747
Chapter 31
Mortgages and Foreclosures
after the Recession
See Separate Lecture Outline System
INTRODUCTION
Mortgage rates are at historic lows. Homes are affordable for many people who could not have afforded them before the
Great Recession. But the number of foreclosures is on the rise and mortgage fraud is becoming increasingly common.
Sometimes, this fraud occurs in the refinancing market, where homeowners may turn to find the funds to pay their mortgages.
Sometimes, the fraud can occur during the sale of a home.
the recession.
ADDITIONAL RESOURCES—
VIDEO SUPPLEMENTS
The following video supplements relate to topics discussed in this chapter—
PowerPoint Slides
To highlight some of this chapter’s key points, you might use the Lecture Review PowerPoint slides compiled for
Chapter 31.
CHAPTER OUTLINE
I. Mortgages
An individual who buys real property typically borrows the funds from a financial institution to pay for it. A mortgage is
a written instrument that gives the creditor an interest in, or a line on, the property as security for the payment.
ADDITIONAL BACKGROUND—
The Sale of Real Estate
Transfers of ownership interests in real property are frequently accomplished by means of a sale. The sale of real
estate is similar to the sale of goods, because it involves a transfer of ownership, often with specific warranties. In the
sale of real estate, however, certain formalities such as the execution of a deed are observed that are not required in
the sale of goods.
Several steps are involved in any sale of real property. The first step is the formation of the land sales contract. A
title search (to verify that the seller has good title to the property and that no other claims to the property exist)
follows, along with, usually, negotiations to obtain financing for the purchase. The final step is the closing.
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estate agents are information brokers. They provide buyers and sellers of real estate with information and specialize in
matching the wants of buyers with the property being offered for sale by sellers. The broker is usually retained by the
seller and acts as the seller’s agent in the sale of the property. As compensation for their services, brokers usually
Generally, a broker may not act as an agent for more than one party without the consent of all parties involved. (There
and the first broker to produce a buyer receives the commission. In an exclusive listing, the seller contracts with just
Sales Contract. Generally, when someone decides to purchase real estate, he or she makes a written offer to
purchase the property and puts up earnest money to show that an earnest, or serious, offer is being made. (If the
offeror decides to withdraw the offer, the earnest money, or deposit binder money, will often be forfeited to the
seller.) The offer states in some detail the exact offering price for the property and lists any other conditions that may
be appropriate. The offer may be conditioned on the offeror’s ability to obtain financing, for example. Within a
specified time period, the seller of the property either accepts or rejects the offer. If the offer is accepted, then a
percent of the purchase price paid to the seller. The buyer can then add to the existing earnest money to bring it up to
Deposits toward the purchase price normally are held in a special account, called an escrow account, until all of the
conditions of sale have been met and the closing takes place, at which time the money is transferred to the seller. The
escrow agent, which may be a title company, bank, or special escrow company, acts as a neutral party in the sales
transaction and facilitates the sale by allowing the buyer and seller to close the transaction without having to exchange
documents and funds. An escrow agent is an agent of all of the parties involved in the sales transaction. When a
conflict between the parties results in conflicting duties on the part of the agent, normally the agent will have a court
resolve the conflict.
Sometimes, an arrangement is made in which a potential buyer is given the right to purchase property in the
possibly buying it in the future will have such a clause added to the lease contract. This right means that the lessee, or
escrow agent, title insurance company, or lending institution from which the purchase price is being borrowed) will
begin the title examination, which entails examining at the county recording office the history of all past transfers and
sales of the property in question. The title examiner will generally obtain an abstract from a private abstract company.
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This document lists all the records relating to a particular parcel of land. After reading the abstract, the examiner will
payments are not made, the trustee can deed the property to the lender or dispose of it by auction, depending on state
law.
There are numerous ways of financing the purchase of real property, some of which are quite creative.
