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Foreclosure Defense

A well-planned foreclosure defense strategy can help you stay in your home or gracefully exit from what has become a bad investment. One of the first things to consider is the current market value of your home. Many homeowners are underwater; their homes are worth less than what they owe. Regardless of whether you want to keep your home or gracefully exit your home, a well-planned foreclosure defense strategy can help you achieve your goals. This is because foreclosure defense is more than simply defending a lawsuit. Armed with the right information, it is possible to create a strategy that works best for your specific situation and goals.

While many attorneys will tell you that the only way to save your home is through a Chapter 13 bankruptcy, this may not always be the case. If you are behind on your mortgage payments, it is possible to get them caught up in a Chapter 13 plan. However, you must be able to afford the “catch-up” payments in addition to your regular monthly mortgage payment. For many homeowners, this is not a workable alternative, nor even advisable on an underwater or break-even property. If your goal is to return your property to the bank with no further liability, then surrendering your property in a Chapter 13 bankruptcy is one option. However, a Chapter 13 surrender does not place the property’s title in the bank’s name. You are still liable for ongoing expenses such as homeowner’s association assessments as long as the property remains in your name.

Fortunately, there are other options. Defending against a foreclosure lawsuit can provide you with a very valuable commodity: time. As the foreclosure crisis deepens, the lifespan of a foreclosure case increases. As of December 2011, the average foreclosure takes 674 days to complete.[i] If you defend against the lawsuit, this timeframe can extend beyond that mark. That additional time is beneficial.

First, you have more time to work out a loss mitigation strategy with your mortgage lender. Obtaining a loan modification can be a lot of work, especially when the lender loses documents or requests information that you have already provided. Extra time eases some of the stress. Also, if your defense attorney is successfully fighting the foreclosure case, your lender may be more likely to work something out with you. A second advantage to additional time is that you may see your financial situation improve over time. This can improve your chances of obtaining a loan modification.

Mortgage Basics

Before digging into the subject of foreclosure defense any further, it is important to understand how a mortgage works. A home loan consists of two parts: the mortgage and the note. The note is also called a promissory note. It states the amount of money lent, what interest rate will apply to those funds, and represents a promise to repay a specific entity (the lender). The mortgage is recorded against the property becoming what is commonly known as a lien or secured lien. The mortgage creates no personal liability. It is the note that creates your personal liability to repay the debt.

In Illinois, the mortgage exists as a lien against your home. You are the legal owner of the title in Illinois. You remain the title owner of the home at all times, even during a foreclosure lawsuit. Your title interest in the home is only terminated by the judicial confirmation of a sheriff’s sale, which happens at the end of a foreclosure lawsuit where the lender is the prevailing party. Even if the lender prevails in the foreclosure lawsuit and sells your home, your liability under the note is not necessarily extinguished by the sheriff’s sale. If the home sells for less than the value of the loan, a deficiency judgment can be entered against you. This is because your obligation to repay the loan is tied to the note and not the mortgage. In many foreclosure defense situations, severing personal liability under the note is a primary goal. Under the Illinois Mortgage Foreclosure Law, lenders have a right to deficiency judgments based on in-hand personal service or abode service. Proper abode service occurs if someone who is a regular resident of the property, who is above 13 years of age, accepts service of the summons on behalf of the person to whom the summons is addressed. The sheriff or process server must also mail a copy of the summons and complaint to the property.

Karl Watson, Oswego, Illinois: The Difference Between a Mortgage and a Note

Karl purchased a home in Oswego, Illinois on August 1, 2006. In order to finance the purchase, he went to Local Prairie Bank to obtain a home loan. The selling price for the home was $300,000. Karl had $60,000 saved as a down payment. Local Prairie Bank lent Karl $240,000 at 7% interest to be paid off over 30 years. At the real estate closing, Karl signed a promissory note. This note represented Karl’s personal promise to repay the $240,000, and also set forth the terms of the loan. Karl also signed a mortgage. The mortgage incorporated the terms of Karl’s promissory note, and secured the value of the promissory note against the value of Karl’s new home. This means that if Karl fails to make the scheduled loan payments, the bank can initiate foreclosure proceedings against Karl’s house. The bank could also directly pursue Karl for the balance of the loan based on the terms of the promissory note. The seller, Sam, executed and delivered to Karl a general warranty deed, which vested title in the property in Karl.

After the closing, the title company recorded the Sam-to-Karl deed with the Kendall County Recorder of Deeds. Shortly thereafter, Local Prairie Bank recorded its mortgage with the Kendall County Recorder of Deeds. Local Prairie Bank’s mortgage functions as a lien against Karl’s property. If Karl attempts to re-sell his property to someone else, a title search will reveal that Karl has an outstanding mortgage on the property. This way, the public is on notice that Karl owns the property, and that the property is subject to Local Prairie Bank’s lien interest. Once Karl pays off his loan, Local Prairie Bank, or the owner of the loan at that point in time, will record a release of mortgage with the Kendall County Recorder of Deeds. This document will release the mortgage lien on Karl’s house. At all times after the closing, Karl is the title owner of his home.

A mortgage is a specific, voluntary lien. It is specific to the piece of property and is voluntary because it was agreed to by the homeowner. A judgment lien is an example of a general, involuntary lien. Judgment liens can be applied against any of an individual’s assets. They are involuntary liens because they are not agreed to, but instead arise by law.

Suppose for a moment that instead of keeping Karl’s loan on its books, Local Prairie Bank sold Karl’s loan to a third party. This would free up the money that Local Prairie Bank lent to Karl, allowing Local Prairie to make another loan. In this scenario, Local Prairie Bank sells Karl’s loan to Bank of New York Mellon, formerly known as Bank of New York. Bank of New York Mellon then deposits the loan into a trust, with Deutsche Bank as the trustee. Once Karl’s loan is part of the Deutsche Bank trust, investors then purchase bonds issued by the trust. These bonds give their holders an interest in the profits generated by every loan in the trust. A more extensive discussion of mortgage securitization can be found later in this document.

