclosure, however, it is very important to understand that such ownership is subject to all junior liens on the property as all junior liens must be accepted when utilizing a deed in lieu (this can be an important consideration if construction or repairs are involved with the property as mechanics liens may be present).
Some borrowers will file for bankruptcy so that the foreclosure process can be delayed. When this occurs, the trustee is ordered by a judge to halt all foreclosure proceedings until the borrower’s outcome in bankruptcy court has been determined; this is called the “automatic stay” of bankruptcy protection. If you borrower files bankruptcy, moving quickly to hire bankruptcy counsel to review and respond to the bankruptcy filings to insure your interests are represented correctly.
Understanding the foreclosure process well in advance of actually experiencing one is very good advice. Let us know if we can help!