SELLER HELD MORTGAGES AND ENFORCEMENT IN NEW YORK
BY
MICHAEL J. LOMBARDO, ESQ.
An owner of investment
property free of a mortgage who desires to sell may face the dilemma of whether
to receive payment in full at closing or to hold a mortgage so that payments
are received over time (with interest). This is what is commonly referred to as seller financing.
There are two main advantages
to a seller holding a mortgage. The
first is to receive a higher rate of interest on the sale proceeds than might
otherwise be available through alternative sources, such as a bank account. The second is the ability to defer capital
gain on the sale proceeds until a future year when the deferred payments of the
purchase price are received.
Likewise, there are two main advantages
to the buyer by having the seller hold a mortgage. First, the rate of interest charged by the
seller is usually lower than the rate of interest a financial institution may
charge the buyer. Second, the closing
costs to the buyer may be less than if the buyer obtains a loan from an
institutional lender.
In this article, we will
explore what the seller must do if the seller has agreed to hold a mortgage but
needs to enforce the seller’s rights because the buyer failed to perform the
buyer’s obligations under the mortgage.
THE DOCUMENTS
Before we explore how a
seller goes about enforcing rights under a mortgage, it is necessary to know
what documents the seller receives from the buyer at the closing if the seller
has agreed to hold a mortgage. At the closing,
the buyer gives the seller, as part of the purchase price, a document by which
the buyer promises to pay the seller the balance of the purchase price over
time usually at a stated rate of interest (this document is called a note) and grants
the seller a lien on the real property purchased as security for the buyer’s
promises made in the note (this document is called a mortgage). The mortgage usually contains other terms too,
such as requiring the buyer to maintain the property, pay the taxes and keep
the property insured, among others. Under the note and mortgage, the buyer is commonly referred to as the borrower
or mortgagor and the seller is commonly referred to as the lender or mortgagee. We will use these terms in the rest of his
article.
BORROWER’S DEFAULT
If the borrower fails to
perform an obligation under the note or mortgage, the lender may be able to consider
the borrower to be in default. However,
before the lender can consider the borrower to be in default, the lender must
be sure to comply with the lender’s obligations under the note and mortgage
that may have to be satisfied before the lender can take legal action to
enforce the note or mortgage. For
example, the note or mortgage may contain a clause that requires the lender to
give the borrower a notice of what the borrower failed to do and may require
the lender to provide the borrower an opportunity to correct the problem. Therefore, it is important that the note and
mortgage be examined carefully to determine what the lender needs to do before
any legal action is taken to enforce the note or mortgage.
Enforcement
1.
Lender’s Election of Remedies.
If the borrower fails to
perform an obligation under the note or mortgage and the lender has provided
the borrower with the notices and opportunity to cure as may be required by the
note or mortgage, the lender then has to decide whether to seek to enforce the lender’s
rights under the note or under the mortgage. Under New York law, a lender must make an election as to which document
should be enforced since the lender cannot bring an action to enforce both at
the same time. If the lender makes an
election to bring a lawsuit to enforce the note, the lender generally cannot
start a foreclosure proceeding until the lender obtains a court judgment on the
note and is unsuccessful in collecting on the judgment. Likewise, if the lender decides to start a
foreclosure proceeding to enforce the mortgage, the lender cannot bring a
separate lawsuit to enforce the note. This is what is referred to as an election of remedies.
2.
Pre-Action Notices
If the borrower is a natural
person, the debt was incurred for personal, family or household purposes and
the mortgage is a lien on property that is a one to four family residential dwelling
or condominium used or occupied (or intended to be used or occupied) in whole
or in part as the home or residence by one or more persons and which is or will
be occupied by the borrower as the borrower’s principal residence a notice may
be required to be given to the borrower 90 days before starting any foreclosure
proceeding. This notice is in addition
to any notice that may be required under the note or mortgage. While the law seems to require a 90 day
pre-foreclosure notice for institutional lenders, due to some uncertainty under
the law, some Judges require that a 90 day pre-foreclosure notice be given
where the mortgage is privately held, such as in the case where the seller
holds a mortgage as part of a sale. In
addition, anyone who has purchased a mortgage (for investment or any other
reason) from a lender that is bound by the requirements for a 90 day
pre-foreclosure notice is also bound by the pre-foreclosure notice requirements
under the law. In addition, it may be
necessary to register the 90 day pre-foreclosure notice with the State Banking
Department.
3.
