This post is not legal advice. It is a general discussion of SOME of the relevant legal issues surrounding foreclosure. If you are considering or facing foreclosure, you need specific legal advice for your particular situation. Consult an attorney in your area.
Practically every day, I get a call from a potential client wondering what to do with a property that is seriously “under water.” A property is under water where the owner owes more on the mortgage(s) than what the property is worth in today’s market. The problem can be compounded by high mortgage payments (in the go-go market of yesteryear, it was not uncommon for someone to buy “more house” than they needed in the hopes of continued double-digit appreciation — the more expensive the asset, the greater the total appreciation). At least once a week, I speak with someone who has mortgage payments of $3000+ per month, where they could rent a suitable place for half that and they owe $50,000+ on the property beyond what it is worth.
So what to do? It’s been the topic of some discussion. One option is to hunker down, bite the bullet, and wait for the market to bounce back. After all, you’ve got to live somewhere. Eventually, the market will start going up and some day you’ll regain equity in the property (equity = value in the property greater than what is owed on it). However, depending on when you bought and what you paid, it may be a loooooooooonnnnng wait…. In the meantime, you’ll keep making those big mortgage payments.
Some people wonder whether they can just walk away from the property and be done with it. The usual plan: Let it go to foreclosure, temporarily ruin your credit, and start saving the difference between rent and the mortgage. To determine whether this is a good idea — or, more accurately, to get an idea as to the risks and benefits of doing so — you must first understand the difference between a judicial foreclosure and a nonjudicial foreclosure. [Author’s Note: This post is written for residents of Washington State. If you live somewhere else, your laws may differ. Yet another reason to consult an attorney.]
First, some background: When you bought the property, you borrowed money from a lender. In doing so, you signed two key documents: a promissory note, and a deed of trust. The promissory note is the legal document that sets forth the debt and the terms of repayment. The deed of trust is a type of deed (a document that transfers title to real property). Under a deed of trust, you transferred title to the property to a trustee, who “owns” the property for the sole purpose of guaranteeing that you repay the debt as set forth by the promissory note. If you fail to pay the debt, the trustee has the power to sell the property without your permission so that the proceeds of the sale can be used to repay the debt.
Now, the two types of foreclosure: A judicial foreclosure is a civil action filed in court by the lender. The lender sues for payment of the debt reflected by the promissory note. The process takes 12+ months and is expensive. At the end of the process, the court will order the sale of the property, the property will be sold at public auction, and the proceeds from that sale (after costs incurred) are applied to the amount owed. If there is a balance remaining on the debt, that difference becomes a judgment against you. This is a “deficiency judgment” because it is a judgment for the deficiency between the amount paid (via the sale) and the amount owed. A “judgment” is a court order requiring a person to pay a specific sum, and if not paid immediately it accrues simple interest at 12% until paid. A judgment expires 10 years after it is entered by the court, but it can easily be renewed for another 10 years. Once a creditor has a judgment, the creditor can use various legal tools to extract payment from the debtor without the debtor’s consent. For example, the creditor can garnish the debtor’s wages (the employer pays a portion of the wages directly to the creditor) or garnish the debtor’s bank account (the bank disburses the funds in the account directly to the creditor). It is safe to say that judgments are bad. So, one should avoid a judicial foreclosure.
The other type of foreclosure is a nonjudicial foreclosure. With this type of foreclosure, the trustee orders the sale of the property under the authority conferred on him or her by the deed of trust. Once again, the proceeds (less costs of sale) are applied to the debt owed under the promissory note. This process is quicker and cheaper than a judicial foreclosure. However, a nonjudicial foreclosure extinguishes the debt set forth in the promissory note, even if the sale does not net enough to repay the debt in full. There is no possible deficiency judgment. Thus, with a nonjudicial foreclosure, the debtor knows that he or she will not owe anything following the foreclosure, regardless of whether or not the lender is repaid in full following the sale.
Obviously, then, foreclosure may make sense if the lender foreclosures nonjudicially, but probably does not make sense if the lender forecloses judicially. Which will happen to you? Unfortunately for debtors, lenders do not advertise in advance which method of foreclosure they intend to use. That said, the vast majority of foreclosures are nonjudicial. A judicial foreclosure would make sense for a lender if the debtor has other assets that can be used to satisfy the deficiency judgment. If the debtor has no other assets, then they are “judgment proof” (a term used to describe someone who simply has no money to satisfy a judgment, thereby discouraging anyone (including a lender) from incurring the costs of a lawsuit). Where the debtor is judgment proof, it makes no sense at all for the lender to incur the costs of obtaining a judgment.