Loss Mitigation

A good foreclosure defense strategy will generally involve loss mitigation efforts. Loss mitigation can involve loan modification, but there are other loss mitigation options available to you. In some situations, requesting a deed in lieu of foreclosure or a consent foreclosure may be the best option. Which strategy is right for you depends on your goals.

Loan Modification

Loan modifications are one of the most popular means of loss mitigation. The Making Home Affordable program includes loan modifications under the Home Affordable Modification Program (HAMP). HAMP is probably the best-known program, but lenders and servicers also have in-house programs that are available to those who do not qualify for a HAMP modification. It is important to note that the vast majority of loan modifications do not include principal reductions. If your home is significantly underwater, a loan modification will not necessarily restore equity in your home. However, a loan modification can provide for curing missed payments and lower your mortgage payment. If you are committed to keeping your home, a loan modification may be the right strategy for you, especially if you don’t have any significant other debts.

The Two Types of Loan Modifications: Temporary and Permanent

Temporary (“Trial”) Loan Modifications

It is important to understand the difference between temporary and permanent loan modifications. Generally, before a lender will offer a permanent loan modification, it requires borrowers to enter into a temporary, or trial, loan modification. These temporary modifications are designed to test a borrower’s ability to make payments. Trial modifications are generally 3 months long. They do not change the terms of a loan. Successfully completing the trial period does not guarantee that the lender will offer a permanent loan modification. If a payment is missed, the lender can choose to reinstate the regular mortgage payment amount. It will also charge the borrower fees and penalties for making partial payments during the trial modification period. If a foreclosure lawsuit has been filed against you, a trial loan modification does not stop the lawsuit. A trial loan modification will not cause the lawsuit to be dismissed. If you are not actively defending the foreclosure lawsuit, obtaining a temporary loan modification provides you with little to no legal protection as the foreclosure lawsuit continues. Even when the lender tells you that the foreclosure is on hold, verify that information independently and continue to monitor the foreclosure case. Experience has shown that your adversary in court will not look out for your interests in any way. Their goal is to obtain a judgment for foreclosure of your home and to pursue a personal deficiency against you.

Although they are supposed to be short-term, some borrowers have experienced the “perpetual” trial modification. These “perpetual” trials are essentially multiple trial modification periods that run back-to-back. When a borrower is in a “perpetual” trial modification, it is often because the lender has misplaced paperwork or has taken too long to process the file and needs updated financial information. The longer a trial loan modification lasts, the bigger the penalty assessed against a borrower, especially if a permanent modification is ultimately not granted. If you are in a situation where your lender or servicer has placed you into several trial loan modifications in a row, consult with an attorney to help evaluate your options.

Permanent Loan Modifications

After successfully completing a temporary loan modification, a borrower may be offered a permanent loan modification. A permanent loan modification changes the terms of the loan and may include a reduced interest rate, reduced payments, and other terms. The specific terms of a modification will vary based on the lender and the borrower’s financial situation. It is extremely rare to see lenders write down the loan’s principal balance via a permanent loan modification.

In situations where the mortgage is in default, loan modifications will often cure the default. This is primarily done in one of two ways. The fees, penalties, and other costs resulting from the missed payments are added to the outstanding loan balance, or they are “tacked on” to the end of the loan. When the default is “tacked on” to the end of the loan, the fees, penalties, and other costs associated with the missed payments are set aside as their own loan balance. This balance is not charged interest, but must be paid off. The balance will be paid off at the end of the loan’s lifetime, when the property is sold, or when the loan is refinanced. Even if a loan modification significantly reduces your monthly payment, it may extend the term of your loan. In other words, the time it will take to pay off your mortgage is extended. If your goal is to ultimately own your home free and clear, a loan modification may delay the realization of that goal.

A permanent loan modification will stop a foreclosure lawsuit. Once the permanent loan modification is granted, the missed payments are considered cured. Since the loan is no longer in default, the foreclosure lawsuit cannot proceed forward. This is because the default that triggered the lawsuit no longer exists. Do not assume that simply because a permanent modification has been offered, the case will automatically be dismissed. If you do not receive the loan modification documents, sign them, and return them, the lender will likely assume that no modification exists. Quite simply, if there’s no paperwork, assume that there is no modification. If you are offered a permanent loan modification, but don’t receive the papers, contact an attorney to discuss your options.

Making Home Affordable Programs

Making Home Affordable (MHA) is administered by the Departments of the Treasury and Housing and Urban Development (HUD). It includes several programs aimed at providing qualifying homeowners with different types of assistance. Although HAMP is the best-known program, there are other programs that can help homeowners refinance their loans, seek alternatives to foreclosure, modify second mortgages, refinance underwater mortgages, and provide relief for unemployed and underemployed homeowners. MHA also includes the Hardest Hit Fund, which provides targeted financial assistance to the housing markets most heavily affected by the foreclosure crisis.

Home Affordable Modification Program (HAMP) [ii]

HAMP is by far the best-known and most-maligned of the MHA programs. Although the government had projected that HAMP would assist millions, its early implementation was poorly-planned. After several revisions to the program’s guidelines, HAMP remains as a viable option for homeowners seeking a loan modification from a lender that is participating in HAMP. The MHA website has a list of every lender that is participating in HAMP.[iii] It can be found here: http://www.makinghomeaffordable.gov/get-started/contact-mortgage/Pages/default.aspx. If you have a government-sponsored loan like a Veterans’ Administration, Fair Housing Administration, or USDA loan, you may also qualify for special HAMP programs.

Homeowners are eligible for HAMP if: 1) they are seeking a loan modification for their primary residence; 2) if the mortgage loan was obtained prior to January 1, 2009; 3) if their mortgage payment is greater than 31% of their pre-tax income; 4) if the balance of the loan is under $729,750; 5) if a financial hardship exists[iv] and they are either delinquent on payments or in imminent danger of falling behind; 6) if they have sufficient, documented income to support mortgage payments; and 7) if they have not been convicted of various mortgage and tax-related crimes. Many people believe that they must be several payments behind to qualify for HAMP. This is absolutely untrue. If a representative from your mortgage servicer tells you that you must be in default to qualify for HAMP, then your servicer may be in violation of current HAMP guidelines.

