Whether COVID-19 will bring on another epic foreclosure crisis remains to be seen. But either way, some homeowners across the U.S. are struggling financially because of coronavirus fallout and might be facing foreclosure because of it. Investors typically need to be ready to pounce during these times. Before you do, it's wise to understand and consider the right of redemption and how it might throw you a curveball.
Right of redemption: What is it?
Simply put, a right of redemption is a legal right that gives a mortgagor, or borrower, who is being foreclosed upon the ability to stop the foreclosure. This right always applies in every state during the foreclosure process, before the actual foreclosure happens. But in some states, mortgagors have the right to buy the home back after the foreclosure takes place. This is called a "statutory right of redemption."
States that allow statutory right of redemption (post-sale redemption)
A post-sale redemption allows mortgagors to reclaim their home after someone has bought it. Here is a list of states that allow a statutory right of redemption, some with certain restrictions (as of September 2020):
- New Jersey
- New Mexico
- North Carolina
- North Dakota
- South Dakota
Keep in mind that laws change often, so be sure to double-check your state's law before you buy a foreclosure so you'll know whether a statutory right of redemption is allowed, and if so, the details that surround it.
For example, each state has different parameters as to how long after the purchase the statutory right of redemption applies, generally between a month and a year. Also, there are sometimes varying parameters based on the type of property purchased. The more knowledge you have, the better position you'll be in to weigh your risks, such as possibly being unable to keep your newest acquisition.
How a mortgagor plays the redemption card during the foreclosure process
What a mortgagor needs to do to stop a foreclosure proceeding before the foreclosure happens is to pay off the debt, including interest plus any fees or penalties. This can happen any time between when foreclosure proceedings begin and the foreclosure sale. If a borrower manages to pay off what's owed, the foreclosure is called off.
Sounds easy enough, but realistically speaking, coming up with enough cash to pay off the total debt, plus interest and fees, especially for someone who hasn't been making mortgage payments for several months, is usually easier said than done.
If borrowers are having financial trouble to the point of missing mortgage payments, they probably won't be able to come up with the entire debt they owe in time to save the home from foreclosure. Although the likelihood of that happening is low, the point is, it can happen, making the right of redemption a last-chance opportunity for mortgagors to keep their home.
Redeeming after a foreclosure sale takes place
It's more likely for a borrower to exercise a statutory right of redemption, which is redemption after the foreclosure takes place. In that case, a mortgagor typically only needs to come up with the foreclosed price of the home (plus fees and penalties), and that price could be less than what the borrower owes.
Some borrowers in post-sale redemption states might use this law to their advantage, e.g., stop paying their mortgage and wait for the home to sell at auction. They then buy the home back, often at a reduced price, which could be less than what they owe.
If the numbers work out, a mortgagor can theoretically buy back their home at a reduced price, then turn around and sell that home for more than what they paid for it as a foreclosed property. This method might be creative, but it doesn't always work. Some states require the mortgagor to pay the foreclosed price plus the full repayment of debt, reducing those types of shenanigans.
Buying a foreclosure in a statutory-right-of-redemption state
If you live in a state that allows a statutory right of redemption, you will not officially own a home you buy at auction until the statutory-right-of-redemption period ends, which is generally between 30 days and a year. Because you must wait to find out whether you get this property or not, you might want to offer less for it. Keep in mind, however, that the less you buy a property for, the more likely the mortgagor will be able to buy it back.
When does a borrower in default need to vacate the property?
When a borrower in default needs to leave the property depends on state law. Mortgagors in all 50 states can stay in the property until it is foreclosed upon. Some states allow the mortgagor to also remain in the home throughout the statutory-right-of-redemption period while other states allow the purchaser of the foreclosed property to take possession immediately, with the stipulation that the mortgagor can get the property back if they pay the required monetary amount within the redemption period.
A word on judicial and nonjudicial foreclosures
Whether a foreclosure is a judicial or nonjudicial one depends on the state in which the foreclosure is taking place. All states allow a judicial foreclosure, and about half the states offer a choice between the two.
In a judicial foreclosure, the bank or mortgage company must file a lawsuit to foreclose. The court will then need to determine whether the foreclosure is warranted and allowable. If the court determines a foreclosure is in order, it enters a judgment against the borrower. This process can take several months or even years to complete.
In a nonjudicial foreclosure, the courts do not need to be involved. That usually only happens if the lender wants the courts involved. In a nonjudicial foreclosure, a trustee generally handles the procedure by alerting the borrower through a notice of default, which requests the borrower pay what is owed or face foreclosure. There are typically a few more steps involved, but those vary by state. A nonjudicial foreclosure is usually faster than a judicial foreclosure, typically taking a few months or less.
The significance of a judicial or nonjudicial foreclosure regarding the right of redemption is that the statutory right of redemption, the right to buy back the home after a foreclosure takes place, is usually allowed only in judicial states and not in nonjudicial ones. And if the foreclosure is a judicial one in a nonjudicial state, the same general rule applies: The borrower has the right to redeem post-sale in a judicial proceeding but not in a nonjudicial proceeding.
The bottom line
The right of redemption is a vehicle to help borrowers. Although it's rare for a distressed mortgagor to be able to redeem a property after missing several mortgage payments, it can happen. And it can be frustrating for investors to bid on and win a property at a foreclosure auction only to have the borrower reclaim that home.
But investors play the cards they're dealt. Once you know the right of redemption laws in your state, you'll be better able to assess your possible investment, and then hope for the best and plan for the worst.