Alternatives to Foreclosure: Other Options for the Prudent Lender

FSKS Explains Alternatives to Foreclosure: Forbearance Agreements, Short Sales, and More

By Vincent DiMaiolo, Jr., Esq., Principal 

Any time a borrower defaults on a loan, a lender must move quickly to determine the best avenue to recover from said default. Many lenders tend to resort to foreclosure in order to recover the amounts owed pursuant to the loan terms. But in many instances, it may pay to consider alternatives to foreclosure.

Upon any indication of an anticipated default or upcoming maturity of a loan obligation, the prudent lender should conduct a due diligence review of the loan. In most cases, the loan documentation should provide a lender with the right to make inspections, obtain appraisals, or require the borrower and/or a guarantor to provide updated financial statements.

These tools will allow a lender to assess its situation – Does the value of the collateral securing the loan support the debt? What is the present condition of the property? If rental units, are they occupied and producing rental income, or are they vacant or non-paying tenancies? Are the loan documents in order and fully executed? What is the financial condition or situation of the borrower that has caused the default? These, and other considerations, must be looked at to determine if foreclosure is the best avenue to recover.

Certain loss mitigation or workout products should be considered if there are issues with being fully secured, if there are issues with the condition of the property, if there may be errors contained in the loan documentation or exposure in servicing the loan, or if there is a situation where it may be worth working with the debtor who has experienced an unusual or temporary financial hardship. In these circumstances, a lender should consider alternatives to foreclosure. Some alternate solutions may include one or a combination of the following resources.

FORBEARANCE AGREEMENTS

A forbearance agreement is a mechanism that provides a borrower the ability to take a deep breath without the risk of legal action being commenced or continued provided certain agreed-upon terms are met. These terms usually provide for some type of ongoing payment to catch up on missed payments, reduce a deficiency, or provide some assurance to the lender of the ability of the borrower to make payments if the forbearance agreement is going to lead to a loan modification or extension. In addition, a lender who may have technical deficiencies with its documentation (i.e., unsigned or incorrectly signed documents, missing documents, etc.) can make the correction of these documents a condition of the forbearance. Likewise, a lender may and should make any forbearance subject to the borrower/guarantor waiving any claims or defenses which they may have in the event of future collection efforts. A forbearance agreement may also provide conditions, such as the borrower providing additional collateral, providing additional guarantees, having rental income segregated into separate accounts or lockboxes, or providing other restrictions that may be applicable to the situation. It should, however, be noted that a forbearance agreement is a temporary solution and should lead to either the loan being brought to a current condition, modified, refinanced, or otherwise paid off.

LOAN MODIFICATIONS/EXTENSIONS

Similar to Forbearance Agreements, Loan Modifications provide for certain terms of the original loan to be amended, such as the amount of the loan, the amount of the monthly or periodic payments, the interest rate charged, or the maturity date of the loan. This, again, is a great opportunity for a lender to correct any deficiencies in its documentation or require, as a condition of the modification or extension, additional collateral to be pledged by the borrower or to obtain additional guarantees, if needed. This option is a permanent option as opposed to the Forbearance Agreement, and sometimes, they are used in conjunction with each other where a forbearance, if complied with by the borrower, will lead to a Loan Modification or Extension.

SHORT SALES

In situations where the value of the collateral for the loan is less than the debt, and there is little likelihood of obtaining additional collateral, a lender may be willing to allow a borrower to sell the property to an outside party for less than what is owed on the obligation. This could be done in conjunction with a new note for the deficiency or forgiveness of the remainder of the debt. In reviewing short sale offers, a lender should request a copy of the sale contract and proposed closing statement so as to make sure that they are receiving all of the available proceeds of the sale and that the borrower or others are not receiving proceeds not known to the lender.

SHORT PAYOFF

Similar to a short sale, a lender may be willing, under certain circumstances, to accept a short payoff from a borrower (for example, if the mortgaged property has environmental concerns). In these types of scenarios, and based upon the borrower’s ability to pay, the lender should consider accepting a short payoff and releasing the mortgage while the property remains with the borrower. In conjunction with this, the options may include executing a new note for the remainder of the amounts owed or forgiving the shortfall.

DEEDS IN LIEU OF FORECLOSURE

In situations where a lender is willing to take back title to the collateral, a deed may be the way to go. This possibility is usually contingent on no other liens being attached to the property so that clean title can be transferred. As with the short sale options where the debt exceeds the value of the property being transferred, these can be accomplished either by having the borrower sign a new note for the deficiency amount, or more commonly, with the lender waiving the remaining amounts owed. Of course, there are many other issues that may inform a lender’s decision to take title, including but not limited to bulk sale tax clearances, municipal taxes outstanding on the property, municipal code violation issues, and other property-related issues (tenancies, etc.).

Of course, in many instances, foreclosure may be the best recourse. The lender should be aware, however, that foreclosure may take some time, and even after it is initiated, the above-mentioned alternatives can still be considered to ultimately resolve the loan.

FSKS is On Your Side

Our attorneys and staff at Fein Such Kahn & Shepard, PC have expertise in assisting lenders mitigate defaulted loans and helping our clients navigate their options to determine the best course of action in dealing with the same. For more information, or if we can be of assistance, please contact us at (973) 538-4700 and ask for Vincent DiMaiolo, Jr., Esq. (vdimaiolo@fskslaw.com).