5. How does a security interest protect the mortgage holder?
If the borrower fails to repay the loan pursuant to the terms of the loan agreement, the mortgage holder may “foreclose” upon the property securing the mortgage loan.
• Foreclosure – Foreclosure is the process by which the mortgage holder takes control of the property securing a debt. The mortgage is foreclosed and the property is repossessed. Once repossessed, the property is sold at public auction to generate funds to repay the loan.
⁃ Note: A party may also undertake strict foreclosure.
• Deficiency Judgment – If the property, once repossessed, does not generate sufficient proceeds from sale to repay the outstanding loan, there is a “deficiency”. Depending upon the mortgage foreclosure process employed by the secured lender, the property owner may still be liable for this deficiency. If so, the lender can bring a civil action asking for a “deficiency judgment” against the debtor.
⁃ Note: A deficiency judgment can be used to execute against the borrower’s other property or assets. This means that the loan holder may seek to repossess and sell the debtors other assets.
• Right or Redemption – Many states offer protections to borrowers who default on loans and lose their properties to foreclosure. One of these protections is known as a “right of redemption”. This right affords a borrower a specific amount of time to repay the amount owed on the foreclosed property and regain possession.
⁃ Note: This inhibits the lender’s ability to sell the land until that redemption period has passed.
⁃ Example: A lender forecloses on property securing a loan. If the state recognizes a right of redemption, a borrower, following foreclosure of his property, has the right, for a statutory period, to pay the lender the whole amount owed. This is normally done by obtaining refinancing of the property with a different lending institution.
The government (generally the local Sheriff’s office) is involved in the process of repossessing and selling the foreclosed property. In foreclosures involving a personal residence, the process often begins with the lender seeking an eviction order against the residents of the property. Once eviction is complete, the lender may follow state procedures to list the property for sale. State law governs the sale of the property, which must be “commercially reasonable” in light of the circumstances. If the secured party pursues strict foreclosure, she may keep the collateral in complete satisfaction of the debt. In this situation, the secured lender cannot pursue a deficiency judgment against the debtor.
• Discussion: How do you feel about the ability of a secured lender to evict an individual from her residence? Do you think the borrower should have any additional protections in the foreclosure process? Why or why not? Why is foreclosure generally a poor option for a mortgage holder to collect the money owed from the debtor? Hint: Think in terms of time and expenses.
• Practice Question: Murphy owns a small tract of land. He decides to start a business and takes out a loan secured by the property to build on the land and start his business. The market is far more competitive than Murphy assumed. He is soon forced to shut down his business and defaults on the loan. What is the process the lender will follow in seeking repayment of the loaned funds?