HAMP modifications can cure missed payments by adding them onto the balance of your mortgage. It can also result in reduced monthly payments. These reduced payments can be the difference between an affordable mortgage and one that is destined to fail. Although HAMP guidelines also allow principal reductions, very few servicers offer principal reductions as part of a HAMP modification. As with most loan modification programs, there is a three-month trial period before a permanent loan modification is issued.

While it is possible to obtain a HAMP modification on your own, many homeowners seek assistance with the application process. This is because it can take many hours on the phone with a servicer’s employees and repeated document submissions to get a file ready for review. A successful HAMP modification will also end any foreclosure lawsuit pending against you because a permanent loan modification cures any missed payments that triggered the lawsuit.

Second Lien Modification Program (2MP) [v]

If your primary mortgage was successfully modified via HAMP, your second mortgage may also be modifiable under the Second Lien Modification Program. The criteria for modifying your second mortgage are similar to those for HAMP. As an added requirement, you cannot have three consecutive missed payments on your HAMP modification. The program expires on December 31, 2012.

As of January 1, 2012, only seventeen servicers currently participate in this program. They are: Bank of America, N.A.; BayviewLoan Servicing, LLC; CitiMortgage, Inc.; Community Credit Union of Florida; GMAC Mortgage, LLC; Green Tree Servicing, LLC; iServeResidential Lending, LLC; iServeServicing, Inc.; JPMorgan Chase Bank, N.A.; NationstarMortgage, LLC; OneWest Bank; PennyMacLoan Services, LLC; PNC Bank, N.A.; PNC Mortgage; Residential Credit Solutions; ServisOne Inc., dba BSI Financial Services, Inc.; and Wells Fargo Bank, N.A.

Home Affordable Foreclosure Alternatives Program (HAFA) [vi]

The Home Affordable Foreclosure Alternatives Program is designed to provide homeowners who cannot afford to keep their homes with viable alternatives to a mortgage foreclosure. HAFA assists homeowners with securing a short sale or a deed in lieu of foreclosure. If your mortgage is backed by Freddie Mac or Fannie Mae, or if your servicer is a HAMP participant, HAFA is available to you as well. Although Illinois has its own deed in lieu of foreclosure, the HAFA version is useful for homeowners who do not live in a state that recognizes the remedy. Most attractive about HAFA is the HAFA short sale. Unlike a traditional short sale, a HAFA short sale completely satisfies a borrower’s personal obligation to repay the loan. If your home is underwater, a HAFA short sale allows you to sell your property and not be faced with a balance due on your mortgage loan.

In order to qualify for HAFA, you must have been in your home for over 12 months and have not purchased a new house in the last 12 months. You must be able to demonstrate a financial hardship. HAFA is only available for loans that were originated prior to January 1, 2009. If you are unsure whether Fannie or Freddie backs your loan, you can find their loan lookup tools online.

To determine whether Fannie Mae owns your loan, go to: http://www.fanniemae.com/loanlookup/. To determine whether Freddie Mac owns your loan, go to: https://ww3.freddiemac.com/corporate/.

Home Affordable Refinance Program (HARP) [vii]

The Home Affordable Refinance Program is available to borrowers who are current on their payments, but cannot find a refinance loan because their homes are underwater. Fannie Mae or Freddie Mac must own or guarantee your loan, and must have acquired the loan on or before May 31, 2009. The loan to value ratio for your home must be greater than 80%. This means that if your loan balance is at $75,000, and your home is worth $100,000, your loan to value ratio is at 75% and you are not eligible for a HARP refinance. If your loan balance is $125,000 and your home is worth $100,000, your loan to value ratio is 125% and you are eligible for a HARP refinance. The HARP refinance program also requires that borrowers have no missed payments in the last 6 months prior to applying and only 1 missed payment in the last 12 months. Refinancing while underwater is normally impossible, so this program offers a benefit in that regard. A HARP refinance will not lower your principal balance. If your home is severely underwater, a HARP refinance only makes sense if you are committed to keeping your home regardless of whether it has negative equity. In that case, HARP can help you secure a lower interest rate for the long-term.

FHA Short Refinance [viii]

Refinancing while underwater is very difficult, if not impossible. If your loan is not backed by Fannie, Freddie, the FHA, the VA, or the USDA, you may be eligible for an FHA Short Refinance. If you are eligible for a new loan under the FHA’s underwriting requirements, you may want to ask your mortgage servicer whether it participates in the FHA Short Refinance program. Participation in this program is entirely voluntary, so your servicer may not participate. In addition to qualifying for a FHA loan, you must be underwater, you must be current on your payments, and your total debt cannot exceed 55% of your monthly pre-tax income. If your servicer participates and you are eligible, the refinance loan must write down your first mortgage to no more than 97.75% of your home’s current value.

Home Affordable Unemployment Program (UP) [ix]

If you are unemployed and eligible for unemployment benefits, the Home Affordable Unemployment Program may be able to reduce your mortgage payments to 31 percent of your income or suspend your mortgage payments for 12 months or longer. Like the rest of the MHA programs, this program is only available for your primary residence. If you received a HAMP loan modification, you are not eligible for this program. If Fannie Mae or Freddie Mac owns or guarantees your loan, you are not eligible for this program, although both companies offer their own unemployment forbearance programs.

Other Loss Mitigation Methods

Deed In Lieu of Foreclosure

If you are not interested in keeping your home, or if you realize that your home is so far underwater that it will take years to see positive equity, you may be eligible for a deed in lieu of foreclosure. In Illinois, the deed in lieu of foreclosure is a remedy created by the Illinois Mortgage Foreclosure Law (IMFL).[x] It may be used before a foreclosure lawsuit is filed. It is also available once a lawsuit has been filed. If a lender accepts a deed in lieu of foreclosure, the homeowner literally deeds the property to the lender. In exchange, the lender waives the right to pursue the homeowner for any deficiency amount. A deficiency is the difference between the current market value of the home and the current balance of the mortgage loan.

