Mortgage Securitizations May Help Borrowers

Endorsements in blank and Pooling and Servicing Agreements may make it impossible for banks to prove they have the right to foreclose. I explained endorsements in blank in Produce the Note, An Alternate View, Part 3 and the right to foreclose, or standing, in Produce the Note, An Alternate View, Part 1. The Pooling and Servicing Agreement (PSA) is the heart of a mortgage securitization. It requires a “depositor” or “transferor” to transfer all of the mortgage loans being securitized to a trustee who “holds” them for the benefit of the investors who buy the mortgage back securities.

The mortgage notes transferred to the trustee pursuant to the PSA must be endorsed in blank. But, under UCC 3-301, transferring possession of a bearer note transfers only the right to enforce the note. It does not transfer ownership of the note and ownership, I have argued, determines who has the right to foreclose. UCC 3-301 affords a non-owner of the note, or even a thief, the right to enforce the note.

Because PSAs routinely required notes in the pool to be endorsed in blank, parties in the secondary mortgage market often endorsed notes in blank well before the PSA depositor or transferor would come into possession. So, if the foreclosing party produces the PSA as proof of its ownership on a motion to dismiss for lack of standing, the borrower will want to know who transferred possession to the foreclosing party and to see proof of that transferee’s ownership. This process should be pursued for every link in the chain all the way back to the party that endorsed the note in blank. The foreclosing party normally has the burden of proof on standing and it likely will be difficult, if not impossible, for the foreclosing party to prove ownership for every transferee in the chain. The longer the chain, the harder it will be. If proof of ownership is lacking at any link, it follows that the foreclosing party has not established the right to foreclose and the foreclosure action should be dismissed.

New York’s Foreclosure Settlement Conference Program

New York’s Foreclosure Settlement Conference program provides court oversight to the mortgage modification process. The goal is to insure that the borrower timely submits the necessary information for the bank to make a modification determination. More importantly for the borrower, the program gives the bank some accountability for receiving the necessary information and for making a timely decision.

Only borrowers who are defendants in a foreclosure lawsuit are eligible for the program. After the bank serves the borrower with the summons and complaint, the bank is obliged to file with the court a form that notifies the court’s clerk to send the parties notice of the first conference. The conference takes place at the courthouse but not in a courtroom, although the borrower may be waiting in a courtroom for the borrower’s case to be called. When the case is called, the borrower will be escorted into a private room. The borrower, the borrower’s lawyer (if the borrower has one), the bank’s lawyer and a state employee who is not a judge are the only people in the room. There is no court reporter or clerk. The bank’s lawyer will give the state employee some basic information about the loan like the type of loan (fixed or adjustable rate, etc.), when the last payment was made and the outstanding principal balance. The state employee will then discuss with the borrower the reasons for the default and whether the borrower wants to retain the property. Assuming the borrower wants to remain in the property, the bank’s lawyer will provide the borrower with some forms to complete and a list of documents to submit. The forms ask for the borrower’s income, expenses, and assets. The documents normally include bank statements, pay stubs, tax returns and a current utility bill. The borrower will also have to submit a hardship affidavit explaining the financial hardship that caused the borrower to default. The hardship affidavit is often one of the forms for the borrower to complete but sometimes the borrower must provide it separately.

The next conference is normally scheduled at the conclusion of the first conference. The borrower should submit the forms and documents before the next conference. The subsequent conferences will address any requests the bank has for additional information or any questions about the information submitted. The length of the process normally requires the borrower to periodically submit updated paystubs and bank statements.

Deed in Lieu of Foreclosure

The “deed in lieu of foreclosure” is the foreclosure alternative in which the property owner turns over the property to the lender and avoids the formal foreclosure process. As in a true short sale, the borrower’s goal in a “deed in lieu” resolution is to avoid liability for the deficiency that results if the property is worth less than what the borrower owes on the debt. The general idea is that the borrower saves the lender the expense of foreclosing by giving the lender the deed to property. In exchange the lender waives the deficiency.

