Empty homes: The foreclosure process

Rick Sorrels

Editor’s Note: This commentary is the second in a four-part series on foreclosure and its effects on KP residents.

One out of every 45 homes in Pierce County was in foreclosure in 2010. For the vast majority of us, our home is the most valuable asset we will ever possess.

Very few of us can pay cash for our homes, so a mortgage is needed.  The mortgages are what are being foreclosed. State law controls mortgages. Let's review the process in Washington state.

Prior to 1965, the only type of mortgage available was a "straight" mortgage (house and land used as collateral for a loan), and it was mandatory for the bank to foreclose through a costly and lengthy lawsuit in the courts.

The only real alternative was to purchase through a Real Estate Contract where the title remained in the seller's name until paid in full. This was risky for the buyer, as the contract could be cancelled upon the first missed payment, with the purchaser losing everything invested up to that point with little recourse. Real Estate Contracts are still used occasionally for purchase of unimproved land.

In 1965, the State Legislature created the Deed of Trust statutes (RCW 61.24), which allow the use of a Deed of Trust, which is a three-party mortgage, with the property "conveyed" to the somewhat-independent third-party Trustee with a power of sale to be used only if the mortgage terms are violated. Deeds of Trust are now the norm.

A Promissory Note contains the particulars of the debt and repayment. The Deed of Trust secures that debt with the real property as collateral.

If a default occurs (failure to fulfill mortgage requirements) the Deed of Trust statutes allows the Trustee to sell the secured real property in as few as 120 days, without court intervention. The process is designed to be quick and efficient, but the statutes must be strictly construed in favor of the borrower because the courts are not involved.

The Trustee, however, is not compelled to use the non-judicial foreclosure process. The Trustee can instead opt to use the lengthy and costly judicial process (a civil lawsuit).

The non-judicial process has been the norm. Judicial foreclosures are rarely done.

A judicial foreclosure does allow deficiency judgments. If the property sells at auction for less than the debt owed, the court can enter judgment for the deficiency.

A non-judicial foreclosure does not allow any deficiency judgment, and the property is sold with all junior-ranking liens extinguished. If a senior ranking lien exists, the property is sold "subject to" the existing senior debt.

Extinguishing a junior lien (Deed of Trust) does NOT extinguish the Promissory Note. It just changes from a secured debt, against the property, to an unsecured debt with no collateral.

A potential problem exists if there is more than one mortgage against the same property.  If there is sufficient equity, then the second-place note holder may frequently "buy out" the senior debt in order to protect the security of his interests. If there is no remaining equity, there is no advantage for the junior lien holder to purchase, so the junior note holder loses his security, but can still attempt to collect his debt as an unsecured debt, through a lawsuit or collections action.

With about 95 percent of the homes in foreclosure being "underwater" (greater debt than the home is worth), property owners are tempted to "walk away", expecting all debts to be cancelled. This works sometimes, but the ex-homeowner may find a deficiency judgment or unsecured debts haunting them for decades.

Starting about a decade ago, banking regulations were eased up to allow a greater percentage of home ownership. The banks "qualified" homeowners for mortgages, which they could not really afford. These mortgages eventually turned "toxic", with a huge number of foreclosures following. The downturn in property values multiplied the foreclosure rate.

During this same time period, the banking industry, always on the lookout for new ways to make money, started "bundling" stacks of mortgages into marketable "securities" which they sold to investors as top-rated and no-risk investments, similar to how stocks, bonds, bank notes, certificates of deposit, transferrable shares, and debentures are sold. The "toxic" mortgages in those bundles were ticking time bombs. Federal bailouts followed in order to save the banking and insurance industries from collapse.

The secondary and even the primary mortgage industry became a machine, feeding ever more mortgages into the securities markets. Industry sources estimate that 85 percent of all home mortgages have now been bundled together into security certificates.

A brick wall was hit in 2007 when the courts started ruling against banks, which were foreclosing these securitized mortgages. It turns out that the state laws which govern deeds and mortgages are not compatible with the industry-wide policies practiced by securities managers.

State law requires that holders of interest in land (deed holders) must be real people or corporations, and that the original Promissory Note must be produced by the note holder upon demand.

When the mortgages became securities, the "note holder" became a meaningless bunch of words on a piece of paper, usually boiling down to just a "certificate number". The note holders were no longer "real entities". It has also been reported that bank personnel had celebrated the packaging and sale of bundles of security certificates with bonfires burning the original Promissory Notes.

In 2008 and 2009, the State Legislature amended the Deed of Trust and the Unlawful Detainer statutes to provide more protections for the homeowner. The Trustee must now be more impartial, and the foreclosure process is extended, requiring a mandatory negotiation process between the bank and the homeowner before a Notice of Default can be issued.

The Unlawful Detainer statutes were amended making it very difficult to evict the homeowner if the foreclosure statutes were violated.

In 2010, Rob McKenna, the Washington State Attorney General, joined with other Attorneys General in requesting a moratorium on foreclosures.

On Oct. 13, 2010, our Attorney General sent a letter to those entities who frequently act as Trustees for Deed of Trust foreclosures. McKenna addressed ongoing investigations, continuing violations of the State foreclosure statutes, and requested that the Trustees "Suspend all foreclosures in which you (the Trustees) have not yet confirmed that all foreclosure-related documents were lawfully signed, that the chain of ownership is clear and has been revealed to you in full, and that the state consumer protection requirements have been followed."

McKenna's letter identified some very interesting (and fraudulent) practices commonly occurring, including that "Lenders are 'reverse-engineering' the chain of title, including back-dating documents to make it appear as though the loan was passed from company to company on certain dates when no such assignment actually occurred."

Several bills are before the current Legislature to further amend the statutes. The result: foreclosures are continuing at a record pace, families are displaced, and more homes stand empty now than ever before.

This article was compiled from Washington statutes, state and federal case law, legal treatises, public records, and published news articles.