Frequently, financing is obtained through a conventional long-term mortgage loan in which the payment schedule
extends over a period of twenty-five to thirty years. Traditionally, the interest rate for long-term loans was fixed—that
buyer will pay, say, 10 percent of the price as a down payment and make periodic (usually monthly) payments to the
If the mortgage terms allow for prepayment privileges, then the borrower can prepay the mortgage before the
maturity date without penalty. Prepayment privileges may be especially important if market interest rates fall below
the interest rate of the mortgage loan—in which case the loan could be refinanced to the advantage of the borrower.
An amortization schedule shows what portions of each monthly payment on a loan-term loan, such as a mortgage
loan, go to the interest and to the principal on the loan, respectively. In the first several years of the loan, the
Closing. The final step in the sale of real estate is the closing—also called settlement or closing escrow. The
of the specific costs that must be paid at the closing.
Warranty of Habitability. The common law rule of caveat emptor (“let the buyer beware”) held that the seller of a
home made no warranties with respect to its soundness or fitness unless such a warranty was specifically included in
the deed or contract of sale. Although caveat emptor is still the rule of law in a minority of states, there is currently a
strong trend against it and in favor of an implied warranty of habitability. Under this new approach, the courts hold
discover them. Currently, in many jurisdictions, courts have placed on sellers a duty to disclose any known defect such
as a rotted roof that materially affects the value of the property and that the buyer could not reasonably discover.
Under these circumstances, nondisclosure is similar to representing that the defect does not exist, and the buyer may
have grounds for a successful lawsuit based on fraud or misrepresentation.
A. TYPES OF MORTGAGES
1. Fixed-Rate Mortgages
2. Adjustable-Rate Mortgages (ARMs)
The interest rate on an adjustable-rate mortgage changes periodically. The rate may begin relatively low and
3. Interest-Only (IO) Mortgages
4. Subprime Mortgages
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5. Construction Loans
6. Participation Loans
A participation loan gives the lender a percentage of revenue, rental income, or resale income from the
7. Balloon Mortgages
8. Hybrid and Reverse Mortgages
A hybrid mortgage starts as a fixed-rate mortgage and converts into an ARM. A reverse mortgage pays an
existing homeowner for the equity in a home. The reverse mortgage is repaid when the home is sold.
B. HOME EQUITY LOANS
Home equity is the portion of a home’s value that is not subject to a mortgage. As a loan is paid, equity accrues. A
home equity loan is secured by this amount, which can be seized if the loan is not repaid. A home equity is
subordinate to a mortgage loan.
C. CREDITOR PROTECTION
Creditors can protect their interests through—
• Private mortgage insurance—if the debtor defaults, the insurer reimburses the creditor for a portion of the
loan.
ADDITIONAL BACKGROUND—
Basic Types of Recording Statutes
Recording statutes are in force in every jurisdiction. Their purpose is to provide prospective buyers with a way to
check whether there has been an earlier transaction. Hence, recording a deed gives constructive notice to the world
that a certain person is now the owner of a particular parcel of real estate.
There are three basic types of recording statutes—
• Race statutes provide that the first purchaser to record a deed has superior rights to the property, regardless
of whether he or she knew that someone else had already bought it but had failed to record the deed.
• Pure notice statutes provide that, regardless of who files first, a person who knows that someone else has
already bought the property cannot claim priority.
1. Statute of Frauds
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2. Important Mortgage Provisions
Terms may include—
• Loan terms—the amount, the interest rate, the period of repayment, and others.
• Provisions for the maintenance of the property.
• A statement obligating the borrower to maintain homeowners’ insurance.
II. Real Estate Financing Law
Congress and the Federal Reserve Board impose disclosure requirements and certain prohibitions on lenders to protect
borrowers from improper lending practices.
A. PREDATORY LENDING AND OTHER IMPROPER PRACTICES
• Predatory lending practices that occur during the loan origination process include failing to disclose terms,
providing misleading information, and lying.