Most lenders in the states where I practice law, Connecticut and New York, require the borrower to list the property for sale for a certain time period (usually at least 90 days) before they will consider a taking a deed in lieu of foreclosing. Whether the lender actually accepts the deed, or waives the deficiency, after the time period expires is an open question. I have not been involved with any deed in lieu transaction in Connecticut or New York nor have I heard of any completed deed in lieu transaction in Connecticut or New York. I think this is largely for three reasons. First, the bank would much prefer that the borrower sell the property rather than the bank have to add the property to its inventory of unsold, “bank-owned” properties. The bank has carrying costs on the properties it owns and there is no reason to increase those costs in a terrible real estate market. Plus, real estate agents will tell you that it is generally easier to sell a property that is occupied than it is to sell a property that is vacant. If the bank takes the deed, the property will be vacant.

Second, Connecticut and New York are judicial foreclosure states. By the time the borrower starts considering a deed in lieu in transaction, the bank has already commenced the foreclosure lawsuit. For residential foreclosures, the parties will spend time in Connecticut’s Foreclosure Mediation program or New York’s Foreclosure Settlement Conference program trying to agree to a mortgage modification. If the programs fail to achieve a modification, most banks believe completing the foreclosure is a foregone conclusion. The bank has less incentive to consider a deed in lieu because it has already initiated and, in its view, can expeditiously complete, the foreclosure without having to waive the deficiency. Contrast this with a nonjudicial foreclosure state where a deed in lieu can avoid commencement of the foreclosure process.

Finally, banks don’t like to waive deficiencies. In a judicial foreclosure state, where the foreclosure lawsuit has already commenced, the borrower gets no real benefit from a deed in lieu if the bank will not waive the deficiency. This is essentially the flip-side of the bank’s viewpoint discussed above: the bank has little incentive to consider a deed in lieu when the foreclosure action is pending and neither does the borrower.

That being said, if a borrower is resigned to losing the property, it cannot hurt to explore the deed in lieu possibility with the bank. At the least, it might provide the borrower with some flexibility in vacating the property.

Short Sale May Not Be All It’s Cracked Up to Be

Lenders may be touting short sales as a foreclosure alternative but the sale may not be truly “short” or even possible. In this post, I discuss how short sales are supposed to work, how they have been (not) working and why they might not work.

How A Short Sale is Supposed to Work

Think of real estate title as a ship. Think of the mortgage as a barnacle that is put on the title when the borrower takes a mortgage loan. The real estate buyer wants to buy a title that is free and clear of all barnacles. This means that the borrower-seller must scrape the mortgage barnacle off the title before she can complete a sale. The normal way to scrape the mortgage barnacle is to use the sale price to pay off the loan associated with the barnacle. If the sale price is insufficient to pay off the underlying debt, the borrower-seller has to ask the lender or mortgage servicer, who often are responsible for foreclosure and short sales, to release its mortgage barnacle even though the sale price is too “short” to fully repay the debt. The difference between what the borrower-seller owes and the net sale proceeds is the deficiency. With a true short sale, the lender takes all of the net proceeds of the sale, releases its mortgage and waives any claim to collect the deficiency from the borrower-seller.

Of course, before the lender or servicer will agree to a short sale, it has to be satisfied that the borrower-seller cannot pay the mortgage and the proposed sale price is reasonable. The borrower-seller demonstrates that he cannot pay the mortgage the same way he does when seeking a mortgage modification: he submits income and expense information and documentation to the lender or servicer, together with an affidavit explaining the hardship. The lender or servicer confirms the reasonableness of the proposed offer with its own appraisal or broker’s price opinion.

