August 18, 2017

The Myth of the “Free House”

This is a great post by Katie Porter and I fully agree with her on every point. I have this discussion on a regular basis with people on all sides of this issue. First, homeowners who signed a note and borrowed money don’t deserve a free and clear house. They may even achieve that on rare occasions but they don’t deserve that. Katie is right on and her point is based on logical reasoning…. the borrower signed a note, someone has the right to the payment of that note. There is an entity that is the real party in interest. Dismissing a foreclosure case filed by a servicing institution against a homeowner does NOT in any way, give the homeowner a free and clear house. The security instrument is still a lien on the property and, like Katie discusses, the issues can be corrected in the future and the case can be re-filed.

If the bank or servicer or trustee commit fraud in the process of trying to foreclose, they deserve every sanction they get for that which could and maybe should include the extinguishment of the deed of trust or mortgage. That’s for the court and jury to decide, case by case.

But this soap box argument that dismissing a foreclosure case or finding in favor of the homeowner or against the servicer is NOT the same as giving the homeowner a free and clear house. Let’s just be clear and be able to articulate this point when in court and this issue comes about because it is this exact sentiment that I believe causes judges to skew their rulings because they truly think their ruling will amount to a “free and clear” house.


The Free House Myth
posted by Katie Porter on

As challenges to whether a “bank” (usually actually a securitized trust) has the right to foreclose because it owns the note and mortgage become more common, rumors swirl about the ability to use such tactics to get a “free house.” There are a few instances of consumer getting a free house, see here and here, for examples, but these are extreme situations not premised on ownership, but on a more fundamental flaw with the mortgage. In general, the idea that even a successful ownership challenge will create a free house to the borrower is an urban myth. I’ll explain why below, but there is a policy point here. The myth of the free house drives policymakers to complain about the moral hazard risks of holding mortgage companies to the law and tries to set up homeowners who are paying their mortgages against those who are not. It serves the banks’ political agenda to be able to point to the “free house” as an obviously unacceptable alternative of consumers winning legal challenges. It’s key then to understand that the “free house” is largely a creature of consumers’ and banks’ over-active imaginations.

In sorting out why even a successful ownership challenge does not give homeowners a free house, it is helpful to parse some key concepts. The first one is standing, which is the right of a party to ask a court for the relief it seeks. This comes in different flavors, including constitutional standing, but in the foreclosure context, usually boils down to whether the moving party is the “real party in interest.” In re Vealthe recent decision from the 9th Circuit BAP authored by Judge Bruce Markell, mentioned previously onCredit Slips , contains a discussion of standing in the foreclosure context. At least in part, the concern of the real party in interest doctrine is to make sure that the plaintiff is the right person to get legal relief in order to protect the defendant from a later action by the person truly entitled to relief. Note that standing is a concept that only applies in court; here that means in judicial foreclosures. In states that allow non-judicial foreclosure, the issue is slightly different. Does the party initiating the non-judicial foreclosure have the authority to do so under the state statute authorizing the sale? For example, cases such as In re Salazar discuss whether a recorded assignment of the mortgage is needed, as opposed to an unrecorded assignment, to initiate a foreclosure. Under either standing or statutory authority, a “win” by the homeowner leads to the same result. The foreclosure cannot proceed.

But this win is not the same as a free house. Just because a party lacked standing or statutory authority does not mean that there is not some party out there that does have the authority to foreclosure. Nor does a win on standing mean that there cannot be action taken to give the initial foreclosing party the authority that they need, which might occur by transferring possession of the note or by executing a series of assignments, to foreclose at a later date. Unless other problems exist, there is still a valid note that obligates the homeowner to pay money due and there is still a mortgage encumbering the house. The homeowner does not get a free house. Rather, the homeowner just doesn’t lose her house today to foreclosure. These are pretty different outcomes!

This doesn’t mean that I think the standing/ownership issue is inconsequential. For homeowners, a successful challenge that results in the dismissal of a foreclosure can lead to a loan modification or the delay itself can give the homeowner the time to find another solution. For investors in mortgage-backed securities, the problems with paperwork likely increase their loss severities in foreclosure, both because of increased litigation costs and because of delay in correcting problems. (And there may be even more serious problems for investors relating to whether the transfers even succeeded in putting the homes in the trust.) But we shouldn’t confuse these issues with the idea that what is at stake in sorting out this mess is giving a “free house” to some Americans, despite the lamentations of this LaSalle Bank lawyer after a judge ruled that LaSalle as trustee lacked standing to foreclose. A fruitful discussion of these issues needs to begin with a clear understanding of the consequences of the problem, as well as empirical evidence on how widespread these problems are. The free house is political handwringing, not legal reality.

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