How can private lenders mitigate their risk?

The mortgage industry, like many others, has experienced a rather tumultuous couple of years. The recent passage of New York’s Foreclosure Abuse Prevention Act (FAPA) has brought about another layer of complexity to private lenders focused on investor loans. Although FAPA presently pertains only to New York state, its enactment may pave the way for similar legislation elsewhere. Regardless, private lenders will be smart to adapt their loss mitigation strategies to adhere to an increasingly challenging regulatory environment with implications across the United States.

For many real estate investors, private lenders are the conduit to purchasing single-family and multifamily investment properties. These types of loans are commercial in nature, like a traditional consumer loan, but there are explicit covenants that, if not adhered to, rightfully afford the lender avenues of recourse to recoup monies they have expended.

The most common of these covenants is the borrower’s obligation to make mortgage payments, typically monthly, toward the loan. If these payments are not made in a timely manner, or any other covenant is breached, the lender generally has authority to declare the loan in default, accelerate the debt owed, and pursue its recourse—most notably, through foreclosure.

Foreclosure is a necessary tool for lenders, but it varies, often quite dramatically, depending on the state where the property is located. California, for example, is a non-judicial foreclosure state whereby a foreclosure is prosecuted not through the court system but via the filing of a Notice of Default. In contrast, New York foreclosures operate through the judicial system, whereby the secured lender would bring a lawsuit to foreclose and sell the property that secures the loan.

Judicial states like New York tend to experience drastically longer timelines than their non-judicial counterparts, but New York also notably endured a two-year moratorium that barred lenders from foreclosing in response to COVID-19. As a result, the system is now inundated with the volume from two years of moratoriums. FAPA brings a new consideration private lenders should be mindful of.

How FAPA Changes the Foreclosure Timeline

FAPA changes the current law in New York by instituting a six-year statute of limitations by which a lender must begin and complete a foreclosure action. This means that from the moment a lis pendens is filed against a property for the first time, the clock will start ticking. Should the lender temporarily halt the foreclosure and then later resume, the lender will still be restricted by the six-year period that went into effect from the initial filing of the lis pendens. Thus, once a lender makes the decision to exercise its right to accelerate the loan and file a lis pendens, it has six years to complete the action before it loses its right to recover on the debt at all. This bill also applies retroactively to any pending action for which a final judgment and order of sale has not been granted.

Although the six-year statute of limitations may seem like plenty of time to complete a foreclosure, the reality is more nuanced. Construction bridge loans, by their nature, tend to go in and out of short-term delinquent status with some frequency. The category has a high rate of loans that may extend beyond the original maturity.

As with any lawsuit, after starting an action, a lender may choose to discontinue it and reinstate the loan to good standing if, for example, the borrower agrees to cure the default in return for a discharge of the lawsuit. There are positive implications to this: For the borrower, ownership of the property remains intact, and the lender can recoup the monies owed to them and maintain a low default rate.

With lenders eager to avoid unnecessary litigation and maintain a book of performing loans, an in-and-out of default scenario may come to fruition; therefore, FAPA may potentially have an outsized effect on this asset class specifically. Under FAPA, the lender will have a much shorter time frame to prosecute and recover on its loan and, therefore, reconsider accepting a payment once a default has been initiated.

Consider this example: A lender files a lis pendens against a property Jan. 1, 2017, initiating the foreclosure. The lender then discontinues this action Jan. 1, 2018, after allowing a reinstatement of the loan. One year later, the borrower again goes into default, prompting the lender to restart the foreclosure action. The effective date, for purposes of the statute of limitations, began Jan. 1, 2017, leaving the lender with a much shorter timeframe to complete the action.

You may be thinking: What about other avenues of recourse afforded to the lender such as the pledge of equity or personal guaranty? That too, under FAPA, is subject to the statute of limitations.

Undoubtably, the strategies surrounding mortgage lenders with respect to this facet of the business will be impacted. In a state many lenders have historically shied away from given the existing challenges and timelines surrounding their recourse, this legislation will add another hurdle.

Mitigating FAPA’s Impact

As the trend for an increasingly complex regulatory environment continues across the U.S., what can private lenders do to mitigate the impact of new bills such as FAPA? In addition to working with associations like AAPL that provide a platform and voice for private lenders to make their case to federal and state legislatures, there are other avenues to mitigate the impact of an increasingly complicated regulatory environment.

Most notably, private lenders and loan originators can leverage a white-label table funding solution through a capital provider that is better equipped to handle an ever-changing regulatory environment. Additionally, by doing so, loan originators can avoid the representations and warranties that a traditional loan sale arrangement includes. The table funding model is balance-sheet-light, operationally efficient, and a much less risky capital source for those looking to diversify their product offerings, scale their business, and better align with the needs of entrepreneurial fix-and-flip and landlord investors. The capital provider not only provides the funding but also underwrites, closes, services, and takes on the risk of the loan—all while navigating the complexities of a changing regulatory environment. The loan can be closed in the loan originator’s name, allowing them to maintain their relationship.

A white-label table-funding solution should allow loan originators to feel comfortable navigating this increasingly fluid landscape to get their loans funded, without taking on the shifting regulatory environment on their own and allowing them to focus on what they do best—identifying borrowers and lending to them.

Lucas Sambrook is a director and real estate counsel at Roc360, responsible for heading the firm’s closing and special servicing departments. Previously, Sambrook was an attorney at a Manhattan real estate law firm, representing large institutional lenders on various financing-related matters. He holds a J.D. from New York Law School and an honors bachelor’s degree from the University of Toronto.

Roc Capital, part of the Roc360 family of companies, has funded more than $8 billion of residential real estate investor loans across the U.S. since 2014. It is positionally and financially poised to continue offering its multitude of real estate services, including a turnkey, white-label table-funding platform.