James R. Balmforth: Closing A Foreclosure Sale With Third Party Bidders

After a borrower defaults on mortgage payments, the lender (or the subsequent loan owner) will likely foreclose. Most foreclosures end in an auction where the property is sold to a new owner. During the foreclosure crisis, foreclosure sales frequently resulted in a deficiency, which means the property sold for less than the borrower owed the lender. But now that the real estate market has mostly recovered, foreclosure sales often bring in more money than the borrower owes.

How Foreclosure Sales Work

Depending on state law and the circumstances, a foreclosure is either judicial or non-judicial. At the end of the process, a trustee or an officer of the court, like the sheriff, will typically conduct a foreclosure sale. In the past, foreclosure sales almost always involved an auctioneer selling the property from the courthouse steps or another public area. Now, the auction can either be live (in-person) or online. Online foreclosure sales are becoming more and more common. At the foreclosure sale, the high bidder might be the foreclosing lender or a third party. If the lender makes a credit bid and no one else makes a higher offer, then the lender gets the property, and it becomes REO. If a third party makes the highest bid, that person or entity must then pay for the property with a money order, cashier’s check, or cash to become the new owner of the home. During the Great Recession, the purchase price at most foreclosure sales was either the loan balance or a lesser amount. Now, though, foreclosure properties often sell for prices that are more than what the borrower owes the foreclosing lender. The amount by which the purchase price exceeds the loan balance is called “excess proceeds.”

If a foreclosure sale results in excess proceeds, the lender doesn’t get to keep that money. The lender is entitled to an amount that’s sufficient to pay off the outstanding balance of the loan plus the costs associated with the foreclosure and sale but no more. Generally, the foreclosed borrower is entitled to the extra money; but, if there were any junior liens on the home, like a second mortgage or HELOC, or if a creditor recorded a judgment lien against the property, those parties get the first crack at the funds. Then, any proceeds left over after paying off these liens belong to the former homeowner.

What Happens If the Sale Amount Is Less Than the Total Debt

If the property sells for less than the borrower owes the lender, the sale results in a deficiency. Then, depending on state law, the lender might be able to get a deficiency judgment against the foreclosed borrower.

How to Find Out If Excess Proceeds Are Available

Typically, if a sale has excess proceeds, the trustee or other sale officer has to send a notice to the foreclosed homeowner’s last known address. But the last known address is usually the foreclosed property. Because most people don’t realize they’re due any excess proceeds, they tend to vacate a foreclosed property without leaving a forwarding address. So, it’s difficult for a trustee or other sale officer to find foreclosed homeowners after a sale. Because a sale might generate excess proceeds, it’s a good idea to track the process.

You should take note of the sale date, which will be included in the foreclosure documents you receive. After the auction, contact the trustee or officer that sold the property. (This information, including the trustee or officer’s name and phone number, should also be in the paperwork you received during the foreclosure, as well as in your local newspaper’s legal section where the sale notice was published. If you can’t figure out who conducted the sale or how to contact that person, call your loan servicer.) Ask if the auction generated excess proceeds. If so, be sure to give the trustee or officer your new address and follow up with a letter sent by both certified mail/return receipt requested and regular mail with your new address and contact information. Also, ask what you need to do to claim your share, if any, of the proceeds.

Credit Bid in a Foreclosure

At a foreclosure sale, the foreclosing lender usually makes a bid on the property using what’s called a “credit bid.” People sometimes think that the lender (or subsequent loan owner) will “repossess” their home in a foreclosure. But this description of the process that a lender uses to get ownership of the property isn’t accurate a foreclosure is different than a repossession. Repossession is a self-help remedy that allows a creditor to simply take possession of an item; the creditor doesn’t have to sue you first. In a car repossession, for example, the lender simply takes the vehicle back. With a foreclosure, however, the lender can’t just take your home. Instead, it must go through a specific process (a foreclosure) and hold a sale, which is typically a public auction. Anyone, including the foreclosing lender, can bid on the home at the sale. Normally, the lender will bid on the property using what’s called a “credit bid.” If the lender is the high bidder at the foreclosure sale, it then gets ownership of the home.

How Foreclosures Work

People who take out a home loan usually sign a security instrument, either a mortgage or deed of trust. This document gives the lender the right to sell the property through a process called foreclosure if the borrowers don’t make the payments or violate the agreement in some other manner. The foreclosure process will be governed, in large part, by state law and will be either judicial or non-judicial.

Judicial Foreclosures Go Through Court

The lender starts a judicial foreclosure by filing a lawsuit in court. If the court agrees that the borrowers have breached the loan agreement, the court orders the home to be sold at a foreclosure sale. (In two states, Connecticut and Vermont, the court may give the home’s title directly to the lender. This process is called a strict foreclosure.)

