Consider these tips to analyze which method is best to protect your investment.

As lenders set their sights on growth, one of the most tried-and-true ways to grab more business is to expand into new markets. The concept seems simple enough. Do some more loans in new markets, which you otherwise would not have had access to, and increase your bottom-line.

Simple enough, right?

Put that way, sure. Simple enough.

But lenders measure risk every day. Expansion into new market(s) brings a complex mix of risk components that must be measured the same as any loan or borrower would be. Those components include real estate conditions such as available inventory and size of buyer pool, economic conditions such as affordability, household income and so on. And, of course, legal conditions can’t be overlooked either.

Legal conditions in lending are heavily impacted by the lender’s ability to not only secure their investment (i.e., the loan) but also secure the collateral (i.e., the pledged property) in the event of a borrower default by way of a foreclosure process. Foreclosures, while a common occurrence for many lenders, are not all created equal because each state has its own “unique” foreclosure process.

This “minor” detail creates a major complexity that lenders looking to expand into new markets need to understand. The process, timelines, and costs associated with each state’s foreclosure process can substantially affect a lender’s position in a given property.

So, what are the different types of foreclosures? As lenders we should know this. Though the “fine print” may vary state by state, there are two primary methods of foreclosure:

1. Judicial (involving the court)
2. Non-judicial (not involving the court)

In general, private lending caters largely to residential investment property owners (landlords, flippers, builders, developers, etc.) who seek alternative financing for their investment properties. Property owners who default on their loans may be subject to losing their properties through a judicial or non-judicial foreclosure process.

Although the term “default” is mostly associated with falling behind on mortgage payments, it is much broader than that. Default may (and likely does) include myriad triggering events such as construction stoppage, term maturity, failure to maintain taxes and/or insurance, and even the occasional transfer of ownership interest, sometimes referred to as a quit-claim deed.

So, if you are a lender (investing your own capital directly to borrowers or indirectly through brokers, correspondents, or other conduits) that chooses to do loans in states outside your own, what do you need to know about judicial vs. non-judicial foreclosures? What is the difference? Which method is preferred? Where should you consider lending?

Judicial Foreclosures

In a judicial foreclosure, the lender must file a lawsuit in the courts to foreclose. After a borrower falls behind on payments, the lender sends a letter notifying its intent to foreclose.

After that, the lender files a lawsuit in the courts and gives the borrower notice by issuing a summons. The borrower can choose to let the foreclosure happen or appear in court to contest it. If the borrower elects to contest, there will be a court-ordered hearing, and the judge decides whether the foreclosure sale should proceed. If the court decides in favor of the lender, it will enter a judgment ordering the sale of the property to satisfy the debt.

In a few states, the borrow is given the opportunity to redeem by paying off the entire mortgage debt prior to the sale date. However, if that is not the case, then the borrower can elect to leave voluntarily or get evicted.

Pros: A lender is more likely to get repaid.

Cons: Long and indefinite timelines (six months to three years), typically more expensive, right of redemption periods where borrowers can buy the real estate back

States where it is the norm: Connecticut, Delaware, Florida, Hawaii, Illinois, Indiana, Kansas, Kentucky, Louisiana, Maine, Maryland, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, Vermont, and Wisconsin

Non-Judicial Foreclosure

In a non-judicial foreclosure state, the lender can foreclose without going through the courts. In non-judicial states, the deed of trust (the legal instrument or security agreement used to buy the property) authorizes a trustee to foreclose on the property if the borrower defaults on their loan.

State laws determine the required milestones, such as how much notice a lender must give a borrower, for this foreclosure process. Although the borrower may have some time to make up missed payments to reinstate their loan, if they cannot do this or enter into some kind of workout plan with the lender, they will receive a notice of intent to sell the property on a specific date. Typically, these sales happen at the courthouse steps by a lender-appointed trustee rather than court-appointed officers.

Pros: Speed and convenience

Cons: The lender typically gives up the right to seek a deficiency judgment against the borrower. Though they don’t involve the court, a fair amount of legal activity surrounds non-judicial foreclosures (namely, lawsuits filed by borrowers, other lien holders, or interested parties) in order to protect their investments.

States where it is the norm:
Alabama, Alaska, Arizona, Arkansas, California, Colorado, District of Columbia, Georgia, Idaho, Iowa, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, North Carolina, Oregon, Rhode Island, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia and Wyoming