• Steering and targeting occurs when a lender manipulates a borrower into a loan that benefits the lender but
B. THE TRUTH–IN-LENDING ACT (TILA)
The Truth-in-Lending Act (TILA) of 1968 requires lenders to disclose the terms of a loan in clear, readily
understandable language so that borrowers can make rational choices. In real estate transactions, TILA applies
only to residential loans.
1. Required Disclosures
Disclosure must be made on standardized forms and based on uniform formulas. Certain loans—ARMs,
reverse mortgages, open-ended home equity loans, and high-interest loans—have special requirements. For
all loans, terms that must be disclosed include—
2. Prohibitions and Requirements
Prepayment penalties cannot be charged on most subprime mortgages and home equity loans. A lender
cannot coerce an appraiser into misstating the value of property on which a loan is to be issued. A loan
cannot be advertised as fixed-rate if its rate or payment amounts fluctuate.
a. Right to Rescind
A mortgage cannot be finalized until seven or more days after a borrower receives TILA paperwork. A
borrower has the right to rescind a mortgage within three business days (Sunday is the only non–
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C. PROTECTION FOR HIGH-COST MORTGAGE LOAN RECIPIENTS
The Home Ownership and Equity Protection Act (HOEPA) of 1994 amended TILA to create a special category of
high-cost and high-fee mortgage products. Rules for the loans are in Regulation Z (enacted by the Federal Reserve
Board to implement TILA). The rules apply to loans for which—
1. Special Consumer Protections
a. Disclosures
In addition to the TILA disclosures, HOEPA requires lenders to disclose—
• The APR, the regular payment amount, and any balloon payments.
• For a loan with a variable interest rate, the possibility that the rate and payment amounts may
increase and to what potential maximum the increase may be.
b. Prohibitions
HOEPA prohibits lenders from—
• Requiring a balloon payment on a loan with a term of five years or less.
• Issuing a loan that results in negative amortization (this occurs when payments do not cover the
2. Remedies and Liabilities
On a lender’s material failure to disclose, a consumer may receive damages in an amount equal to all
finance charges and fees paid. On a lender’s failure to comply with HOEPA, the borrower’s right to rescind is
extended to three years.
CASE SYNOPSIS—
Case 31.1: Bank of New York v. Parnell
Kathleen Parnell signed a note and mortgage in favor of EquiCredit Corp. of America. EquiCredit assigned the note
and mortgage to the Bank of New York. Parnell tried to rescind the deal about two years later, claiming that the
rescission period would not expire until three years after the date of the loan because EquiCredit had not made the
required disclosures under the Home Ownership; and Equity Protection Act (HOEPA) of 1994. The bank contended that
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Parnell had received the disclosures, but that even if she had not, there would be no wrong because HOEPA did not
cover the loan. The bank filed a petition in a Louisiana state court against Parnell to collect unpaid mortgage payments.
The court issued a judgment in the bank’s favor and ordered Parnell’s property to be seized and sold. Parnell appealed.
Notes and Questions
What action might a consumer take to avoid the litigation that ensued in this case? The facts in this case are spare.
But in light of factors noted in the court’s opinion, it seems likely that the downward spiral of default and seizure began
with a high-cost mortgage. In the first instance, the consumer should have considered carefully whether she could
afford the terms of the loan. If not, she should have walked away from the deal. Once she had agreed to the terms, she
should have contacted the holder of the note and mortgage to attempt to renegotiate it as soon as it appeared that
she could not make the payments. In the meantime, however, she should have made every effort to continue to make
those payments.
ANSWER TO “THE LEGAL ENVIRONMENT DIMENSION”
QUESTION IN CASE 31.1
The Truth-in-Lending Act, HOEPA, and other consumer protection laws exist to protect purchasers from
unscrupulous lenders or sellers. As consumers become better informed about these issues, will these laws still be
ANSWER TO “WHAT IF THE FACTS WERE DIFFERENT?” IN CASE 31.1
If the lender had been dealing with a borrower who was a professor of finance at Harvard, would the appellate
judge have ruled the same way? Why or why not? No, because the level of the borrower’s sophistication and
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the party on the other side of the transaction.
