Delinquency, Default, Foreclosure, and Bankruptcy – What’s the difference?
When discussing real estate mortgages, these terms all have similar yet distinctively different meanings, even though the terms tend to be used somewhat interchangeably.
Real estate delinquency, or as it is sometimes called a “late payment”, happens when a borrower fails to make a payment in a timely way. Typically monthly payments must be made by the 5th of the month or they can be considered “late”. Of the terms discussed here, this is the least serious.
Real estate default is when a real estate mortgage loan payment is late. A lender typically will give a borrower a certain time period to catch the payment up before making a formal “declaration of default. Once a lender notifies a borrower that their real estate loan is in default then the lender can commence foreclosure and also start charging the “delinquent interest rate” that is commonly stated in the “promissory note” A violation of any covenants found in the loan agreement, the deed of trust, or any other loan document can also create a default.
Lenders of real estate mortgages, at their option, can then pursue either litigious or non-litigious action. Non-litigious arrangements are called forbearance agreements, and are the preferred choice of the lender because they do not restricted flexibility and do not lead to foreclosure costs (third-party costs, deterioration of the property, lost revenue, and other write-down cost). A forbearance agreement also benefits the borrower since the delinquent interest and legal costs, once a default is declared, are very expensive. Frequently, the borrower also loses the title to the property.
Foreclosure is the legal process where (in Colorado) a lender notifies the Public Trustee of the county where the property is located. The notification states that the loan is in default and asks the Public Trustee to commence foreclosure – i. e. the process that allows a lender to take title to the collateral property. In Colorado the full process takes approximately 5 months and the borrower has certain specific rights during this period to cure the default and stop the foreclosure.
If the borrower does not exercise these rights (which typically require the borrower to bring the loan current and/or cure any violations of the loan covenants, then the Public Trustee offers the property for sale at a public auction and the lender normally will acquire title to the property and the former owner (borrower) loses all rights to this property. Foreclosure is generally regarded as a failure by both parties and is used as a last resort. The lender, if it required and obtained a personal guarantee from the owner of the property, may also elect to sue the guarantor individually for what is called “a deficiency judgment”.
Bankruptcy allows the borrower in a loan to place jurisdiction over the loan in the Federal Bankruptcy Courts. Lenders cannot prevent borrowers from filing bankruptcy. Filing for bankruptcy may be done even when a property is in foreclosure. The lender then must go to bankruptcy court and convince the Judge that it should be allowed to continue the foreclosure while the borrower tries to convince the Judge of the opposite. Bankruptcy is an extremely complex process, even more so than foreclosure. It is expensive and time consuming. At the of the day the Lender frequently will prevail in the bankruptcy proceedings because they have the financial resources and experience to handle the legal aspects of the proceedings better than the borrower can do.
Essentially delinquency, default, foreclosure, and bankruptcy are all steps down the road to a disaster for the borrower. Each one is worse than the one before. A real estate mortgage borrower’s best choice when facing any of these proceedings is to establish a line of communication with their lender and do their best to negotiate a scenario that will prevent these actions from being taken. Commercial lenders are much more willing than one might believe to work with borrowers to avoid what is a bad option for both parties.
[google_authorship], because of his more than 40 years of experience in funding hard money loans, is considered an authority on hard money or bridge financing. He frequently speaks at meetings and conferences and writes articles on these subjects.