While a deed in lieu is a powerful remedy, they are not frequently granted. Most lenders will not accept a deed in lieu if there is a second or third mortgage on the property. This is because the lender would be taking the property subject to the junior mortgages – it would not be obtaining free title to the property. In order to resell the property, it would have to pay off the other mortgages. Similarly, if there are other liens against your home such as judgment liens or mechanic’s liens, the lender will require that you cure those liens before accepting a deed in lieu. In addition to that requirement, lenders will commonly require you to list your home for sale for a period of 90 days and provide financial documentation that establishes you have a valid hardship. Being underwater is not necessarily a financial hardship unless other circumstances help establish that a hardship exists. It is not possible to force a lender to accept a deed in lieu of foreclosure – it must be agreed to by both parties.

In some situations, a lender may send you an IRS Form 1099 reflecting the amount of the deficiency. In the past, this would have been considered taxable income as cancelled debt. However, if the home was your primary residence, and the value of the loan was under $2 million ($1 million for married couples filing separately), then this type of income is not taxable through December 31, 2012,[xi] pursuant to the Mortgage Forgiveness Debt Relief Act of 2007[xii].

Whitney and Bart Smith, Naperville, Illinois: A Sample Deed In Lieu of Foreclosure

Whitney and Bart Smith own a home in the DuPage County portion of Naperville, Illinois. They purchased their home in 2007 for $750,000. It is now worth $450,000 and they owe $600,000. When they purchased the home, both Whitney and Bart were both engineers for Tellabs and had a combined household income of $200,000 a year. In mid-2010, Bart was laid off. They managed to make their mortgage payments by tapping into their savings account when Whitney’s income fell short. In early-2011, Whitney was also laid off. By then, Bart had found a replacement job, but only making half of his previous income. The couple continued to make their mortgage payments by tapping into their dwindling savings. In the summer of 2011, they decided that they were throwing good money after bad. They listed their home for sale, but had no luck finding a buyer. They finally asked their lender for a deed in lieu of foreclosure. After submitting their financial paperwork and demonstrating their economic hardship, their lender agreed to a deed in lieu of foreclosure. Whitney and Bart got a specific move-out date from the lender, and the lender avoided the costs of taking the property through the foreclosure process. The lender also waived its right to collect a deficiency, giving Whitney and Bart some clarity and peace of mind. This kind of certainty is the luxury of the informed.

Consent Foreclosure

If your lender has already filed a foreclosure action against you, the IMFL provides an additional remedy: the consent foreclosure.[xiii] A consent foreclosure is just what it sounds like. In exchange for the lender agreeing to waive any deficiency, you consent to a judgment of foreclosure being entered against your property. Title to the property vests in the mortgagee without conducting a sheriff’s sale. Unlike a deed in lieu of foreclosure, this remedy is available even if you have multiple liens against the property. So long as those lien holders do not object to the consent foreclosure, the procedure has the effect of voiding those liens. However, the consent foreclosure does not terminate any personal liability on the debts that correspond with any junior liens.

At one point in time, a simple letter to the lender’s attorneys was all that had to be done to secure a consent foreclosure. Some lenders are now requiring that borrowers list their home for 90 days and that they submit financial documentation before the lender will accept a consent foreclosure. As is the case with many loss mitigation strategies, defending against the foreclosure in state court is a key component to making a consent foreclosure work. Some lenders will realize that litigating the foreclosure will take a long time and agree to the consent foreclosure to cut their own expenses.

Kelsey Adams, Chicago, Illinois: A Sample Consent Foreclosure

Kelsey Adams owns an investment property in the Lincoln Park neighborhood of Chicago, Illinois. When he purchased the property, a 4-unit brownstone, he had four tenants who paid their rent on time. As the economic crisis deepened, two of his tenants quit paying their rent, forcing him to default on his mortgage payments. Kelsey also owns his own home, and he was forced to prioritize his income on making the mortgage payments on his primary residence. Both properties are underwater. The investment property is now in foreclosure. Kelsey’s attorney sends a letter to the lender’s attorneys requesting a consent foreclosure. Within 45 days, the lender accepts Kelsey’s offer and sends a set of stipulations to Kelsey’s attorney for Kelsey’s signature. The stipulations are agreed-upon facts that establish the statutory requirements for a consent foreclosure. Kelsey executes the stipulations and returns them to the lender’s attorney. 45 days later, Kelsey’s attorney appears in court when the consent foreclosure judgment is entered. The judgment vests title to the property in the lender, and Kelsey enjoys the certainty of knowing that he is not liable for any deficiency on the property. He has managed to rid himself of a failed investment and can comfortably make the mortgage payments on his primary residence. Since the property is not Kelsey’s primary residence, Kelsey will want to consult with a CPA to determine what, if any, tax liability he may incur. Had the property included Kelsey’s primary residence, his potential tax liability would have been waived so long as the consent foreclosure was to be completed before December 31, 2012.

Short Sale

Some defense attorneys will tell you that a short sale is a great idea. Some will tell you that it is a terrible idea. The truth is usually somewhere in the middle. A short sale does not necessarily provide you with protection from a deficiency. In a short sale, the deficiency is the difference between the selling price of the house and the balance of your mortgage loan (or loans). In some situations, borrowers must bring cash to the closing table just to get the money returned to the lender up to a level that the lender will accept.

Additionally, short sales offer very little predictability or certainty. A potential buyer may walk away if the bank drags its feet accepting the buyer’s offer. Sales can fall through because the bank simply will not approve the sale price. It may be that the buyer cannot obtain financing due to a low appraisal value, among other reasons. At the end of the day, a short sale is probably the least efficient means of loss mitigation, but it can be rather lucrative for attorneys and realtors. Furthermore, the conflicts of interest that are inherent in most short sale transactions are unsettling. Typically, the seller pays the fees of all the parties involved. However, in your typical short sale, the realtor and attorney’s fees are paid by the lender. The seller has less control over the transaction and, as a result, is exposed to less predictable, unsatisfactory outcomes.