How Short Sales have been (Not) Working

Many mortgage servicers have been unwilling to waive the deficiency. The reason for this isn’t entirely clear but probably has something to do with restrictions imposed by mortgage securitization. In a mortgage securitization, the issuer pools mortgages and sells mortgage backed securities, or “MBS”, to investors. The MBS entitles the investor to receive a share of the pooled mortgage payments. The mortgage barnacle, and the personal liability of the borrower, gives the investor security that it will actually receive its proper share of the pooled payments. If the servicer waives the deficiency, the investors may claim that they had a right to that deficiency and the servicer harmed them by the waiver. It is safer for the servicer to refuse to waive the deficiency.

The refusal to waive the deficiency may be a distinction without much of a difference. Though the deficiency still exists, it is an open question whether any lender or servicer would actively attempt to enforce it. Doing so would most likely require a separate lawsuit because a foreclosure deficiency presumes a foreclosure of title. In a short sale, title is not foreclosed; it is sold with the servicer’s consent. A separate lawsuit to obtain a judgment on the unpaid portion of the debt is another expense for the servicer and one that is unlikely to yield a benefit because the borrower-seller is not likely to have the financial resources to pay it. In such circumstances the borrower-seller is said to be “judgment proof.” The added expense, without any added benefit, may be enough to deter the lender or servicer from pursuing a separate lawsuit based on the deficiency.

A short sale without a waiver of deficiency may be preferable to a foreclosure and deficiency judgment in any event. In a foreclosure lawsuit where the property value is less than the debt, the foreclosing party can obtain a judgment for the deficiency, or deficiency judgment, as part of the foreclosure lawsuit. There is virtually no added expense for the foreclosing party since the foreclosure and deficiency judgment are accomplished as part of the same lawsuit. Though the risk to the borrower of anyone actually trying to collect on the deficiency judgment remains remote, the judgment itself remains viable for a long time — 15 or 20 years in many jurisdictions. That means someone could show up to collect in year 14, after the borrower has righted her financial ship. Contrast that to the short sale with no waiver of deficiency; statutes of limitation can protect the borrower-seller from attempts to collect a long unpaid debt.

Why Short Sales Might Not Work

Going back to mortgage barnacles, a real estate title can have multiple barnacles. For example, many borrowers have a first mortgage and a home equity line of credit, or HELOC. The HELOC is another barnacle. All barnacles have to be removed to sell the property. The first mortgage is usually the largest and the first mortgage lender usually wants all of the net sale proceeds (assuming the net proceeds aren’t enough to fully repay the first mortgage). The HELOC, and any other mortgages or liens, can prevent the sale by refusing to release their barnacles unless they get paid something too. If they can’t agree with the first mortgage on who gets how much, the property can’t be sold. If it takes too long for them to agree, the borrower-seller may lose the buyer, who can’t wait around forever.

The possibility of bickering barnacles and lost buyers makes it imperative for anyone considering selling a property via short sale to use a real estate broker experienced in short sales. From what I’ve seen, an experienced short sale broker can be the difference between a completed short sale and a completed foreclosure.

Motion to Dismiss for Lack of Standing

Produce the Note, An Alternate View, Parts 1, 2 and 3 explained why borrowers might be better off asking the foreclosing party to prove ownership of the debt rather than asking it to produce the note. But how and when does the borrower go about asking the lender to do either of these things? In my view, the best way to do it is by a formal motion to dismiss for lack of standing. Part 1 of the Produce the Note series explained that standing is an aspect of subject matter jurisdiction and that if the foreclosing party lacks standing, the court lacks subject matter jurisdiction. If the court lacks subject matter jurisdiction, the case must be dismissed. When a borrower asks the foreclosing party to prove ownership of the debt (or to produce the note if the borrower goes that route), the borrower is really asking the court to dismiss the case because the foreclosing party can’t prove ownership of the debt (or produce the note). Whether the borrower does this informally, by making the request at a court appearance for example, or formally, by filing a written request with the court, the borrower’s request is a motion to dismiss for lack of subject matter jurisdiction. If the borrower chooses to ask the foreclosing party to prove it owns the debt, the borrower should make a formal written motion. The mortgage industry wants to prove standing merely by producing the note and that is all the courts have been requiring. The borrower needs to why producing the note is not sufficient and that requires a written explanation.