So, if you’re willing to assume the risk of a judicial foreclosure, and/or you have no assets whatsoever such that you are comfortable being judgment proof, then it may make sense to just walk away. [Note: you’ll have a hard time getting credit, finding a landlord, or otherwise living in the modern world if there is an unpaid judgment against you.] However, this is only ONE of the TWO key factors you need to consider. Stay tuned for Part 2.
Good article, Craig. Looking forward to Part 2. Unfortunately we are all getting more educated on foreclosure these days. Just a note on rents: “At least once a week, I speak with someone who has mortgage payments of $3000+ per month, where they could rent a suitable place for half that”. Maybe. My general sense is that rents commonly run $.80/sf/mo to $1.20/sf (browse http://www.zilpy.com for a quick idea in your area), so if you need 2,500sf for your family, getting down to half that $3,000 may not be so easy.
Best Regards,
Chuck
Great article, Craig!
Having a good general understanding of the foreclosure processes is very helpful for real estate agents as we tread through these difficult financial times. These days we may encounter a number of property owners that are in various stages of foreclosure, at least more often than we did in the past.
It seems to me that the main problem for us agents is in getting in over over our heads with advice. Even if we think we understand the foreclosure process and options available we are not allowed to practice law and could get ourselves into huge trouble by giving advice.
But those agents who still want to be knowledgeable on the ins and outs of this subject, and we should, I have a great recommendation. I just took a EXCELLENT class from Rain City Guide’s own Jillayne Schlicke that was “all about foreclosures”. I highly recommend it as a way to learn the ins and outs of this subject.
I know RCG doesn’t like to see promotion of people’s business’s here, but hopefully the editors will let me leave this plug for Jillayne because it doesn’t have any follow links to Jillayne’s site.
I’ve heard anecdotally from people even with assets that they’re going to walk away because they’re so far underwater — they don’t believe the banks will pursue a deficiency judgment against them because of the cost, and because the banks are overwhelmed as it is. how aggressive are the banks in determining a person’s assets? how do they determine whether it’s worth their time to pursue them?
Chuck,
There is a big difference between “need” and “want” – especially when it comes to the amount of space you need to live in. There is a definite trend toward smaller homes in general, and I think many families currently in 2,500-3,500sq ft homes would not be sacrificing all that much to move down into the 1,700 to 2,000 sq ft range (or smaller).
Gene
Just gonna chime in and agree with Gene,
I grew up in a house with 4 people in it that was about 1,400 sq ft. It never seemed small.. While I can see why it’d be nice to have more room.. you can live very comfortably and happily a LOT less space.
I used to work for a guy who was in the US from Macau (near Hong Kong). He grew up in about 1,000 sq ft with a family of 6…
So yea, want and need are two different things.. 🙂
Just gonna chime in and agree with Gene,
I grew up in a house with 4 people in it that was about 1,400 sq ft. It never seemed small.. While I can see why it’d be nice to have more room.. you can live very comfortably and happily a LOT less space.
I used to work for a guy who was in the US from Macau (near Hong Kong). He grew up in about 1,000 sq ft with a family of 6…
So yea, want and need are two different things.. 🙂
Tim — great questions. Unfortunately, I don’t know the answers. I have no idea about how — or even whether — banks determine the method of foreclosure. Maybe we’ll get lucky and some recently laid off disgruntled bank employee will give us some insight. However, the odds are pretty low of there being layoffs involving people who participate in this process, given the reality of the current market.
Living in Seattle now for 20+ years and going home to Reno Nv 5x a year and seeing the destruction that this housing boom created I advise all clients that life is far more important and we should never judge a persons decision.
I have many friends who bought at 450k-500k and their home is now worth 200-250k. Many have decided to walk and I supported them all along the way. Hundreds of investors in our network have let their homes go and will continue to over the next decade.
The cost of owning when taxes, insurance, and upkeep are combined with upside down assets will lead to many years of short sale activity. The masses will NOT bring funds to close and in our mobile society I like to state ” They are coming back in huge numbers.” Not a question of if….Just when..
People are not stupid. A family makes a home…not the house. I urge everyone to not judge anyones decisions. We only live once and I support everyone in their choices.
Living in Seattle now for 20+ years and going home to Reno Nv 5x a year and seeing the destruction that this housing boom created I advise all clients that life is far more important and we should never judge a persons decision.
I have many friends who bought at 450k-500k and their home is now worth 200-250k. Many have decided to walk and I supported them all along the way. Hundreds of investors in our network have let their homes go and will continue to over the next decade.
