In these challenging financial times an increasing number of property owners are at risk of losing their investment for failure to make mortgage payments. A bank or credit union has various options available during default. In many cases, the lender wants to give the borrower an opportunity to catch-up on the mortgage payments. This is broadly described as “forbearing” or waiting to exercise default rights and remedies. In order to forbear, the lender will require the borrower to enter into an agreement acknowledging the default, balance due, and establishing new repayment terms and special remedies in case the borrower defaults again. The lender needs some incentive for delaying its rights and giving the borrower another chance; special remedies provide that incentive to the lender.
A common special remedy is a voluntary foreclosure agreement or a “VFA”. Voluntary foreclosure is unique to Minnesota and is governed entirely by statute (Minn. Stat. §582.32). This article will explain the nature and general process of voluntary foreclosure so that borrowers know what to expect if a lender requests a VFA and lenders understand the statutory requirements for voluntary foreclosure.
For clarity, the following terms are defined: Redemption: The borrower’s right to repurchase mortgaged property for a period after the sheriff’s foreclosure sale by paying the defaulted mortgage debt, plus costs and interest. Reinstatement: The borrower’s right to cure the default by paying the delinquent amounts and reinstate the mortgage before the sheriff’s foreclosure sale occurs. Deficiency: The amount still owed when the mortgaged property is sold at the sheriff’s foreclosure sale for less than the outstanding debt. Generally, the borrower is liable to the lender for the amount of the deficiency.
The principal characteristics of voluntary foreclosure are: (1) the redemption period is reduced to two months; (2) the lender waives any right to a deficiency and the right to pursue personal liability against the borrower; (3) the borrower waives the right to contest the foreclosure, to surplus sale proceeds, to possession of the real estate, and agrees to the appointment of a receiver; and finally, (4) there is no right of reinstatement.
The typical redemption period is six months but in some cases 12 months. The VFA reduces the redemption period, which is an advantage for the lender because it allows the lender to acquire clear title to the property faster and permits the lender to sell it more quickly. On the other hand, because of the lender’s waiver of the right to pursue the borrower for any deficiency or personal liability, the borrower is assured a “clean slate” as to the mortgage debt. A foreclosure does impact credit scores, but the borrower does not have to worry about the lender obtaining a judgment and garnishing wages or taking other collection steps. In a normal foreclosure, the borrower has the right to possession, occupancy, and collection of any rents or other income from the mortgaged property through the period of redemption. If the redemption period is six months, the borrower can continue to use the property, benefit from its operations and retain generated revenue for all six months. With a VFA not only is the redemption reduced, but the borrower agrees to turn over possession, rents and other benefits of the mortgaged property to the lender starting with the effective date of the VFA. This can be a great advantage to a lender.
Consider the case of a convenience store. There are significant overhead costs to operating and maintaining a store, including perishable items, expensive equipment and fuel tanks to be kept filled and in compliance with state regulations. A borrower in default may be financially overwhelmed, unable to maintain the store, and unmotivated to invest more money into a sinking investment. The mortgaged property may be preserved and its value retained if the lender takes immediate possession and has the control to keep it operating and properly managed. The lender can prepare the property for re-sale or listing much more quickly.
With a VFA, the borrower does not have the right to pay the defaulted amount and stop the foreclosure sale, or reinstate the mortgage. In essence, the borrower has already had a “second chance” and as a result of defaulting again, the borrower will have to pay the entire mortgage debt during the shortened redemption period or will lose the property to foreclosure.
Before voluntary foreclosure can be considered, the mortgaged property must qualify. To be eligible the mortgaged property must meet certain qualifications: no part of it may be classified as homestead or in agricultural use, and the mortgage must have been executed after July 31, 1993. For example, if the mortgage is against your home, it is not eligible for voluntary foreclosure. To prove that the mortgaged property qualifies, during the voluntary foreclosure the lender must obtain a certificate signed by the county or city assessor stating that – as of date of the VFA – the mortgaged property was not classified as homestead or in agricultural use. This certificate must be recorded before or with sheriff’s certificate of sale following the foreclosure sale.
A voluntary foreclosure agreement can only be entered into during default; in other words, the lender cannot ask a borrower to sign a VFA when the mortgage is initially given or while it is current. As noted above, a VFA is a common request by a lender when a borrower is in default. Once a voluntary foreclosure agreement is signed, the lender or the lender’s attorney typically holds the VFA to be used only in the event of default. The effective date of the VFA is always left blank until it is ready to be used, namely, until default has occurred. This is because the VFA must be recorded in the county where the mortgaged property is located within seven days after the effective date. Both the lender and borrower hope that the VFA never becomes necessary and therefore, they do not want it to be recorded prematurely. If default occurs, the current date is entered as the effective date and the VFA is recorded.
In order to use the VFA, at least one element of the default must have existed for one month; merely making a payment a week late does not allow the lender to exercise the VFA.
Once the VFA is recorded, the foreclosure begins. Notice of the foreclosure must be served just as in a standard foreclosure by advertisement. All individuals in possession of the mortgaged property are served and notice is mailed to all junior creditors. In addition, the notice of voluntary foreclosure sale must be published for four weeks. Junior creditors have rights of redemption following the borrower’s right of redemption like in a standard foreclosure, although their redemption period is also reduced to two months. There is one exception to this: if the mortgaged property is subject to a Federal tax lien, then the IRS is entitled to a 120-day redemption period instead of the two month redemption period.
In conclusion, voluntary foreclosure is indeed “voluntary”. There are very specific requirements dictating the applicability and use of a voluntary foreclosure agreement, which protect borrowers from misleading or vague language. A VFA presents a unique opportunity for both lenders and borrowers but the consequences should always be considered carefully.
By Dehlia Seim
Published in Business North, February 2012