Homeowners are faced with foreclosure due to many causes. Job loss, medical emergencies, divorce and many other events can result in the inability to keep payments current on a home loan. Once a homeowner starts to fall behind on a home loan, it becomes increasingly difficult to catch up. Loan servicers add late payment fees when loan payments are not made on time and if a foreclosure proceeding is actually started, thousands of dollars in additional amounts must be paid by the homeowner to stop the foreclosure process. The cost of foreclosure to the homeowner is not just measured by loss of investment in the real estate, families are disrupted by foreclosure and it is one of the many causes of divorce.
Oregon, and many other states have laws that allow a lender to foreclose a home loan without filing an action in court. In Oregon, most home loans are secured by a deed of trust. If the loan goes into default, the trust deed can be foreclosed in two ways. The secured lender may either use the traditional method of judicial foreclosure or may ask the trustee to foreclose the loan non-judicially.
Oregon law allows a trust deed to be foreclosed in court as if it were a mortgage. When foreclosed as a mortgage, a complaint is filed in court by the lender as the plaintiff and if the lender prevails the court will order a sale of the property. The delinquent borrower must either pay the balance due in full before the foreclosure sale or the house will be sold to the highest bidder by the county sheriff. After the sheriff’s sale the homeowner has 189 day to redeem the property by paying the amount the high bidder paid at the sale plus certain other costs. However, it is much easier and less expensive for the lender to foreclose a trust deed by non-judicial means.
Many states, including Oregon, permit foreclosure of a trust deed by advertisement and sale. If a borrower defaults on a home loan, the lender must first give reasonable notice of the default, then if the homeowner fails to bring the loan current, a notice of default is recorded by the trustee who holds title for the benefit of the lender. The notice of default and a notice of sale is then served on the homeowner as well as other interest holders in the property. The notice of sale specifies a date and place when and where the trustee will conduct a public sale of the property. The date of proposed sale must be at least 120 days after the date the notice is served on all interested parties. Until five days before the sale, the homeowner has the right to bring the loan current and have the sale cancelled. The sale must be conducted in the place and at the time specified in the notice and it must be open to the public. On the date of sale, if the loan has not been brought current, the trustee or someone hired by the trustee will announce that the property is to be sold or can give notice that the sale will be adjourned to a later date. If the sale is conducted, the property will be sold by auction to the highest bidder for cash. Once the sale is over, the homeowner can be given a 10 day notice to leave the property or be subject to eviction by the sheriff. There is no right to redeem the property and the homeowner loses all rights in the property.
While non-judicial foreclosure is less expensive for the lender, homeowners have limited options to object when there is a dispute over the default or over charges claimed by the lender. A borrower must go to court, pay a filing fee and post a bond to stop a non-judicial foreclosure in state court. A bankruptcy filing is another way to stop the foreclosure but it can have major consequences for the borrower.
Home loans have become a complicated financial arrangement. At one time, a loan was made by a bank or savings and loan association. The lender would collect payments and monitor the performance of the borrower. When the loan was fully paid, the security arrangement would be cancelled and title to the house would be transferred to the homeowner free of any interest of the lender. If the borrower had problems making the payment the lender would discuss the situation and could either modify the loan terms or hold off on foreclosure to give the borrower a chance to bring the loan current. In small towns, the lender often had a personal relationship with the borrower and knew when the default was caused by a temporary situation that could be remedied by forbearance and knew when foreclosure was the only reasonable option. The problem with this arrangement was that demand for home loans grew faster than the lending resources of most commercial banks and other lenders.
Modern home loans involve many parties. Even if the loan is originated by a local bank, once the loan is made and the transaction is closed, the loan is quickly transferred to a wholesaler or aggregator. This way the bank can make a profit on the fees charged to put the loan together and perhaps sell the loan at a profit, is able to recover its money to lend to another borrower and faces little or no risk of loss in the event the borrower defaults.
Home loan payments are now collected by a loan servicer. The originator of the loan may continue as the servicer or may transfer the responsibility for servicing the loan to another company. However, the loan servicer is seldom the owner of the loan. The loan has been sold by the originator to the wholesaler, and the wholesaler then collects a group of loans of the same type and characteristics together and sells them to an investment bank.