Foreclosure Defense Strategies

Defending a residential foreclosure in Illinois involves more than simply replying to a complaint and going to trial. As with most situations that affect your personal finances, the best solution for you may not be the best solution for someone else. It is important that you make an informed decision after considering all of your options. Done properly, litigation is a powerful element of loss mitigation. This section offers a deeper discussion of the interplay between loss mitigation and litigation.

Litigation and Loss Mitigation

Many homeowners who want to keep their homes but aren’t good bankruptcy candidates choose to fight their foreclosure case in court while pursuing a loan modification or another loss mitigation strategy. This approach can be effective in two different ways.

Stu Martin, Belvidere, Illinois: Seeking A Loan Modification

Stu fell behind on his mortgage payments after being laid off from his job of 10 years at the Chrysler Assembly Plant in Belvidere, Illinois. Stu has recently found a new job, and is making slightly less money than he was at his previous job. Stu’s house is not significantly underwater, and he wants to keep his home. By defending his foreclosure case in court, which is his constitutional right, Stu will buy himself more time to obtain a loan modification. Since his income is only slightly less than it was before, he may have a good chance of getting a modification. If his lender refuses to offer a loan modification for any reason, Stu still has several possible safety valves: a Chapter 7 bankruptcy, a deed in lieu of foreclosure, or a consent foreclosure. While none of those options will save his home, they will both eliminate his potential liability for a deficiency in the future. Stu may also qualify for a Chapter 13 bankruptcy, which could save his home if he can afford to make monthly plan payments.

Amy Collins, Addison, Illinois: Chapter 7 Bankruptcy and Foreclosure Defense

Amy’s home in Addison, Illinois, is worth 25% less than the value of her mortgage. She is currently employed as a nurse at a local urgent care clinic. Amy has missed some mortgage payments, but is not actively in foreclosure. She realizes that she will likely lose her home and, given that the home is so deeply underwater, she does not have any real financial benefit to keeping the property. Amy’s house has two mortgages, so she is not a good candidate for a deed in lieu of foreclosure. She would have to settle the second mortgage before being approved for a deed in lieu of foreclosure. Amy has children in school and would like to remain in her children’s school district for as long as possible.

Amy has two main options for pursuing a foreclosure defense strategy. Amy’s income is within the limit for passing the means test, so she is eligible for a Chapter 7 bankruptcy. She has some unsecure debts that she could discharge and, like the vast majority of Americans, does not have any significant assets other than her cars and retirement fund. Filing a Chapter 7 bankruptcy will help Amy get rid of her debts and will sever her personal liability under the note, which would remain secured against her home by her mortgage. If her lender then files a foreclosure lawsuit against her, she is protected from any deficiency judgment that may arise. Her credit has also started to improve because the Chapter 7 bankruptcy discharge has forced her lender to stop reporting her mortgage as delinquent. More importantly, two years after her discharge, Amy may be eligible to purchase another home with a Federal Housing Administration loan.[xiv] With the FHA’s lower interest rate and superior terms, she will have a better opportunity to pay off her mortgage. Paying off a mortgage as soon as possible is a critical goal of an informed borrower. Working to pay interest is never advisable, but that is what many Americans unwittingly do each day.

If the lender files a foreclosure action Amy now has options. She can ignore the lawsuit and begin looking for somewhere else to live. Even an uncontested foreclosure case can take a year to complete, so she has a great deal of time. If Amy wants to extend her time in the home, she can fight the foreclosure lawsuit. Defending a foreclosure significantly extends the time it takes a lender to complete the case, and may even result in the case being dismissed. If Amy’s income increases or if she changes her mind, she may even be able to obtain a loan modification and remain in the home. Filing a Chapter 7 does not eliminate Amy’s chances of obtaining a loan modification. No matter what she decides, she will have zero personal liability for the debt after her Chapter 7 discharge is granted. This kind of predictability is invaluable in a foreclosure situation and is one of the luxuries of being informed.

Foreclosure Defenses

Many people think that a foreclosure case is a simple matter. The assumption is that if the homeowner failed to make payments, then the bank wins. In reality, foreclosure cases aren’t that simple. The current foreclosure crisis has exposed many problems with the foreclosure process and homeowners typically have valid defenses against a foreclosure lawsuit. These defenses can cause a case to be dismissed. Here is a sampling of some of the most common defenses. Keep in mind that as the law develops, new defenses arise and some older defenses may not be as applicable. Moreover, every judge is different. In Illinois, there is no right to a jury trial in a foreclosure lawsuit, so the outcome of a specific defense is largely based upon a specific judge and whether he or she is convinced by the argument.

Lack of Standing

This specific defense is by far one of the most effective defenses to a foreclosure action. Long ago, most homeowners knew their loan officer. This is because loans used to be originated, held, and serviced by the same bank for the life of the loan. In the modern mortgage lending industry this is almost never the case. The lender whose name is on the note and mortgage may not be the entity that brings the foreclosure lawsuit. Illinois state law requires that the plaintiff in a lawsuit have a legitimate interest in the case. When a plaintiff does not have a legitimate interest in the case, the plaintiff lacks the standing to sue. A plaintiff that lacks standing cannot bring a lawsuit, and the case must be dismissed. Additionally, a plaintiff must have standing from the moment it files the lawsuit. If a plaintiff gains standing to sue during the pendency of the case, but after the date of filing, the case must be dismissed. In that instance, the plaintiff is free to re-file the lawsuit, but the case must be restarted from scratch. Some common standing issues are discussed below.

A Brief History of U.S. Mortgages

In the past, most homeowners borrowed the money to purchase their home from a local bank. The bank issued a short-term loan with a balloon payment at the end of the loan’s lifetime. Some loans were for as short as 5 or 10 years. The longest-term mortgages were 15 year mortgages. After the Great Depression, the government created the Federal Housing Administration in 1934 to help repair the damaged housing economy. Another entity that helped transform mortgage lending was the Home Owners’ Loan Corporation, which was established in 1933. Both agencies helped transition the mortgage market into 15 and 30 year fixed-rate mortgages, which were seen as a superior alternative to the balloon-payment mortgages that had been popular before the Great Depression.

