The Economics of Non-Judicial Foreclosures

Have I mentioned of late how much I love my commenters? Many

thanks to James

Moore, who adds a very interesting twist to my obsession over

the proportion of mortgages which are non-recourse.

Moore gets straight to the heart of the matter: the key

question isn’t how many mortgages are non-recourse, but rather how many

mortgage lenders would go after their borrowers for unpaid mortgage

debts even after the property in question is sold at foreclosure.

Moore’s insight is that just because a lender can

pursue a borrower, doesn’t mean it will. And the

key distinction to be made here is between judicial and non-judicial

foreclosure.

I’ll let Tanta

explain the difference:

Foreclosures can be

“judicial” or “non-judicial.”

Some states require judicial foreclosure; most states allow one or the

other at the lender’s election or in certain other

circumstances. A judicial foreclosure requires the lender to sue the

borrower in court for satisfaction of the debt. A non-judicial

foreclosure allows the lender to use the “power of sale

clause” in the mortgage document to force sale of the

property without a court order.
Because

the non-judicial foreclosure uses powers granted to the lender in the

mortgage document, which is executed by the borrower at the time the

loan is made, the property sale is, in essence, already

“authorized” by the borrower. When you sign a

mortgage document, you are agreeing in advance to sell your property at

public auction if you do not pay the debt as agreed in the note.
Non-judicial foreclosure is

almost always faster and cheaper for the lender than a judicial

foreclosure. Most of the time, when there is a choice, the lender

chooses the non-judicial option for that reason. The big benefit to the

lender of a judicial foreclosure is that the lender can ask the court,

when appropriate, to enter a “deficiency judgment”

against the borrower; this makes the borrower liable for any difference

between the proceeds of the sale and the debt owed when the borrower is

upside-down. Practically speaking, a lender who chooses non-judicial

foreclosure generally waives its right to seek a deficiency judgment.

The lender’s calculation, obviously, comes down to weighing

the benefit of quick sale and reduced expenses against the cost of

(potentially) writing off part of the debt.

If a mortgage lender wants to sue a borrower for repayment

over and above the sale proceeds from the property, then, it basically

needs to go to court and get a deficiency judgment. If you’re going to

go to court anyway, you might as well get a judicial foreclosure: if

you opt for a non-judicial foreclosure, then the chances of your going

back to court for a deficiency judgment are essentially nil.

Now Moore says that in California, at least (all this is

complicated greatly by the fact that foreclosure law is made by the

states, not the federal government), “you just don’t see judicial

foreclosures” – they’re simply too expensive for the lenders,

and the extra money the lender might be able to squeeze out of the

borrower simply can’t compensate for the cost of getting that

deficiency judgment in the first place.

This surprises me, I must say. After all, California was

ground zero when it came to mortgage innovations like 125% LTV

mortgages, where the bank lent the borrower more money than the

property was worth. Clearly, no one is going to do that unless you have

a reasonable expectation that you can go after the borrower

individually for any monies not received in foreclosure. The credit

markets might have gone a bit crazy over the past few years, but they

didn’t go that crazy. (Please

tell me they didn’t go that crazy.)

But it’s also obvious that in these stressed times when

lenders can’t even service their loans properly because they’re

overwhelmed by the volume of defaults, they’re going to be extremely

hesitant to go through the hassle of a judicial foreclosure, if they

have a much easier alternative in non-judicial foreclosure.

So maybe even recourse borrowers might be able to walk away

from their homes without declaring bankruptcy – “jingle

mail”, it’s called – with the reasonable expectation that

their bank won’t pursue them for any extra money. If that’s the case,

it adds a whole new and rather unpleasant twist to the dynamics of the

property market. Suddenly, it becomes economically idiotic for many

prime borrowers to continue to make their mortgage payments, even if

they can quite comfortably afford them. And the implications of that

for properety prices are nasty indeed.