Pre-Foreclosure Process
Once the decision has been
made by the mortgagee to start a foreclosure proceeding, the mortgagee will
need to determine who has an interest in the property and, whether that
interest is subordinate (or sometimes called junior) to the lien of the
mortgage being foreclosed. Anyone having
a subordinate or junior interest must be made a party to the foreclosure
proceeding. Examples of interests that
are junior to a first mortgage being foreclosed are interests such as a second
mortgage (e.g. a home equity loan), interests of tenants who became tenants
after the mortgage became a lien on the property, judgment creditors who have
been granted a judgment after the mortgage became a lien on the property, as
well as others. The failure to name any
party with a junior interest to the mortgage being foreclosed means that the
successful bidder at the foreclosure sale will be purchasing the property subject
to the rights of the junior interest. For example, if there is a tenant on the property who is not made a
party to the foreclosure proceeding, the tenant’s rights, whatever they may be,
will survive the foreclosure proceeding and the purchaser of the property at
the foreclosure sale will have to honor those rights. This may affect a person’s willingness to bid
on the property at the foreclosure sale (discussed below). Real estate taxes are never subordinate to
the lien of a mortgage, even if the tax did not first come due until after the
mortgage became a lien.
4.
Foreclosure Process-Pre Sale
Once the parties to the
foreclosure proceeding are determined, a Lis Pendens, or Notice of Pendency, is
filed with the County Clerk to put the world on notice that a foreclosure
proceeding is about to begin. Anyone who
obtains an interest in the property after the Lis Pendens is filed need not be
named a party to the foreclosure proceeding but will still have that interest
cut off by the foreclosure proceeding. The parties to the foreclosure proceeding are then served with the
Summons and Complaint.
If the property is an owner
occupied one to four family dwelling, special notices must accompany the
Summons and Complaint that is served on the owner and tenants of the property. One of the notices required is intended to
inform the owner that the owner can lose the property through the foreclosure
process and to let the owner know that the State encourages the owner to seek
assistance in learning of the options that may be available to the owner. In addition, if there are tenants who occupy
any other part of the property, those tenants must also receive a notice
directed to their rights as tenants. The
rights of tenants post foreclosure are discussed later on.
In a foreclosure of
residential property in which the borrower is a resident, the court is required
to hold a settlement conference within 60 days after the lender files proof
that the borrower was served with the papers that are used to start the foreclosure,
and the law mandates that both the lender and borrower negotiate in good faith
to settle the foreclosure, which may require a loan modification. Even if the note and mortgage allows the
lender to collect legal fees to enforce the mortgage, the lender is not
entitled to be reimbursed for legal fees incurred in attending the settlement
conference.
Assuming there are no
defenses to the proceeding raised by anyone made a party to the foreclosure
proceeding, and the lender and borrower cannot reach a settlement, a Referee is
appointed by the Court to compute how much is owed to the lender. Once that is determined, the lender obtains a
Judgment of Foreclosure which then allows the lender to have the property sold
at auction by a Referee. The law requires
that notice of the sale of property be published in a newspaper from between 3
to 4 weeks before the sale, and sometimes the notice of sale has to be
posted.
Once a
Judgment of Foreclosure and Sale is obtained permitting the Referee to sell the
property, the lender has the obligation to maintain the property if the
property is residential property (including mixed residential and commercial
use) between the time the Judgment is obtained and the time title to the
property is transferred by the Referee if the property is vacant, becomes
vacant, or is abandoned by the borrower but occupied by a tenant. There are some exceptions and suspensions,
and technicalities as to what is meant by maintaining the property and if this
applies, consultation with an attorney is a must.
5.
Foreclosure Process-Sale
On the scheduled date of the
sale, the Referee will conduct an auction of the property. The lender usually, but not always, opens the
bid for the property for the amount owed to the lender. If the property is worth less than what is
owed to the lender, the lender may open the bid for the value of the
property. Others are then invited to bid
until a high bidder is determined by the Referee.
The sale of the property
conducted by the Referee will be subject to Terms of Sale that are determined
and usually read before the bidding starts. The terms of sale usually provide for the following:
· 10% down (bank
draft or cashier’s check) at the auction
· Close within 30
days, sometimes less time is provided-Time is of the essence (if late, interest
is usually charged at 9% per annum).
· The Referee will
provide a deed, but usually nothing else. The obligation to obtain a title search, survey etc. is the purchaser’s
responsibility.
· The sale is
usually subject to any state of facts a survey of the property will show. What this means is that if, for example, a
survey will show a title defect (like a driveway located entirely on a
neighbor’s property), the Referee has no obligation to fix the problem.
· The purchase is
“as is”, with no right to inspect. The
reason there is no right to inspect is because the property still belongs to
the owner who took out the mortgage until the property is sold.