In general, banks kept mortgage loans on their books as a liability, and balanced those liabilities by keeping enough assets on hand to cover all but the most catastrophic losses. This meant that once a lender had issued a certain amount of loans, it was unable to issue more loans without acquiring extra capital. Some banks would sell their loans to the secondary market, thus freeing up funds for issuing more loans. This secondary market allowed banks to sustainably lend money to homeowners for quite some time. Midway through the 20 ^th century, some of the first mortgage-backed securities were issued. However, federal regulations kept the number low and limited the types of mortgages that could be securitized.

As time went on, regulations were lifted and more lenders got into the business of issuing mortgage-backed securities. The system worked well for a while, but further deregulation and the desire to keep increasing profits eventually led to the housing boom that preceded the 2008 collapse.

Mortgage Securitization Issues

One of the main causes of the financial crisis was the failure of mortgage-backed securities. Mortgage-backed securities are intended to be long-term, stable investments. Many mutual funds, pension funds and other investment vehicles buy mortgage-backed securities as part of their overall portfolio. These securities are supposed to be stable because the risk of loss is spread across a large pool of mortgage loans. If one homeowner defaults and the property goes into foreclosure, it does not destroy the entire pool. A mortgage pool that contains a large number of high-risk or subprime loans is a different matter. When many loans in a pool default, the value of the mortgage-backed securities plummets.

During the housing boom, mortgage lenders were securitizing the vast majority of the loans that were issued. However, many of these loans were poorly underwritten – the borrowers were given a loan that they could not afford, often without any documentation to support their financial status. Lenders pushed to create these loans to provide more mortgages for the securitization process. Since it is possible to increase profits by keeping overhead low, many mortgage lenders cut corners in order to maximize profits. In a perfect world, a mortgage-backed security trust would be properly established and funded. In the real world, many of these trusts were not.

A typical mortgage security trust involves several parties. The parties and their respective duties are defined by a document called the Pooling and Servicing Agreement (PSA). At the beginning of the chain is your original lender. This could be a small mortgage lender or a major bank. In securitization terms, this person is called the Seller. The Seller originates the loan and then sells it, for value, to another entity called the Sponsor. The Sponsor then sells the loan, for value, to a third entity called the Depositor. The Depositor then transfers the loan into the trust. This chain is necessary because mortgage-backed securities must be “bankruptcy remote.” If the original lender goes bankrupt, the subsequent sales of the loan insulate it from being repossessed by a bankruptcy trustee. A typical PSA requires that each stage of this process is documented in writing and that the original documents all make it into the trust before its closing date.

In theory, loan securitization is a simple process that merely involves lots of paperwork. During the real estate boom, this process was generally mismanaged and did not work as intended. In fact, in 2010, an employee of BAC (Bank of America/Countrywide) testified in open court that Countrywide loans were never properly handled when they were securitized.[xv] Instead of sending the original documents to the trustee, Countrywide held those documents in its warehouse. If her testimony is true for every Countrywide loan, then trusts holding those loans do not actually hold the loans. This is because, by law, a trust cannot take actions that are outside the powers granted to the trust by the trust documents. Since PSAs require that the trust or its document custodian[xvi] have actual possession of the original loan documents by the trust’s closing date, a trust that is not in possession of the original loan documents by the closing date cannot own the loan.

This presents an interesting problem for trusts that are attempting to foreclose on a home. If the trust cannot demonstrate that it was in possession of the original documents pursuant to the terms of its PSA, then it does not own the loan. If the trust does not own the loan, it cannot enforce the mortgage or the note against the homeowner. In that situation, the trust does not have standing to sue and the foreclosure case should be dismissed. Depending on the documents that the trust attaches to its complaint, your foreclosure defense attorney should be able to make an initial determination as to whether this defense is available to you.

A Mortgage Loan in Orland Park, Illinois: An Example of Mortgage Securitization

Local Prairie Bank issues as many loans as it possibly can issue without over-extending itself. Local Prairie Bank regularly sells its loans to Midwest Mortgage Holding, LLC in order to free up available capital for issuing new loans. Midwest Mortgage Holding, LLC then sells large packages of loans to National Bank Depositor LLC, which is a subsidiary of National Bank Mortgage Trusts, N.A. National Bank Depositor LLC conveys each package of loans into separate securitization trusts. Each trust is governed by its own Pooling and Servicing Agreement. For example, a loan issued by Local Prairie Bank in June of 2007 became a part of NBMT Asset-Backed Securities Trust, Series 2007-3. This way, if Local Prairie Bank becomes insolvent, there are two “true” sales in between Local Prairie Bank and the securitization trust. This all but eliminates the risk of a bankruptcy trustee clawing back loans into Local Prairie Bank’s bankruptcy estate. Bankruptcy trustees are impartial third parties tasked with overseeing bankruptcy cases. They have very broad powers designed to protect the assets of a bankruptcy filer (also known as the bankruptcy estate). Those powers include, among others, recovering assets that were sold shortly before a bankruptcy filing.

National Bank Mortgage Trusts, N.A. assigns its servicing rights in the mortgage loans to American Loan Servicing, Inc., which collects mortgage payments from homeowners and remits the payments to National Bank Mortgage Trusts, N.A. for distribution to the holders of the mortgage securities. So long as each entity in the chain followed the terms set forth in the Pooling and Servicing Agreement, the securitization trust properly owns the loans it holds and should be a stable, long-term investment.

Show Me the Note

At the beginning of the foreclosure crisis, the “show me the note” movement began. If the party attempting to foreclose on your home is not your original lender, demanding to see the original note is an essential tactic and a valid defense to foreclosure. If the party attempting to foreclose on your home is your original lender, you still want to demand that the original note be produced for inspection. What’s the big deal about the original note? Only the original note can be enforced against a borrower. Notes are negotiable instruments. A negotiable instrument is a type of financial document that can be transferred from one party to another. This transfer generally involves signing it (indorsement) and then delivering the original to the new owner. Other examples of a negotiable instrument would be a personal check or a twenty dollar bill. No bank will cash a photocopy of a check, and nobody in their right mind would give someone two tens for a photocopied twenty. This is because only the original document has any value. The same goes for notes associated with home loans.

