The Basics of What a Foreclosure Is and How it Works

I am amazed sometimes at how often I am asked questions such as “If this mortgage loan forecloses, then when does the lender get the property back?” or “Can you please tell the lender that I want to buy the property?” Whenever the law firm posts a property for foreclosure auction, the phone will often ring and some person will be on the line wanting to try to buy the property that is being foreclosed upon from the mortgage lender. These people literally do not understand that the mortgage lender does not own the property. The mortgage lender holds a lien against the property, but the borrower on the loan owns the property itself. So, if you want to buy the property, then call the owner, not the law firm representing the mortgage holder.

Mortgage lenders on seller-financed properties sometimes ask questions like “If I start a foreclosure on this property, then when do I get my property back?” This question is absurd. The person asking it probably does not understand what a foreclosure is, how a foreclosure works, or how seller-financing works.  The lender can never be assured that the lender will get the property back. the lender may or may not ever get the property back. It is true that the lender gets to make the opening bid at the foreclosure auction (referred to as the “credit bid”). It is true that if no one outbids the opening credit bid, then the lender will be the winning bidder and will get the property back. But, it is not true that the lender will always or inevitably get the property back. A mortgage lender has no surefire way to “get the property back.” That right does not exist. Instead, the mortgage lender has the right to auction the property off on the courthouse steps (or such other area as the County Commissioner’s Court has designated for the foreclosure auction to occur). The purpose of the auction is to sell the property to the highest bidder so that the proceeds from the auction can go towards paying down the balance owed on the mortgage loan.

Many people know the term “foreclosure,” but they do not know what it means. A “foreclosure” is a public auction. Sometimes people say, “I do not want to auction off the property, I just want to foreclose on it.” This is nonsense. A foreclosure and an auction are the same thing. A foreclosure auction is a type of auction. Every foreclosure is an auction, but not all auctions are foreclosure auctions.

Seller-finance mortgage lenders often think that foreclosures are a process for “getting their property back.” Public perception of foreclosures can be that foreclosures are a process for mortgage lenders to seize and acquire back their collateral. This public perception is faulty and inaccurate. At a foreclosure auction, the mortgage lender typically makes the opening bid. The mortgage lender can open the bidding at the amount owed on the loan without paying anything out-of-pocket to fulfil the bid. Lender’s opening credit bids are often winning bids. As a result, public perception suggests that lender’s bids are always a way to get collateral back. Public perception is flawed. The fact that many lender’s opening bids are winning bids does not mean that all lender’s opening credit bids are winning bids. To understand why many lender’s opening credit bids are winning bids, one must understand the concept of “home equity.”

The “equity” in a piece of real estate is the difference between the value of the real estate and the amount owed on mortgage liens. So, if the house is worth $200,000 and the house is encumbered by a $100,00 mortgage lien, then the owner of the house, who is also the borrower on the mortgage loan, has $100,000 in “home equity” or just “equity” in the house. Most homeowners can do basic math. If their house is getting foreclosed upon because they cannot pay a $100,000 mortgage, but the house is worth $200,000, then the homeowner will just sell the house. The mortgage will be paid off when the house sells. The homeowner will pocket $100,000. Thus, the homeowner can convert his/her home equity into cash.

Many foreclosures are initiated, but not consummated. The foreclosures that are consummated tend to be the foreclosures on the properties with very little “equity.” When there is “equity,” the homeowner is motivated to capture the equity by either (a) selling the house, (b) filing a bankruptcy case or a series of bankruptcy cases, (c) refinancing the mortgage, or (d) working out a bankruptcy-prevention payment plan and foreclosure deferral plan with the mortgage lender. All of the foregoing would result in the cancellation of the initiated foreclosure prior to the consummation of the foreclosure. Due to the foregoing, the foreclosures that are consummated tend to be the ones involving little “home equity.” The pool of buyers that haunt the monthly foreclosure auction sites know that the high equity properties are the best to purchase. The high equity properties present the least risk to the foreclosure sale buyer. The foreclosure sale buyer often cannot see the inside of the house, which makes determining an appropriate bid very difficult. Because the mortgage lender opens the foreclosure auction bidding with a credit bid, because the consummated foreclosures tend to be the foreclosures on low equity collateral, and because the foreclosure sale buyer pool tends to have very little information on the condition of the inside of the real estate that is being auctioned, among other reasons, the credit bids often prevail. However, on high equity foreclosures, the credit bid goes from being likely to prevail to being unlikely to prevail (except, possibly, for unique and difficult-to-use property like expensive property, vacant land, or unique commercial property). Some counties have a much more active foreclosure sale buyer pool than others. For the foregoing reasons, the general public may have a perception that foreclosures are a process for the mortgage lender to “get its property back,” but the truth is much more complicated. The truth is that mortgage lenders often get their collateral back when there is little equity and a high credit bid, which tends to happen often because the high equity foreclosures with low credit bids tend to not consummate as often.