The investment bank generally does not hold the loans for long itself. The loans are transferred into a trust established for investment purposes. Various interests in the trust are sold to investors. While the investment bank may continue to own some interest in the investment trust, many other investors are now involved and have various types of interests to protect.
Some of the investment trusts are established and guaranteed by agencies of the federal government such as the Federal Housing Administration (FHA) or the Veterans Administration (VA). Others are established and guaranteed by what are known as “Government Sponsored Enterprises”. (GSE) The two largest and best known GSEs are the Federal Home Loan Mortgage Corporation (”FHLMC”), normally referred to as Freddie Mac, and Federal National Mortgage Association (”FNMA”), nicknamed Fannie Mae. In 2008 those two GSEs were responsible for guarantee of nearly four trillion home loans. While the GSEs were for a time without formal US government backing, late in 2008 they ran into financial trouble and were essentially nationalized by the government.
Because so many parties with are involved in modern home loans, it has become very difficult for a defaulting borrower to work out a solution when a problem arises and payments fall behind. The only contact for the homeowner is the loan servicer. The servicer is responsible for collecting and accounting for payments but does not usually own the loan. The actual owner is a trust that is in turn owned by various investors with differing rights and interests. Not only do multiple investors own the loan, they own hundreds of other loans in the same trust. It has become very difficult to bring all of the parties to the table for a meeting.
Just as the way home loans are made has changed greatly, so has the type and complexity of home loan changed. Fifty years ago home loans were made with a large down payment and relatively standard payment terms. Most home loans required at least a 20% down payment by the borrower and the interest rate was fixed for the term of the loan, usually 30 years. Loans were only made to borrowers with good credit who could show a history of regular income. The monthly loan payments, including property taxes and insurance could be no more than about 35% of the borrower’s gross household income. This type of loan is now called a “Prime” loan.
Over the years the home loan business became enormously profitable. Literally billions of dollars in profits were made by the companies involved in the loan process, from originators to wholesalers to the investment bankers on Wall Street who packaged the loans and sold them to investors. Consequently, new loan products were invented so that loans could be made to borrowers who did not qualify for Prime loans. Two other general categories of borrowers were established, Alt-A loans and Subprime borrowers.
Alt-A borrowers have good credit but cannot measure up to the exacting standards of a Prime loan. Often, Alt-A borrowers would normally qualify for prime loans but lack sufficient documentation to meet the more exacting underwriting standards of that portfolio. An Alt-A borrower might have income from several different sources that may be difficult to adequately document. In situations where the borrower has no paycheck stubs or other normal documentation, income can be “stated” by the borrower and verified for Alt-A loan purposes with copies of tax returns or bank statements.
Subprime makes up the other non-prime category of borrowers. These borrowers do not have great credit. While subprime does not have a specific credit rating dividing line, most subprime borrowers have credit scores under 680. Other things may put a prospective borrower in the subprime category such as two or more loan payments in the last 12 months that were 30 days late, or at least one loan payment within the last 36 months that was 90 days late. Judgments, a prior foreclosure, a repossession, or non-payment of a loan in the past would place a borrower in the subprime category as would a bankruptcy filing in the previous 5 years.
While most prime loans have relatively low fixed interest rates and a 30 year amortization, the Alt-A and subprime loans often have very different terms. These non-prime loans often have adjustable interest rates, balloon payments, exotic payment terms that can lead to dramatic increases in payment and other, less consumer friendly aspects. Frequently, these loans have a low initial fixed interest rate that lasts for two or three years and then changes to an adjustable rate with a hefty increase for the remaining term of the loan. These loans are called 2/28 and 3/27 loans where the first number refers to the period of low fixed rate interest and the second number refers to the higher floating rate period.
Loan originators sold the 2/28 and 3/27 loans to borrowers with the promise that, if they made their payments on time, the loan could easily be refinanced before the interest rate increased. While home values were on the increase, this was often true. Once the housing market began to stagnate and values declined, it became impossible to refinance even when the payment history was excellent.
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