Can lenders foreclose on your house after the forbearance period has expired even during the COVID-19 pandemic?
The purpose of this blog is to provide basic information to help homeowners make an informed decision about whether or not a forbearance is a suitable fit. A forbearance does not eliminate your mortgage debt. It does not guarantee an approval of a loan modification. A forbearance simply pushes your payment date to a later date.
Forbearance vs. Loan Modification: An Analogy
A forbearance is a short-term remedy, which is a suitable option for a minor setback. Similar to how you would use a band aid for a superficial scratch and stitches for a deep cut. You can’t use a band aid for a deep cut, because if not treated properly the deep wound can turn into a novel health problem (pun intended), such as infection or even amputation. Similarly, a forbearance can lead to foreclosure.A loan modification, on the other hand, provides for a long-term remedy. In a loan modification agreement (assuming you apply and are approved), the lender agrees to modify the original loan terms (i.e. the 100-or-so pages you had to go through with a notary when you first purchased or refinanced your home).
In order to better understand how a forbearance agreement in the face of the COVID-19 pandemic may actually set you up for foreclosure, we must go back to your original loan documents, deed of trust and mortgage note (back to the same the 100-or-so pages you had to go through when you first purchased or refinanced your home). You probably signed all the loan documents without having a meaningful opportunity to read and understand all the legalese. Yet, even if you did have such an opportunity, it’s unlikely that you would be able to talk yourself out of an acceleration clause. However, you can do things differently when it comes to a forbearance agreement. You can learn the differences between a forbearance and loan modification. By learning the differences between the two loss mitigation options you will be have the opportunity to make an informed decision with respect to your home.
In order to make an informed decision on whether to enter a forbearance agreement, I’d like to draw your attention to the following two clauses in your loan documents: (1) acceleration clause and (2) prior forbearance clause.
(1) Almost all mortgage notes include an acceleration clause. An acceleration clause in a mortgage note is very common and allows the lender to accelerate the maturity date on your note if you fail to make a monthly mortgage payment (i.e. go into default). Without an acceleration clause, the lender’s only recourse for a borrower’s default is a lawsuit to recover the delinquent payments or a partial foreclosure for the amount of the delinquent payments each time a borrower defaults on his/her mortgage.
A common issue with acceleration clauses arises when lenders approve homeowners for a forbearance. In some states, a lender cannot accelerate the loan if they have a history of allowing late payments unless the lender first provides notice to the borrower that a timely payment will be required under the mortgage. States that follow this principle of reinstatement of timeliness do not allow lenders to accelerate and foreclose until the late payment after reinstatement of timely performance.
(2) However, in states such as California, lenders can overcome this obstacle by simply including a “prior forbearance” clause in the note or deed of trust, such as the following:
“Lender may exercise the option to accelerate during any default by Borrower regardless of any prior forbearance.”
The above is a prior forbearance clause and it is among your lender’s most favorite clauses. A prior forbearance clause allows the lender to accelerate your loan when payment is late even if late payments have been made in the past (such as late payments during a post-COVID-19 forbearance plan). Under a prior forbearance clause, your lender/servicer does not need to reinstate its right to demand payment before declaring the loan in default and accelerating the loan for the full amount due. So, as you can see, it does not matter if the lender approved you for a forbearance plan during the COVID-19 pandemic, once the forbearance period expires the lender can immediately take steps toward the foreclosure of your home.
Depending on the extent of the forbearance or loan modification, the original debt and the debt for which a forbearance is granted, or as modified, could be treated differently for federal income tax purposes. Generally, these exchanges result in a loss to the lender. See Cottage Savings Association v. Commissioner, 499 U.S. 554 (1991) and the Treasury regulations under Section 1001 of the Internal Revenue Code of 1986, as amended. However, you would need to consult a tax professional or financial advisor to determine whether the transaction would be treated as an exchange resulting in taxable gain or loss.
Having said that, a forbearance agreement may be a good opportunity for homeowners who have a game plan to get back on track during the forbearance period.
Will you be saving your money in the meantime so when your forbearance period expires in let’s say three months? Will you be able to pay the delinquent amount in full at the end of these three months?
• If yes, then consider making partial payments to your lender to avoid having to pay a lump sum at the end of your forbearance period. You must first communicate with your lender and ask whether the partial payments are acceptable or whether they would go to an unapplied funds account.
• If no, then consider re-reading the explanation above about the acceleration and prior forbearance clauses, or consider contacting an experienced foreclosure defense attorney to explore your options.
Have you been furloughed or laid off?
• If you have lost income due a furlough (as opposed to being laid off), then perhaps a forbearance agreement may be a good opportunity for you to recover from the loss of income as you anticipate returning to work, at an indefinite time in the future. If you do not know when you will return to work then you should consider having a back-up plan for seeking other employment. That being said, it is always a good idea to consult with an experienced foreclosure defense attorney about your rights and the steps you can take during the forbearance period to protect your interests in your home.
• If you have lost income due to being laid off, are you planning on applying for new jobs anytime soon? If not, then a forbearance would only be a band aid on a deep wound that would ultimately place you at risk of foreclosure. An experienced foreclosure defense attorney will help you explore potential long-term remedies given your circumstances.
This blog is meant to provide readers with answers to commonly asked questions about the forbearance offers from lenders during the COVID-19 pandemic. Contact The Property Lawyer™ today for a free consultation to discuss your specific mortgage situation.
Disclaimer: The information provided in this blog is informational, ONLY and generally based on California law. The subject matter and applicable law are evolving or in constant state of change. No legal advice is given and no attorney/client or other relationship is established or intended.