Q: I read with interest your comment on prepayment panalties. Why can't I simply arrange new financial, cease payment on the old loan, and pay off in full when the old lender forecloses?
A: In an earlier column, I indicated that there are times when a lender might charge you a prepayment penalty if you refinance with another lender. Your suggestion to let the loan go to default, and then at the foreclosure proceeding pay the original lender in full without penalty is ingenious I doubt that this would work, however, for two basic reasons.
First, no new lender will be willing to go along with this procedure, since they may not have a clean first lien on your property e until the prepayment penalty is paid.
When a mortage lending institution commits funds, it insists on a clean and clear title, so that if it must foreclose, it will be in a top priority position. Genrally speaking, the only way to clear up the first lien from your original lender is to have a release of the original deed of trust filed in the appropriate land records office.
In order to obtain such a release, the original note must be marked "paid and cancelled" by the original lender. As a general rule, no mortage lender will be willing to release their lien until they have been paid in full - including any prepayment penalty to which they might be entitled.
Second, I doubt that the lender will allow your scheme to bear fruit, since they will insist on the prepayment penalty, under any circumstances.
Your question prompts some discussion of foreclosure. Foreclosures shoule be the last resort for the lender and the borrower, and should not be undertaken casually. Usually, the lender will be more than willing to cooperate with the borrower to avoid foreclosure, until all other avenues of relief have been exhausted. In fact, housing counseling assistance is available for many families who are threatened with foreclosure proceedings.
When you purchased your house, you signed a deed of trust, and in effect you deeded the property "in trust" to a trustee selected by the lender. If and when you pay off your mortgage, the trustees will release their security from the land records. If, no the other hand, you do not make payment, the trustees can be directed to institute foreclosure proceedings. After advertising the property for a period of time, the trustees are authorized by law to sell your house to the highest bidder at a foreclosure sale.
I don't recommend anyone to go through foreclosure proceedings. First, your credit rating will surely be hurt. This is a matter of public record, and why do you want to affect your credit standing in the community?
Second, the standard form deeds of trust require you to pay trustee's fees and attorney's fees in connection with the foreclosure proceedings. This fee can be exorbitantly high. Additionally, the advertising costs and other expenses incurred in connection with the foreclosure will be deducted from the gross proceeds at a forceclosure sale.
Finally, you run the risk that your house will be sold out from under you, at a price considerably lower than the market value. In some jurisdictions, you may even be subjected to a deficiency judgment, and will have to pay additional monies to clear your loan obligation.
Benny L. Kass is a Washington attorney. Write him in care of The Washington Post Real Estate Section, 1150 15th St. NW, Washington 20071.