Non-judicial Foreclosures: No Court Action

In a non-judicial foreclosure, the lender follows particular out-of-court steps to foreclose. State law spells out exactly what the lender must do to complete the process. While the exact steps vary among states, the lender might have to do one or more of the following:
• mail the borrowers a notice of default or notice of sale
• record a foreclosure notice in the land records
• post a notice about the foreclosure sale on the property, or
• publish information about the foreclosure sale in the newspaper.
Once the lender completes the state-specific process, a foreclosure sale will take place.

How Credit Bids Work

At the foreclosure sale, which is an auction, the lender will usually make a credit bid. With a credit bid, the lender bids the debt that the borrower owes. Basically, the lender gets a credit in this amount. The lender can bid the full amount of the debt, including foreclosure fees and costs, or it might bid less. If the lender is the highest bidder at the sale and becomes the new owner of the property, but bids less than the total debt, it might be able to seek a deficiency judgment against the borrower. Whether or not the lender can get a deficiency judgment depends on state law. Other parties who bid on a property at a foreclosure sale must bid cash or a cash equivalent, like a cashier’s check. If a third party is the high bidder at the sale, the proceeds from the sale are used to repay the borrowers’ debt. (If the proceeds aren’t sufficient to pay off the full amount of the debt, the lender can, if state law allows it, get a deficiency judgment.) Often, though, the foreclosing lender is the high bidder at the foreclosure sale. After the lender buys the property at the sale and gets title to the home, the property is considered “Real Estate Owned” (REO).

Can Anyone Show Up at a Foreclosure Auction to Bid?

Foreclosure usually ends with the sale of the property at an auction. The highest bidder is the new owner of the property, but if no one shows up or bids high enough, the foreclosing bank becomes the owner. A foreclosure auction is usually completely open to the public, so anyone can show up, but some types of bidders are more common than others.

Lender Representatives

An agent or representative of the lender usually attends foreclosure auctions to protect their interests. The home needs to sell for an amount the lender deems acceptable, usually the total left on the mortgage plus the lender’s legal fees related to the foreclosure. The lender may send an agent to the sale even if state laws allow the lender to set a minimum bid ahead of the time. Some states let the lender set a minimum bidding amount before the sale, so the auction starts at that bid amount.

Homeowner

A homeowner can bid on their own property at the foreclosure auction. Although it’s not very common, as you need a cash deposit if you’re the winning bidder and must be able to finance the sale, it’s not illegal for a person to bid on their own property at a public foreclosure auction. However, while a third-party bidder isn’t on the hook for your loan debt, you may be, depending on your state’s laws. So, if you buy your home back at auction for less than what was owed, your lender may take you to court for the difference, which is known as a deficiency judgment. If your lender foreclosed, your state may give you a specific amount of time after the auction known as a redemption period to buy your home back, even if another person won it.

Investors

Investors often attend foreclosure auctions as a means to buy property at prices below the market value. Investors, especially those involved in the construction industries who don’t mind a house that needs work, may join forces and use pooled money to bid aggressively at auctions. Foreclosed homes are sold “as-is” and may have damage from the homeowner or as a result of the home staying vacant for weeks or months before the sale.

Auction Considerations

Each state has its own rules regarding the foreclosure auction process and money required if you’re the winning bidder. For example, in Arizona, you only need an earnest cash deposit at the auction, but you’ll have only a day to get the full bid amount. If you can’t get it together, the trustee can cancel the sale and you’ll lose you cash. In other states, you need the full amount upfront and must pay immediately after your win.
How to Recover a Bid Deposit When a High Bidder Defaults on a Foreclosure

Bid

Recently, in Utah Court of Appeals issued an opinion that provides a blueprint for a lender to pocket a cash recovery if it is outbid at a foreclosure sale but the high bidder subsequently defaults on its bid. If a foreclosure goes to resale because a high bidder defaults, a lender can reduce its original bid by the high bidder’s deposit and then recover those funds from the Clerk of Superior Court. In other words, the lender can acquire the property for less money (and less credit on the secured debt) and recover cash in the process. A foreclosure sale is a public event in which anyone can bid on the property being foreclosed. Usually the trustee conducting the foreclosure is the only person who attends the sale and, upon instructions from the lender, he places a credit bid for the lender. But sometimes the borrower, an associate of the borrower, or some other third party will out-bid the lender, either on the courthouse steps or by filing a higher “upset bid” during the 10-day period that follows the public sale.

While a lender exercising its foreclosure rights may submit a credit bid, any other high bidder must secure its bid with a cash deposit equal to 5% of the bid. The high bidder then typically has 30 days to pay the balance of the purchase price to the trustee. If the third-party bidder fails to close on the purchase, the trustee may move the Clerk of Superior Court to allow a resale of the property. Utah law imposes liability on a defaulting high bidder to the extent of the total if the amount of the final sale price is less than the high bidder’s original bid plus all costs of resale. The 5% deposit secures payment of this amount.
If you’ve defaulted on your mortgage loan, consider talking to a lawyer to learn about the foreclosure procedures in your state and find out whether you have any potential defenses to the action. You can also ask a lawyer for information about loss mitigation options, like a mortgage modification or short sale.