The cost of owning when taxes, insurance, and upkeep are combined with upside down assets will lead to many years of short sale activity. The masses will NOT bring funds to close and in our mobile society I like to state ” They are coming back in huge numbers.” Not a question of if….Just when..
People are not stupid. A family makes a home…not the house. I urge everyone to not judge anyones decisions. We only live once and I support everyone in their choices.
Ray, I’ll go out on a limb here and suggest that most of the people that bought $450K houses that are now worth $250K probably do not have an extra $200K laying around, even if they did want to avoid a short sale.
Now say instead of being greedy and buying the most expensive house they could qualify for, they had bought a $225K house. If the $225K house dropped the same amout, they’d only be underwater $100K.
With all the additional savings they’d have from buying a cheaper home, digging out from under $100K of negative equity would be much easier – Certainly not pleasant, but doable as long as they lived within their means.
Ray, I’ll go out on a limb here and suggest that most of the people that bought $450K houses that are now worth $250K probably do not have an extra $200K laying around, even if they did want to avoid a short sale.
Now say instead of being greedy and buying the most expensive house they could qualify for, they had bought a $225K house. If the $225K house dropped the same amout, they’d only be underwater $100K.
With all the additional savings they’d have from buying a cheaper home, digging out from under $100K of negative equity would be much easier – Certainly not pleasant, but doable as long as they lived within their means.
I work with a Realtor who did everything he could possibly think of to get a short sale done only to have the bank back out at the last minute. It’s funny how banks say they will work with you. Now the home is in foreclosure with home prices going down. They’ll look back and wish they would have taken the extra $100,000 they could have gotten out of the already arrange short sale. That Realtor decided it wasn’t worth it, let them foreclose, and is now rebuilding his credit. I actually think he made a very wise choice.
Todd, on an individual basis the bank will NEVER look back and WISH anything. That house is just a #. Not tied to anyone REAL at the bank! They could care less.
Rob-u-blind. When the majority of the buyers bought at 450k there were NONE at 250k. I know this for a fact unless they wanted to drive out to Fernley (35 miles) where the homes were going for 240k. Now they are 120k !
Being upside down 100k or 300k is still very unmanageable in this economic climate.
I’ve had a judicial foreclosure action filed against me (and my wife) for four investment properties we own in Tulsa. Given the liability of owning these homes (long story), we let them lapse into foreclosure. The attorney I retained in Tulsa recommended (and I concurred) that we don’t contest the action, which will transfer ownership (and liability) sooner to the lender. The houses are then sold at auction, and the lender has 90 days to decide if it will go after a deficiency judgment. A big difference in Oklahoma (OK) over what Craig described (which I assume is WA) – a lender can only go after the difference between the *current appraised value* and the debt owed. Given we paid 20% down, it will be hard to claim values fell much more in excess of 20% over 2 years (so guesses our attorney).
If they decide to go after deficiency, and we want to contest the amount, it becomes a battle of appraisers.
Keep in mind that the debt we own on all the houses *total* is ~$150K. If the market fell by 30% in the last two years, we’d owe the bank around $24K (with interest and legal fees).
Our last line of defense (and one we’d make sure the lender is aware of in that 90 day decision period), is that only I signed the note. Since WA is a community property state, and I’ve been married 10 years, our argument will be that in addition to the costs of the lender ‘domesticating’ any deficiency judgement in WA, I don’t really have any separate property of my own to go after (granted, it’s not a very strong argument – but it may be enough to persuade the lender not to pursue).
Of course, I’m hoping that it’s not worth it to the lender to go all the way to WA to go after $25K.
I’ve had a judicial foreclosure action filed against me (and my wife) for four investment properties we own in Tulsa. Given the liability of owning these homes (long story), we let them lapse into foreclosure. The attorney I retained in Tulsa recommended (and I concurred) that we don’t contest the action, which will transfer ownership (and liability) sooner to the lender. The houses are then sold at auction, and the lender has 90 days to decide if it will go after a deficiency judgment. A big difference in Oklahoma (OK) over what Craig described (which I assume is WA) – a lender can only go after the difference between the *current appraised value* and the debt owed. Given we paid 20% down, it will be hard to claim values fell much more in excess of 20% over 2 years (so guesses our attorney).
If they decide to go after deficiency, and we want to contest the amount, it becomes a battle of appraisers.
Keep in mind that the debt we own on all the houses *total* is ~$150K. If the market fell by 30% in the last two years, we’d owe the bank around $24K (with interest and legal fees).