When you are being sued by a party that is not your original lender, the stakes are even higher. The plaintiff must demonstrate more than mere possession of the original note. The original note is payable only to one party – the original lender. In order to be enforceable by anyone else, the note must bear indorsements that either name a new party as the payee of the note or that make whomever holds the original note the payee. These are known as special and blank indorsements. If you indorse the back of your paycheck, you have just created a blank indorsement. By indorsing the check and not naming a specific payee, your indorsement converts the check to what is known as “bearer paper.” If you drop your check on the ground, whoever finds it can cash it. If, instead, you indorse the back of your paycheck and write, “Pay to the order of Bob Smith,” then only Bob Smith can cash the check because it is now specifically payable to him. This type of indorsement is sometimes referred to as “order paper” because it is payable to the order of the named individual. As with the original note, a photocopy of a note with indorsements is insufficient. The original document must bear the indorsements in order for the indorsements to be valid. Additionally, even if the note is indorsed, it must still be delivered to the new owner, otherwise, the indorsements have no true effect. This process is known as negotiation.

A Lockport, Illinois Property: An Example of Why “Show Me the Note” is Powerful

Let’s say that in 1998 you purchased a home in Lockport, Illinois and took out a mortgage loan with Chase Bank. During the time you owned the home, you received a letter from MahnaMahna Mortgage Company, Inc. informing you that it was the new owner of your home loan. Being a responsible person, you began making your payments to MahnaMahna as requested. Years later, in 2010, you fell behind on your mortgage payments. After several missed payments, you received a knock at the door and were served with a summons by the Will County sheriff. The summons listed Washington Morgan Chase Bank as the plaintiff and indicated that it was a summons in a foreclosure action. Attached to the summons was a complaint with two exhibits. One of those exhibits was a copy of the note you executed in 1998. The note has no signatures on it besides your signature. In that situation, you would want to demand to view the original note. You’d also want to assert that, based on the face of its documents, Washington Morgan Chase Bank lacks the required standing to bring the foreclosure lawsuit. Unless Washington Morgan Chase Bank can demonstrate that it was in possession of the original note, which was either indorsed in blank or indorsed as payable to Washington Morgan Chase Bank, at the time it filed its lawsuit, it lacks the required legal standing to bring the lawsuit. Since a party must have standing on the date that it files its lawsuit, Washington Morgan Chase Bank can likely file a new lawsuit if it actually has standing. However, its current lawsuit must be dismissed as a matter of law. This is the heart of a solid standing defense.

If you are considering hiring an attorney to defend your home from foreclosure, make sure to ask whether that attorney is familiar with both mortgage securitization and standing issues in general. This area of law is constantly developing. For instance, some attorneys are now arguing that a home loan note cannot be transferred by indorsement and a change in physical possession. Although this argument has its merits, it is currently untested in Illinois and goes against the “common understanding” of most judges and attorneys.

Failure to Accelerate/Failure to Satisfy A Condition Precedent

Before a lender can initiate a foreclosure lawsuit against you, it must take certain steps to notify you of your default and that you are subject to foreclosure. This obligation may be imposed by state or federal law, but is also contained in almost every mortgage. In most mortgage documents, this obligation is stated in paragraph 22. The notice must be provided in the format described in the mortgage. If you received a notice that did not comply with the mortgage’s terms, or if you did not receive any notice at all, your lender cannot bring a foreclosure action against you. Most mortgages and notes are the same. Many are Fannie Mae/Freddie Mac Uniform Instruments and are designed to keep terms consistent from loan-to-loan. In general, the lending industry uses form documents to keep loan terms consistent. This is also known as “boilerplate” language. The reason loan terms are kept consistent is to facilitate the sale and negotiation of the loans. Some mortgages and notes are exceptions to the rule, the terms contained in the standard paragraph 22 may be in paragraph 18 or paragraph 23. This is why attention to detail is an important quality for a foreclosure defense attorney.

This mortgage clause is one of the few clauses in the mortgage that protects you as a borrower. The vast majority of a mortgage’s language is designed to protect the bank’s interests, not yours. However, because this clause is contained in almost every mortgage, it is considered a “condition precedent” to filing a foreclosure lawsuit. In simpler terms, a bank must give you an opportunity to catch up on your missed payments before proceeding with a foreclosure lawsuit. Even if your lender insists that it properly notified you, it may not be able to properly document that it provided this notice. In that case, it is as if the notice was never provided. A mortgage foreclosure lawsuit is serious business, and you should make your lender dots every “i” and crosses every “t” if it is going to attempt to foreclose on your home.

Setoff

This defense alleges that you are owed money by the bank or that the bank has improperly applied your payments. While this defense does not necessarily defeat a lawsuit, it can offset the amount of money that the bank claims that you owe. This is particularly useful if you are trying to exercise your right of reinstatement or redemption. If you believe that you have a claim for setoff, inform your foreclosure defense attorney so that he or she can explore the issue for you.

Chet Jackson, Glenview, Illinois: An Example of a Setoff Claim

Chet always paid his mortgage on time. When he had extra money, he would make a pre-payment against his loan’s principal balance by sending a separate check with a letter indicating that he was making a pre-payment. Pursuant to the terms of his promissory note, this was sufficient to ensure that the bank was properly applying his prepayments towards his principal balance. In total, Chet pre-paid $45,000 towards his loan’s principal balance over the course of 4 years. His goal from the time he took the mortgage was to pay it off as quickly as possible. In late-2010, Chet was laid off from his position with the U.S. Department of Education, where he monitored student loan providers for 15 years. Although he was able to make mortgage payments with a combination of his unemployment benefits and savings, Chet soon ran out of savings and was forced to default on his mortgage.