Sometimes mortgage lenders will say things like “Can I bid more than my loan amount so that no one else gets my property?” The answer is yes, of course you can. All the lender needs to do is bring cash or certified funds to the foreclosure auction. The lender can bid the full amount owed on the mortgage loan without paying anything out-of-pocket. This is referred to as a “credit bid” because in a credit bid no money changes hands. The balance owed to the mortgage lender must be paid to the mortgage lender from the foreclosure auction proceeds. Accordingly, the mortgage lender can bid up to that balance without paying anything in cash out-of-pocket because the funds would simply go to the lender anyways. The law does not require the doing of a useless thing. Accordingly, the lender does not need to pay itself. If, however, the mortgage lender bids more than the balance owed on the mortgage, then the mortgage lender must pay the overage in cash or certified funds. The lender needs to raise some cash and bring the cash or certified funds to the foreclosure.

What Happens to the Foreclosure Sale Proceeds Above and Beyond the Mortgage Lender’s Credit Bid?

The foreclosure sale trustee who conducts the public foreclosure auction at the courthouse or place designated by the County Commissioner’s Court will take cash or certified funds as payment at the foreclosure auction. The bidders must pay in cash or certified funds on the spot, without delay. If a bidder wins the foreclosure auction, but does not immediately pay in cash or certified funds, then the trustee will typically verbally void the auction and immediately re-auction the property to a bidder that is prepared to pay on the spot. The trustee will usually do this up until the deadline specified in the Notice of Trustee’s Sale until a winning bidder makes good on a winning bid.

The trustee then takes the foreclosure sale proceeds and disburses them. First, the trustee will pay off the mortgage lender. If the mortgage lender has been paid in full and there are funds left over, then the trustee will search for junior lienholders, seek to confirm whether they have valid liens, and pay them using the foreclosure sale proceeds. If there are no junior lienholders to pay, then the trustee will disburse the overage funds to the borrowers on the mortgage loan, i.e., the former owners of the subject real estate.

The mortgage lender will never be paid more than what the mortgage lender is owed at a foreclosure auction. The “equity” in the house does not belong to the mortgage lien holder. If the mortgage lender bids more than the credit bid, then the mortgage lender must pay in cash or certified funds and those funds, above and beyond the credit bid, will be disbursed to the junior lienholders and/or the former owners of the property (the borrowers on the mortgage loan).

If there is a dispute as to who the foreclosure proceeds are supposed to be disbursed to, then the trustee might file a lawsuit called an “interpleader.” In an interpleader, the trustee will deposit the disputed funds into the registry of the Court, serve citations upon all interested parties, and then let those parties argue their case to the Judge as to why they should receive the funds.

How Long Does a Foreclosure Take?

Foreclosures always occur on the first Tuesday of the month unless that date would fall on a specified holiday. “If the first Tuesday of a month occurs on January 1 or July 4, a public sale under Subsection (a) must be held between 10 a.m. and 4 p.m. on the first Wednesday of the month.” Tex. Prop. Code Ann. § 51.002(a-1). In order to foreclose a property on the first Tuesday of the month, the mortgage lender must have a notice of foreclosure sale (also known as a “Notice of Trustee’s Sale”) posted and served “at least 21 days before the date of sale.” Id. at (b). So, you look at a calendar for the first Tuesday of the month, and then you count back three Tuesdays from that Tuesday. The foregoing date is your posting deadline if you want your property to be in the next monthly foreclosure auction.

