Most people prefer not to think about foreclosure. It’s a scary concept that brings fear.
When purchasing or investing in real estate, lenders play an important role in the purchase since they provide a majority of the funds for the transaction. But when the borrower falls behind on payments, the lender may foreclosure on the property. So understanding foreclosure rules for the state your property is located in is important.
State Foreclosure Rules Vary
Every state has different foreclosure rules. As real estate investors (or homeowners), it important to understand that the state that your property is located in plays an important role in how quickly a property foreclosure can happen. Some states are lender friendly while other states favor the borrower.
Depending on the transaction, a real estate investor can be either the borrower or the lender.
- Rental Property - the investor is the borrower and the bank is the lender
- Real Estate Debt Notes - investors are the lender
- Commercial Equity Deal - investors are the borrowers and the bank is the lender
It's important to research if the state that your property is located in is more friendly to the borrower or the lender. For example:
- Virginia, Georgia - Very lender friendly
- California, Oregon & Washington - Lender friendly but borrowers have some rights
- Illinois, Ohio, Louisiana - Very borrower friendly
What does it mean for a state to be lender friendly versus borrower friendly? While the specific rules are complex, a simple way for real estate investors to think about it is how quickly a lender can foreclose on a property when the borrower is behind in payments.
Judicial vs. Non-judicial
The first thing to assess is if the state that your property/investment is located is a judicial foreclosure state or a non-judicial foreclosure state. In a judicial foreclosure state, the lender will need to file a lawsuit in court and the case must goes through the court system. In a non-judicial foreclosure state, the lender can bypass the court system following a set of state-specific rules and out-of-court procedural steps to foreclose on a property. Avoiding the court system allows a lender to foreclosure on a property more quickly.
Oregon, California and Washington are non-judicial foreclosure states. That means that a lender can foreclosure more quickly. Illinois, Ohio and Louisiana are judicial foreclosure states. That means that the foreclosure must go through the court system and can take significantly longer.
Another important aspect of foreclosure is reinstatement. A reinstatement occurs when the borrower brings the delinquent loan current in one payment by paying the overdue payments, plus fees and expenses incurred as a result of the default. Once the loan is reinstated, the borrower resumes making regular payments on the debt. In a foreclosure, state law sometimes gives a borrower the right to reinstate up until a specific deadline.
Illinois, for example, permits reinstatement for up to 90 days after the foreclosure process has started. Virginia, on the other hand, does not permit any reinstatement once the foreclosure process has been initiated. Oregon is more balanced and provides the borrower reinstatement rights up to 5 days before the foreclosure sale.
Options after the foreclosure sale are important to understand as well. Redemption permits borrowers to redeem or “buy back” their home after a foreclosure sale. Depending on state law, in order to redeem, you have to reimburse the purchaser for the amount he or she paid at the sale (plus certain allowable costs) or repay the total mortgage debt, plus interest and expenses.
Illinois, again permit redemption for up to 90 days after the sale of the foreclosed property giving the original owner time to recover the property. Oregon and California do not permit redemptions.
When investing in a real estate deal, although considered a worst-case situation, a foreclosure scenario must be evaluated. As a borrower, it determines how long you can hold on to your property if you are behind on your payments. As a lender, it determines how quickly you can recover your investment capital.
At Avestor, when we evaluate real estate deals, foreclosure risk and the speed at which an investor’s capital can get returned is one of numerous factors that we assess when grading the quality of the investment opportunity.
Before making any real estate investment transaction, whether you are the borrower or the lender, remember to take some time to understand the foreclosure rules for the state that your property is located.