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   ARTICLE   |   From Scotsman Guide Residential Edition   |   July 2014

Courts Cast an Eye on Mortgage Lending

Take a closer look at recent trends in foreclosures and related litigation

Courts Cast an Eye on Mortgage Lending

Sharp declines aren’t usually indicators of positive news — that is, unless you’re talking about the national foreclosure picture. Recent trends in foreclosure statistics are declining, and a number of beneficial court decisions have been handed down nationwide, good signs for an industry that’s seen its share of turmoil in the last few years.

As always, however, the mortgage arena is constantly evolving, and it’s a good idea for mortgage bankers to keep themselves in the loop. What’s defined the foreclosure picture as of late, and which court decisions demand particular scrutiny? As far as foreclosures goes, this past year was a sight for sore eyes in many respects. To cite just one example of good news, 87 of the top 100 metropolitan areas showed declining foreclosure rates this past year, according to CoreLogic. One major contributor to this downward trend was a national delinquency rate of 6.39 percent at the end of this past fourth quarter, the lowest level since the first quarter of 2008, according to the Mortgage Bankers Association.

There’s still a long road to recovery ahead, however, as the current national delinquency rate is still significantly higher than the 1.5 percent to 2 percent rate that was common in the 1990s. The following primer on recent foreclosure trends and the judicial decisions that may affect them is important to consider.

National Trends

Since the financial crisis began in 2008, nearly 4.9 million foreclosures have been completed, according to CoreLogic. As of this past January, about 794,000 homes were in some stage of foreclosure, a year-over-year decrease of 33 percent and the 27th consecutive month of year-over-year declines. Zooming in on this trend, during this past January alone, there were 48,000 completed foreclosures in the United States, down from 59,000 in January 2013.

Interestingly, five states, including four in the Northeast (Connecticut, New Jersey, Maine and New York), led the United States this past January in terms of having the largest foreclosure inventory. These inventories ranged from 3.4 percent (Connecticut and Maine) to 6.4 percent (Florida) as a percentage of all mortgaged homes, according to CoreLogic. This past January, every state posted a double-digit decline in foreclosures year over year.

Conspicuously, almost 75 percent of loans currently in foreclosure were originated between 2004 and 2008, according to RealtyTrac. Moreover, 37 percent of all outstanding mortgages in the United States that are not in foreclosure were originated between 2004 and 2008, representing almost 14 million loans. As many originators already know, this was a time period of particular vulnerability for so-called toxic loans. Also, nearly 88 percent of these loans have an interest rate of 6 percent or higher, which indicates that these homeowners have not pursued refinances and may be vulnerable to defaults in the foreseeable future.

Of course, rising home prices in most areas will help, as will steady job growth and various government programs. Still, rising interest rates may counteract some of these benefits, and many of these loans will end up in foreclosure in the next few years.

Legal Developments

Current statistics only tell a small part of the foreclosure story, however. Judicial foreclosure states continue to struggle in terms of working through their foreclosure backlogs. There’s also been a recent spike in contested foreclosures and lender-liability claims, which has created a bottleneck effect across the country.

This will require that savvy bankers, brokers and other mortgage professionals keep a watchful eye on the courts, which in turn will help them stay informed and prepared for the impact of new laws, regulations and pivotal cases working their way through the appellate process. With strained judicial resources and a large amount of complex “problem cases” still left, the remainder of this year promises to be another active period in foreclosure law. Nonetheless, several recent court decisions have shaped a judicial landscape that will help level the playing field for mortgage lenders.

Because of the widely publicized nature of cases against banks involving robosigning in 2011 and 2012, many defaulting borrowers will preemptively challenge a foreclosing lender’s standing, based on a claim that the lender relied on this unlawful practice in the given case. In Newman v. Bank of New York Mellon, however, the court granted a defendant’s motion and dismissed the complaint after finding that claims of robosigning as to mortgage assignments were irrelevant to whether or not the bank had standing to foreclose.