One of the best features of the lack of subject matter jurisdiction is that in some jurisdictions, like Connecticut, it cannot be waived or conferred by consent. This means that the borrower can raise it at any time. Other jurisdictions may require the borrower to do something, like raise it as a defense in the pleadings, to preserve the right to move to dismiss later. Assuming the borrower has properly preserved it, or doesn’t have to, the question of when to move to dismiss for lack of subject matter jurisdiction is really a question of strategy in a particular case. It may not be beneficial to do it early in the case when, for example, the borrower is participating in the Foreclosure Mediation Program (CT) or the Foreclosure Settlement Conference Program (NY). The goal of these programs is to modify the mortgage to keep the borrower in the property. They are essentially “court-annexed” programs, which means that if there is no case pending against the borrower, the borrower cannot participate in the program. A successful motion to dismiss will take the borrower out of the program because it results in there being no case. On the other hand, it may be beneficial to do it early in the case when no court-annexed program is available to the borrower as in the case of an investment property. In those circumstances, the borrower might get some leverage in negotiating a workout or modification if the foreclosing party is facing dismissal.

Foreclosure is Not Neccessarily Flipping a Switch

When you took your mortgage loan, you signed a mortgage instrument, which gave the lender an interest in your real estate as collateral for repayment of the mortgage loan. The mortgage instrument normally is called a “mortgage deed” or “deed of trust” depending on the state where the property is located. The mortgage instrument provides that if you do not pay the loan, you are in default. This activates the lender’s right to take the collateral. “Foreclosure” is the process by which the lender takes the collateral.

The steps in the foreclosure process are determined by the state where the property is located. Some states, like Connecticut and New York, are “judicial” foreclosure states. This means that the lender must start a lawsuit against you in order to foreclose. The lender’s goal is a foreclosure judgment. The lawsuit is, for the most part, like any other lawsuit, which is to say that it can take considerable time for the lender to obtain the foreclosure judgment. The borrower has rights that it can exercise as part of the foreclosure lawsuit that can delay the foreclosure judgment or, in some circumstances, stop the lawsuit entirely. This is “foreclosure defense.” So, in Connecticut and New York (and possibly any other judicial foreclosure state) a lender does not foreclose merely by flipping a switch. With proper assistance, the property owner can often retain the property for an extended period.

I frequently use a train analogy to describe the foreclosure lawsuit process. The first stop on the train is the summons and complaint, which starts the lawsuit. The foreclosure judgment is the last stop. There are a number of stops between the summons and complaint and foreclosure judgment. Foreclosure defense is trying to make sure the lender moves as slowly as possible between stops and attempting to insure that the lender makes every stop. Sometimes a borrower can derail the train, which means that the lender has to start the process all over again.

Connecticut and New York have programs associated with foreclosure lawsuits that are designed to help homeowners and lenders achieve a mortgage modification. The programs, in addition to helping with modification, slow the foreclosure lawsuit process. Connecticut’s program is called “Foreclosure Mediation” and New York’s is the “Foreclosure Settlement Conference Program.” Borrowers are admitted to these programs when the foreclosure lawsuit starts.

The foreclosure process is closer to flipping a switch in nonjudicial foreclosure states because the lender does not need to involve the courts. Instead, it follows the procedure set forth in the mortgage instrument, which ordinarily provides the lender the right to sell the property at an auction on a specified number of days notice to the borrower.

Some states provide for both judicial and nonjudicial foreclosures. Click here for RealtyTrac’s state-by-state listing of foreclosure procedures. I don’t know how RealtyTrac calculated the “Process Period” but my experience in Connecticut and New York has been different.