With mortgage practices under fire on Capitol Hill and across the country, a federal court in Cleveland has now turned up the heat on lenders with a remarkable decision: Homeowners can’t be foreclosed unless loan owners actually go to court.
At first this may seem unimportant. After all, when a home is financed doesn’t a lender own the loan? And if a borrower doesn’t pay shouldn’t the lender have a right to foreclose?
It turns out that the first question is not so simple. A large proportion of the institutions that we see as “lenders” don’t actually own the loans they make. Instead, they create loans and then sell them to issuers. The issuers package the loans to create mortgage-backed securities (MBS) and those securities are then sold to investors worldwide. The investors, in turn, are represented by a trustee.
That means, according to a ruling by federal judge Christopher Boyko of the U.S. District Court in Ohio, that many foreclosures cannot proceed because the actual loan owners are not the lenders that originally issued the loans — even though the names of those original note holders continue to appear in official records.
Before someone can lose their home in a foreclosure a plaintiff must prove that it’s actually the loan owner. In more than a dozen Ohio foreclosure cases Deutsche Bank said it owned various notes and mortgages. However, Boyko found in each case that the paperwork actually identified the original lenders as the loan owners and said nothing about Deutsche Bank.
The problem is that the original lenders who created the loans — the lenders listed as the loan owners in public records — were not seeking to foreclose. Instead, it was Deutsche Bank that was taking homeowners to court and Deutsche Bank, said Boyko, had no grounds to foreclose because it did not own the loans or have any authority to foreclose.
Given that borrowers make monthly payments and that the money ultimately goes to those who own the mortgages, the Boyko decision seems odd. Aren’t the loan owners the ones getting the monthly payments?
It used to be that if you wanted a mortgage you went to a local lender such as a savings & loan association or a commercial bank. The lender actually owned the loan.
However, the system changed with the development of the “secondary” market. Now local lenders could sell their loans to investors around the country. Big institutions, such as Fannie Mae and Freddie Mac, would buy local loans, but only if those loans met certain standards. The loans that could readily be sold on the secondary market were called “conforming” mortgages because they conformed to the requirements established by Fannie Mae and Freddie Mac.
With the secondary system a local lender could make loans, sell those mortgages, replenish its capital with the money it got from selling, and then make more loans. More loans meant the lender could generate more fees and charges. More loans also meant more money was available for local loans, and that helped lubricate the local housing market.
Within the secondary market Fannie Mae, Freddie Mac and others would create securities backed by mortgages. Those securities would be sold to investors worldwide. The securities sold well because home mortgages were believed to represent little risk and because Fannie Mae and Freddie Mac made certain guarantees. Since Fannie Mae and Freddie Mac were “government-sponsored enterprises” that could borrow directly from the U.S. Treasury, many investors thought mortgage-backed securities were just about risk-free.
Fannie Mae and Freddie Mac are not the only ones packaging mortgages, however. Wall Street firms got into the act and began accepting loans that did not meet conforming loan standards — mortgages with little down, loans with “nontraditional” terms and super-sized “jumbo” loans that neither Fannie Mae nor Freddie Mac would buy.
In the past few years it would not be uncommon for a lender to put up capital to fund a loan. The loan would be marketed to borrowers by a mortgage banker or a mortgage broker who, essentially, was a salesman for the lender. To borrowers, the mortgage broker or the mortgage banker was their “lender,” however that was not usually the case. Instead, the loan was typically sold by the original lender to an “issuer” and borrowers would make payments to a “servicer.”
The actual owner of the loan at this point was not the original lender, not the mortgage broker, not the mortgage banker nor the servicer or the issuer. Why? When the loan was sold to the issuer, the issuer took that one mortgage, packaged it with other loans, and created a private-label mortgage-backed security (MBS). In effect, the issuer sold the loan to the holders of the mortgage-backed security.
But those who invest in the MBS do not actually own the loan either. They have, perhaps, an “equitable interest” in the sense that they are entitled to interest from the mortgage payments and a return of their capital when the loan is sold, paid off or foreclosed.
However, it could be that a single loan might wind up in several loan pools, each with a different level of investor risk — more risk would hopefully produce a higher level of return. Or, it could be that a loan is in one pool today and another pool tomorrow.
In such circumstances, as lawyers might ask, who is the real party in interest, the party who actually owns the loan?
“This court acknowledges the right of banks, holding valid mortgages, to receive timely payments,” said Boyko. “And, if they do not receive timely payments, banks have the right to properly file actions on the defaulted notes — seeking foreclosure on the property securing the notes. Yet, this court possesses the independent obligations to preserve the judicial integrity of the federal court and to jealously guard federal jurisdiction. Neither the fluidity of the secondary mortgage market, nor monetary or economic considerations of the parties, nor the convenience of the litigants supersede those obligations.”
In other words, a borrower can only be foreclosed when the actual owner of the loan goes to court. In the cases seen by Boyko, the paperwork said the loan owners were various banks, not the trustee for the owners of a mortgage-backed security.
What does it all mean?
First, the Boyko decision could be stayed or over-turned by higher courts. It may have no standing in other districts. It could also be voided with new laws from Congress.
While no one can predict how courts may rule, help for lenders, trustees and MBS investors from Washington is unlikely. The politics of the time — with an estimated two million homeowners facing foreclosure this year — make assistance from Capitol Hill improbable, regardless of PAC contributions.
Second, Judge Boyko asked a simple question: If a borrower fails to pay their mortgage then who is hurt? It’s not the original lender because they sold the loan. It’s not servicers because they do not have title to the mortgage. It may not be an individual trustee if a single mortgage has been used to support several mortgage-backed securities. Lastly, since mortgage-backed securities can be sold with electronic speed, it may not be the investor who held a stake in one particular MBS 10 minutes ago.
If the Boyko decision spreads to other districts and courtrooms, then issuers will have to tie specific loans to particular mortgage-backed securities. In the same way that real estate titles are recorded in official records, a similar system will be needed for loan documents. Such a system will support investor claims when borrowers default, but at the same time such a system will also prevent unjustified foreclosures and forfeitures.
“Given the huge stakes in this matter, everyone benefits by knowing who actually owns individual loans,” says James J. Saccacio, chairman and chief executive officer of RealtyTrac, the leading online marketplace for foreclosure properties. “There’s no doubt that some foreclosures can be avoided if only borrowers and loan owners communicated at the earliest possible moment. For such a situation to arise the name of the loan owner has to be disclosed in a way that’s easily accessible to borrowers, disclosure which is not common today.”
Columnist Peter G. Miller is the author of The Common-Sense Mortgage and is syndicated in more than 100 newspapers.