When he was served with a foreclosure summons and complaint, Chet hired a seasoned foreclosure defense attorney. After reviewing the complaint, Chet and his attorney noticed that the amount due alleged in the complaint was significantly higher than it should be. Chet provided his attorney with his mortgage statements from the past five years. After carefully examining the statements, it was evident that his lender had not been properly or accurately applying his pre-payments towards principal, but was instead applying those payments towards interest. In his answer to the foreclosure complaint, Chet asserted the $45,000 in pre-payments as a setoff against the total amount owed. Had his payments been properly applied, Chet would have a significantly lower amount of money to pay in order to redeem his loan. Given that Chet had been paying his mortgage on time for a long time, and given the equity in his home, Chet was able to refinance his loan to a lower interest rate with better terms and avoid foreclosure.

Constructive Contract/Promissory Estoppel

This defense is often used when a lender attempts to foreclose on your home while you are making payments pursuant to a trial or permanent loan modification agreement. As many homeowners who have tried to obtain a loan modification know, the loan modification process is often confusing and poorly managed. You may be offered a trial modification over the phone, begin making payments, and never receive the actual documents that memorialize the trial modification. The same thing often happens for borrowers who have been offered a permanent loan modification. Another common occurrence is being kept in a perpetual trial modification. A typical trial modification is supposed to last three months. If you have been in a trial modification for a longer period of time, you may be able to claim that the bank’s failure to convert you to a permanent loan modification is a breach of your agreements with the bank.

Trial loan modifications do not typically guarantee that you will receive a permanent loan modification. They do not permanently change the terms of your loan. However, a bank’s actions and the statements of its employees can potentially change this. For example, if you have been making trial loan modification payments for 18 months, and the bank’s employees keep assuring you that your permanent modification is “coming soon,” you may be able to claim that a contract exists between you and the bank.

Even if you do not have a written agreement, an oral agreement may be sufficient to modify your loan. If you relied on the bank’s statements and fully performed your obligations, a contract exists by operation of law. This is what is known as a constructive contract or promissory estoppel. If you believe that this issue applies to your case, inform your attorney so that he or she can evaluate the issue.

Morgan Gibson, Plainfield, Illinois: A Constructive Contract Claim

As the financial crisis deepened, Morgan, a marketing executive, realized that he could no longer afford his adjustable rate mortgage loan. He contacted his lender and requested that he be considered for a HAMP loan modification. Morgan’s lender informed him that he was not eligible for a HAMP modification, but that it would put him into an in-house trial loan modification program. If Morgan made three trial payments on time, and his financial status had remained stable, he would be offered a permanent loan modification. Morgan followed the lender’s instructions and made his three timely trial payments. After he made his third payment, Morgan contacted his lender to find out whether he would be offered a permanent loan modification. His lender informed him that he would receive a permanent loan modification with payments beginning in the next month. Morgan was instructed to send a check for $50 to cover the cost of overnight delivery of his permanent modification documents.

Morgan sent his check to the lender, but never received his permanent loan modification documents. Morgan was afraid that if he didn’t start making his new payments on time, he would not be offered another modification. His lender assured him that the documents were on their way. When the first payment became due, Morgan made it. Morgan continued to pay the modified loan payment for over a year. He was literally horrified when, 13 months after making his first payment, he received a foreclosure summons and complaint. The complaint alleged that Morgan was in default on his mortgage payments from the beginning of his trial modification some 16 months earlier. Morgan explained the situation to his attorney, who filed an answer to the complaint with affirmative defenses and counterclaims, asserting Morgan’s constructive contract with his lender. Although Morgan had never executed his permanent modification documents, the fact that his lender continued to accept his payments without notifying him of a problem was evidence that Morgan and the lender had entered into an oral, yet permanent, loan modification agreement.

Rescission

This defense is based on the federal Truth In Lending Act (TILA). Under the Act, lenders are required to provide specific disclosures to borrowers either before the loan closes or at closing, or both, depending on the notice. For example, when you are refinancing the loan on your primary residence, you are entitled to receive two copies of a document called the “Notice of Right to Cancel.” If you don’t receive two copies, or if the notices do not comply with the suggested format, there has been a violation of TILA. Normally, you only have three days to rescind your loan. If your lender violates TILA, however, you have three years to rescind your loan.

So what is rescission? Quite simply, rescission is the process of unwinding the loan and returning the borrower and the lender to where they were before the loan was issued. In practice, the remedy is a bit different. The statute establishes an order of performance in a TILA rescission. Once the loan has been properly rescinded, the bank must release the mortgage and return any payments to the borrower. The borrower is then supposed to return the funds that the bank lent. A courts is free to modify this tender strategy if fairness dictates that it should. The effect of the broad equitable power to modify tender has been the subject of much of the case law related to TILA rescissions. As the law continues to evolve and develop, this remedy may be strengthened or weakened. In the meantime, it is always important to have your attorney evaluate your loan documents and determine whether you have a potential claim under TILA.

Rob and Linda Madison, Crystal Lake, Illinois: A Basis for Rescission

Rob and Linda are a married couple. Rob is a general contractor and Linda teaches high school English. They refinanced their home’s mortgage two years ago. At the closing, Rob and Linda were provided with two copies of the Notice of Right to Cancel. The loan was taken out only in Rob’s name, but Linda signed the mortgage to waive her homestead rights. In Illinois, homestead rights are created by statute and protect up to $15,000 of the value of a person’s primary residence from liens. Most mortgage lenders require that borrowers waive these rights to make foreclosing on a mortgage easier. Based on these facts, Rob and Linda were not provided with the right number of copies of the Notice of Right to Cancel. TILA requires that every person with an interest in the property be provided with two copies of the Notice. Even though Linda was not personally obligated to repay the loan, the fact that she signed the mortgage entitled her to receive two copies of the Notice in addition to the two copies Rob should have received. Since their lender failed to provide enough copies, Rob and Linda have a three year right to rescind their loan. This provides Rob and Linda with a means of unwinding the loan, which can place them in a stronger bargaining position with their lender.