On residential property, the mortgage lender must “serve . . . written notice . . . giving the debtor at least 20 days to cure the default” before the Notice of Trustee’s Sale is posted. So, on any residential foreclosure, there is a bare minimum of a 20-day cure notice, plus a 21-day posting notice. This is at least 41 days of notice that is required. The mortgage lender, however, cannot merely follow the notice provisions listed in Section 51.002 of the Texas Property Code. Instead, the mortgage lender needs to read the loan origination documents and give any additional notice that is required in those documents. Then, the lender needs to evaluate whether any consumer-protection laws would impose further notice requirements. Please see our other, more in-depth, foreclosure article here (https://ghristlaw.com/blogs/foreclosures-in-texas/) for more information about federal consumer-protection laws like Dodd-Frank or RESPA. If 12 C.F.R. § 1024.41(f)(i) applies, then the Notice of Trustee’s Sale should be posted when the “borrower’s mortgage loan obligation is more than 120 days delinquent.”

A common rule of thumb for when a seller-finance mortgage lender or servicer should transfer the file to a foreclosure law firm is to refer the file once the borrower’s mortgage loan account has been delinquent for sixty (60) days. This is not a requirement, just a commonly-used modus operandi for seller-financed mortgage loans.

As a result of the foregoing, without consideration for which consumer-protection laws apply or do not apply and not accounting for what any particular loan documents may require, a rule of thumb for many seller-financed mortgages would be for the foreclosing law firm to give a 20 day notice to cure and notice of intent to accelerate followed by a notice of acceleration. Between and after these notices, an additional 20 to 30 or so days may accrue. As a result of the foregoing, with these notices and a 60-day delinquency referral, the loan should roughly be at about the 120-day delinquency mark when it is time to go from the notice of acceleration to the posting of the Notice of Trustee’s Sale.

So, the answer to the question “How long does a foreclosure take?” is that “it depends on the facts and circumstances,” but generally the foreclosure would likely occur about 150 days after the seller-financed residential mortgage loan first became delinquent in a typical situation. Obviously, a bankruptcy or a series of bankruptcies by the borrower would greatly delay this. When bankruptcies are taken into account, the foreclosure process could take several years. In some extreme cases, over a decade.

Should I Take a Deed-in-Lieu of Foreclosure?

When it comes to taking a deed in lieu of foreclosure in Texas, the most important law that the lender mortgagee needs to be aware of is Section 51.006 of the Texas Property Code. Before reviewing Tex. Prop. Code § 51.006, however, the lender should be aware of some basic lien priority concepts. “We recognize the well-established rule that following the valid foreclosure of a senior lien, junior liens, if not satisfied from the proceeds of sale, are extinguished.” AMC Mortg. Services, Inc. v. Watts, 260 S.W.3d 582, 585 (Tex. App.—Dallas 2008, no pet.). “In a contest over rights or interests in property, the party that is first in time is first in right.” Id. As a result of the foregoing, when a seller-financed mortgage lien forecloses, the foreclosure will “extinguish” junior lienholders such as mechanic’s liens, judgment liens, or any other liens (subject to some notable exceptions) that arise after the date that the property was seller-financed. Notable exceptions include property tax liens (typically held by school districts, hospitals, and cities) and, to an extent, federal tax liens. Please see our other, less basic, article on foreclosures for more information about foreclosure’s effect on federal tax liens: https://ghristlaw.com/blogs/foreclosures-in-texas/.

Based on the foregoing, the answer to the question “Should I take a deed-in-lieu of foreclosure?” is that you should probably (a) run a title search, and (b) if the title search reveals junior liens that would be “extinguished” by a foreclosure yet would not be “extinguished” by a deed in lieu, then you should probably foreclose rather than take a deed-in-lieu so as to avoid paying junior liens that the mortgagor should be responsible for. Under Section 51.006 of the Texas Property Code, a lender who qualifies and follows the proper procedures may get a mulligan. If the rules in Tex. Prop. Code § 51.006 apply, then the lender can go ahead and foreclose so as to extinguish junior liens even after the deed-in-lieu has been taken. Please note that Section 51.006 does not give every mortgagee a mulligan on the deed-in-lieu in every situation. Instead, you need to read that law, evaluate whether it applies, and follow the procedures listed therein.

Copyright, Ian Ghrist, 2020, All Rights Reserved. Unauthorized reproduction strictly prohibited.

Disclaimer: This document is for informational purposes only. Do not rely on any part of this document as legal advice. Instead, seek out the advice of a licensed attorney with regard to the particular facts and circumstances of your legal matter. Also, this information may be out-of-date or wrong and is not intended to be comprehensive or to address any potential or specific factual or legal scenario.