· The purchaser is
responsible for obtaining whatever title documents, including a survey, the
purchaser desires to have examined before the closing. Neither the lender nor the Referee has any
obligation to provide any title documents other than the Referee’s deed.
· The purchaser is
responsible for all closing costs (tax, recording fees, title insurance etc.).
· The deposit paid
at auction will be lost if the purchaser fails to close on time. If the purchaser does fail to close on time,
the property is usually sold to the next highest bidder at the auction.
· Some auctions are
conducted that result in a sale of the property subject to any existing
property taxes. While the law does
require the property taxes to be paid out of the proceeds from the auction,
some sales are made that pass this obligation onto the purchaser. Therefore, it is important to understand the
terms of sale so as to avoid any surprises.
If the Referee improperly
conducts the foreclosure sale, the validity of the sale could be called into
question.
6.
Foreclosure Process-Post Sale
Once
the property has been sold and the Referee has given a deed to the purchaser at
the foreclosure sale, the Referee is required to file a report of the sale with
the Court. The Court, upon application,
will in most cases approve the Referee’s Report of Sale. Although this is an important step in the
foreclosure proceeding, there are many instances where this is not done. Even if all the steps required to be taken in
the foreclosure proceeding were properly taken, if the former owner of the
property refuses to vacate the property, the purchaser is responsible for
evicting the former owner.
If the
property is in any manner used as residential property (including mixed
residential and commercial use), the purchaser of the property (which may be
the lender) needs to provide a notice to the tenants advising that they may
have the right to remain on the property until the later of the end of the
lease term or 90 days from the mailing of the notice. This right is in addition to any other right
of the tenants such as the rights a tenant may have by not being named a part
to the foreclosure proceeding.
7.
Foreclosure Process-Special Issues
Sometimes
the foreclosure proceeding can be delayed or there may be some particular
interest in the property that could affect the finality of the sale. Some of these issues are as follows:
· The bankruptcy
filing by the owner of the property during the foreclosure process (sometimes
even on the eve of the foreclosure sale). If a bankruptcy proceeding is filed, the foreclosure proceeding must
stop until the lender receives permission from the Bankruptcy Court to proceed
with the foreclosure.
· If the United
States government has a lien against the property, the United States has what
is called a right of redemption-i.e. it has between 120 days and 1 year from
date of sale to match the purchase price and take the property.
· Appeal from the
Judgment of Foreclosure if there is a contested foreclosure proceeding.
· The foreclosure
of a second or third mortgage may trigger a due on sale clause of a senior
mortgage. This means that immediately
following the sale of the property by the Referee to the purchaser, the holder
of the senior mortgage can demand payment in full on the debt secured by its
mortgage, and if there is a failure to pay, the holder of the senior mortgage
can start its own foreclosure proceeding.
8.
Borrower's Right to Recover Legal Fees
Legislation has been passed providing for recovery of legal fees by borrowers against lenders under certain conditions. If, as is common, a mortgage provides that the lender is entitled to recover legal fees if the lender forecloses the mortgage or if the borrower fails to perform an obligation under the mortgage, then the borrower has an implied right to recover from the lender legal fees incurred by the borrower if the borrower successfully defends against a foreclosure proceeding or if the borrower incurs legal fees arising out of the lender's failure to perform an obligation under the mortgage. This is an implied right which means it applies even if the mortgage has no provision for recovery of legal fees by a borrower, as is commonly the case. However, this implied right to legal feels is limited to those mortgages that cover a 1-4 family owner-borrower occuppied property or condominium unit. (See generally Real Property Law §282).
CONCLUSION
Structuring a sale so that
the seller is holding a mortgage for part of the sale price can have benefits
for both the seller and buyer. However,
the seller may need to comply with certain obligations before any legal action
is taken against a defaulting buyer. If
you are considering holding a mortgage as part of a sale, you should contact an
attorney before a contract is signed to let your attorney know of your plans so
that you and your attorney can discuss the process in case you are faced with a
defaulting buyer and to discuss other steps that might be taken in an attempt
to protect your interests.
CAUTION: THIS ARTICLE IS INTENDED TO PRESENT
GENERAL INFORMATION AND IS NOT INTENDED TO BE A SUBSTITUTE FOR CONSULTATION
WITH LEGAL COUNSEL.
IRS
CIRCULAR 230 Disclosure: To ensure compliance with requirements imposed
by the IRS, please be aware that any U.S. federal tax advice contained in this
communication (including any attachments or enclosures) is not intended or
written to be used and cannot be used for the purpose of (i) avoiding penalties that may be imposed under the
Internal Revenue Code or (ii) promoting, marketing or recommending to any other
person any transaction or matter addressed herein.
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Last Update: March 28, 2011