Our last line of defense (and one we’d make sure the lender is aware of in that 90 day decision period), is that only I signed the note. Since WA is a community property state, and I’ve been married 10 years, our argument will be that in addition to the costs of the lender ‘domesticating’ any deficiency judgement in WA, I don’t really have any separate property of my own to go after (granted, it’s not a very strong argument – but it may be enough to persuade the lender not to pursue).
Of course, I’m hoping that it’s not worth it to the lender to go all the way to WA to go after $25K.
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http://raincityguide.com/2009/04/22/when-is-foreclosure-right-for-you-part-2-of-2/
Craig:
I enjoyed re-reading your articles.
One suggestion would be to add some tags, like strategic default in washington, so that folks can find this posting. Strategic default may be a candidate for 2010’s word of the year!
Regarding whether a bank elects to use judicial or non judicial foreclosure:
How does the bank know what assets you have? I suppose they would have some of that information on the original loan application, and they could find other properties you own, sure, because that’s a public record. But do they know what’s currently in your bank account, retirement account, and under the mattress? Can they require the debtor or the depository institution to disclose that before filing a judicial foreclosure?
And, in BK proceedings, I seem to recall hearing that retirement assets (401K, IRA, etc) are not considered liquid, or recoverable by the debtor/judgement holder. Does that have any basis in fact?
Yup, I know you do not offer legal advice on a blog, and no, I don’t think I need to get some, but it helps the public to have a general knowledge, and the service that you provide here is valuable.
Thanks!
Craig:
I enjoyed re-reading your articles.
One suggestion would be to add some tags, like strategic default in washington, so that folks can find this posting. Strategic default may be a candidate for 2010’s word of the year!
Regarding whether a bank elects to use judicial or non judicial foreclosure:
How does the bank know what assets you have? I suppose they would have some of that information on the original loan application, and they could find other properties you own, sure, because that’s a public record. But do they know what’s currently in your bank account, retirement account, and under the mattress? Can they require the debtor or the depository institution to disclose that before filing a judicial foreclosure?
And, in BK proceedings, I seem to recall hearing that retirement assets (401K, IRA, etc) are not considered liquid, or recoverable by the debtor/judgement holder. Does that have any basis in fact?
Yup, I know you do not offer legal advice on a blog, and no, I don’t think I need to get some, but it helps the public to have a general knowledge, and the service that you provide here is valuable.
Thanks!
Roger — thanks for the suggestion re: tags. I will apply those shortly.
As for your comments: (1) Yes, its not clear what information a bank has about a debtor’s assets, and/or how they use that information in making a determination to seek a deficiency judgment. This is one argument for why a buyer should not first seek a short sale or loan modification before simply defaulting, because those processes typically require the borrower to provide the bank with financial information. If your financial information indicates you can afford the debt, then (a) the bank will be less inclined to grant your request, and (b) the bank will be more likely to hold you accountable for the debt (at least in theory — its possible that this is an entirely different department that knows nothing about information provided by the borrower previously).
(2) Yes, as a general matter, retirement funds, pension payments, SS and disability payments are all immune from creditors.
Finally, speaking of “strategic default,” I saw this article today in the newspaper box (I can hear the younger readers now: “What’s a newspaper?”).
Roger — thanks for the suggestion re: tags. I will apply those shortly.
As for your comments: (1) Yes, its not clear what information a bank has about a debtor’s assets, and/or how they use that information in making a determination to seek a deficiency judgment. This is one argument for why a buyer should not first seek a short sale or loan modification before simply defaulting, because those processes typically require the borrower to provide the bank with financial information. If your financial information indicates you can afford the debt, then (a) the bank will be less inclined to grant your request, and (b) the bank will be more likely to hold you accountable for the debt (at least in theory — its possible that this is an entirely different department that knows nothing about information provided by the borrower previously).
(2) Yes, as a general matter, retirement funds, pension payments, SS and disability payments are all immune from creditors.
Finally, speaking of “strategic default,” I saw this article today in the newspaper box (I can hear the younger readers now: “What’s a newspaper?”).
I want to thank you for sharing this information. My husband and I have been undecisive on what to do with our home. We had thought about walking away but now I will definately look into other alternatives..We have tried to sell our home. We had it on the market for 12months and NOTHING! We have made alot of upgrades since then so hopefully second time around someone else would like to enjoy our home.
I can agree with the comment above that we all only live once. If the underwater mortgage is way more than one can handle along with upkeep costs, the best way to go is walking away. If possible, the non-judicial foreclosure sounds like the preferred option when no others are available.