In addition, many defaulting borrowers have asserted that a loan servicer, as opposed to the loan originator, lacks the standing required to bring an action for foreclosure. Nevertheless, in J.E. Robert Co. Inc. v. Signature Properties LLC, the Connecticut Supreme Court upheld the authority of a mortgage loan servicer to commence and prosecute foreclosure action in its own name. Similarly, in Acosta v. Fannie Mae, a Texas Federal Court upheld the ability of a servicer to foreclose.

On the other hand, in Federal Home Loan Mortgage Corp. v. Schwartzwald, the Ohio Supreme Court joined other courts that have refused to allow banks to foreclose if they cannot prove by written evidence at the time of foreclosure that they have a legal right to foreclose. The court’s ruling suggests that a bank may not be able to foreclosure if it cannot provide proof that it owns the rights to the mortgage and/or the loan’s note. This ruling left several unanswered questions, however, particularly with regards to whether or not the lender can use alternate evidence to prove its property rights and with regards to how a borrower can clear a title to a property that appears to still be encumbered by a mortgage.

Industry professionals would be wise to also consider two recent decisions that have demonstrated judicial treatment of foreclosure actions are likely to implement a heightened focus on substantive issues of law rather than overemphasizing minute technical details. In U.S. Bank National Association v. Guillaume, for instance, the New Jersey Supreme Court permitted a foreclosure action despite faulty procedures. It applied the equitable doctrine of substantial compliance to allow a bank to foreclose regardless of its failure to include the name and address of the actual lender on the notice of intent to foreclose (as required by state law). Also, in Buchanan v. HSBC Mortgage Services, the Indiana Court of Appeals held that, under Indiana code, an assignment was valid when endorsed to HSBC in blank and absent of any evidence of a lack of authority on the part of the signatory.

Finally, mortgage originators should take note of California’s enactment of its Homeowner Bill of Rights, which went into effect in January 2013. Among other things, it prohibits banks from proceeding with foreclosures if the homeowner is seeking a loan modification, and it requires the bank to act on qualified applications for loan modifications. It also calls for a single point of contact and provides penalties for lenders that record and file unverified documents.

What to expect

With the combined impact of promising statistics and several pivotal judicial decisions, the rest of this year is likely to yield more contested litigation as complex cases are initiated and move through the system.

Although overall foreclosure numbers are down, these numbers are somewhat deceiving, because the implementation of mediation programs and other obstacles placed in the way of foreclosing lenders by the courts have delayed the progress of foreclosure actions in many jurisdictions. Further, the presence of a substantial number of pre-2008 loans not yet in foreclosure coupled with the delay in processing older foreclosure cases will likely lead to increased litigation.

Mortgage professionals should also note that there’s been a marked increase in affirmative claims from borrowers involved in foreclosure and lender-liability litigation. Borrowers seeking to avoid foreclosure who are unable or unwilling to pay lender-demand notes have increasingly looked to obscure statutes and motion practice to thwart foreclosure. Their claims are often based on property-preservation claims, mortgage-release issues, wrongful-foreclosure lawsuits, and purported violations of the Truth in Lending Act, Real Estate Settlement Procedures Act and Fair Debt Collection Practices Act.

It’s also worth mentioning that title issues are on the rise, as refinances in recent years and a lack of subordination agreements create priority issues. In addition to equitable subordination, equitable subrogation and reformation issues caused by sloppy lending practices are cropping up more and more frequently. Several indicators point to an increased reliance on mediation, new legislation, more settlements and judicial clarity from the high courts.

In the short term, industry observers and professionals should expect more loan sales and service transfers, as bad debt is sold and the market for troubled loans continues to expand. The most prudent approach for the long term will involve keeping a close eye on the constantly changing judicial landscape, as it adapts to continuing fallout from the era of toxic loans and offers useful precedent for efficiently addressing the increased waves of foreclosure litigation that are certain to roll in throughout this year. 


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