Defaults & Failure to Pay
A very real part of Trust Deed investing is borrower default and failure to pay. Here we will describe your options when a default occurs. Most lenders and note holders are not anxious to foreclose. As a result, it is not uncommon for loan payments to be several months delinquent prior to the commencing of a foreclosure. Frequently the borrower who is delinquent on your loan is also delinquent on other obligations, which can include junior mortgages. This is why Secure Deeds does not recommend junior lien positions (2nd mortgage, 3rd, 4th, etc.) If you are in a junior position and the borrower has defaulted on your loan, that usually kicks in an automatic default on a senior loan, in which case you would have to pay the senior loan off in order to have a chance of recovering your investment.
Assignment of Rents
If the property produces income you may elect to collect the rents and profits during the foreclosure process to help maintain the obligations of the note. As additional security for your loan, on all Non-Owner Occupied loans you should have received an assignment of rents extension on the deed of trust. Trying to administer this provision on you own is not effective and therefore not recommended. You will want to contact a lawyer or other legal counsel to help you enforce the assignment of rents provision.
When foreclosing a deed of trust, all sums owing ands secured by the deed of trust are accelerated and immediately become due regardles of the maturity date identified in the promissory note, provided that an acceleration clause is included in the note and/or deed of trust. There are two methods used to foreclose on deeds of trust: judicial foreclosure and nonjudicial foreclosure.
A judicial foreclosure is when the lender files a lawsuit in a local superior court to foreclose on the property. When the lender files a lawsuit against the borrower in a local superior court to judicially foreclose, the property, unless the default is remedied, will be ordered sold at a publicly held sale supervised by the court. The judicial action to foreclose is often more costly and will typically take more time to complete than the nonjudicial foreclosure.
On a nonjudicial foreclosure the trustee (or successor trustee which is usually your attorney) named in the deed of trust will proceed with the foreclosure at your direction and, unless the default is remedied, sell the property without court supervision. This privately held public sale procedure will usually take at least four months to complete.
One of the major differences between the two types of foreclosure is your right to seek a deficiency judgment, which is available on non-purchase money mortgages (most refinances and non owner occupied properties). A deficiency judgment is for the amount, if any, that is insufficient to repay the entire amount owed by the borrower, including all the fees, costs, and expenses of the foreclosure. A deficiency judgment is only available if the judicial foreclosure method is used.
Deed In Lieu of Foreclosure
Another remedy available to the lender is to negotiate a deed in lieu of foreclosure. A properly executed deed in lieu of foreclosure, when accepted by you, will transfer the title of the property to you without going through a foreclosure. The advantages to this method are elimination of foreclosure fees, costs, and expenses, and that you will have an immediate ownership and control of the security (subject property). One disadvantage is that you are accepting the property subject to all junior liens, which are typically removed in a foreclosure.
The borrower, in an effort to prolong or avoid the sale of the property in a foreclosure, may seek the protection of an automatic stay (a prohibition of further foreclosure action) by filing a petition in bankruptcy in a federal court or bring an action on state court to restrain the nonjudicial foreclosure sale through a temporary restraining order. A bankruptcy petition which is filed in federal court prior to the sale of the property prevents the lender from selling the property without relief of the automatic stay. A temporary restraining order will act to delay the sale until the state court determines whether a preliminary injunction (preventing foreclosure) is to be granted until a full hearing or trial can be held on the matter. You will need the assistance of a lawyer to ask the court for a relief from automatic stay (removal of the prohibition, thereby allowing you to foreclose). You will also need a lawyer to respond to a restraining order. It is important to act quickly when responding to either an automatic stay petition or a restraining order.
No matter which of the above methods you use to recover your investment, keep in mind that the fees, costs, and expenses incurred during the process can add up quickly and reduce the equity of the property. It is also important to note that while acting to recover your investment during a default, you may not receive any income from your trust deed investment, and return of your principal investment will be delayed until you gain ownership or control over the property.