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Recent cases focusing on a borrower’s exercise of the right of rescission under the Truth–in-Lending Act (TILA)
of 1968 include the following.
• Sam v. American Home Mortgage Servicing, __ F.Supp.2d __, 2010 WL 761228 (E.D.Cal. 2010) (a claim for
rescission under TILA is timely when a borrower sends a letter to a creditor seeking rescission within the three-year
period, and if the creditor fails to respond, the plaintiff has an additional year to file a suit).
• Lal v. American Home Servicing, Inc., 680 F.Supp.2d 1218 (E.D.Cal. 2010) (borrowers who sought to rescind their
mortgage under TILA failed to sufficiently allege their ability to tender the amount owed on the mortgage as a
prerequisite to rescission—their assertion that they were “prepared to tender from a refinance, funds from savings,
and assistance by family members” was too tenuous to establish their ability to repay).
• Wilson v. JPMorgan Chase Bank, NA, __ F.Supp.2d __, 2010 WL 2574032 (E.D.Cal. 2010) (when a borrower
exercises her right of rescission and the creditor refuses to comply, the borrower has three years from the date on
which she consummated her loan to file a complaint and she must demonstrate an ability to tender payment of the net
proceeds—in this case, the plaintiff met neither of these requirements).
• Gates v. Wachovia Mortgage, FSB, __ F.Supp.2d __ , 2010 WL 902818 (E.D.Cal. 2010) (a claim for rescission under
TILA is timely when a borrower sends a letter to a creditor seeking rescission within the three-year period, and if the
creditor fails to respond, the plaintiff has an additional year to file a suit—there are no technical requirements that
before this suit).
D. PROTECTION FOR HIGHER-PRICED MORTGAGE LOANS
Higher-Priced Mortgage Loans (HPMLs) make up a second category of expensive loans under Regulation Z.
1. Requirements to Qualify
To qualify as an HPML, a mortgage must—
• Secure a borrower’s principal home.
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2. Special Protections for Consumers
For an HPML loan, a lender—
• Cannot base a loan on the value of a borrower’s home without verifying the borrower’s ability to repay
it. This can be done through a review of the borrower’s financial records—tax returns, bank account
statements, payroll records, and credit obligations.
ADDITIONAL BACKGROUND—
Bureau of Consumer Financial Protection (BCFP)
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Pub L. No. 111-203, created a new
government agency—the Bureau of Consumer Financial Protection (BCFP)—to oversee consumer credit
products, including mortgages. The BCFP consolidated the consumer protection functions of several other federal
agencies and operates under the auspices of the Federal Reserve Board.
The BCFP—
• Issues rules and regulations for many financial products.
• Has far-reaching powers to prohibit abusive products and practices.
• Oversees banks, mortgage lenders, and credit firms.
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SEC. 1021. PURPOSE, OBJECTIVES, AND FUNCTIONS.
(a) PURPOSE.—The Bureau shall seek to implement and, where applicable, enforce Federal consumer financial law
consistently for the purpose of ensuring that all consumers have access to markets for consumer financial
products and services and that markets for consumer financial products and services are fair, transparent, and
competitive.
(b) OBJECTIVES.—The Bureau is authorized to exercise its authorities under Federal consumer financial law for the
(1) consumers are provided with timely and understandable information to make responsible decisions about
(2) consumers are protected from unfair, deceptive, or abusive acts and practices and from discrimination;
(3) outdated, unnecessary, or unduly burdensome regulations are regularly identified and addressed in order to
(4) Federal consumer financial law is enforced consistently, without regard to the status of a person as a
depository institution, in order to promote fair competition; and
(5) markets for consumer financial products and services operate transparently and efficiently to facilitate access
and innovation.
(c) FUNCTIONS.—The primary functions of the Bureau are—
(1) conducting financial education programs;
(2) collecting, investigating, and responding to consumer complaints;
(3) collecting, researching, monitoring, and publishing information relevant to the functioning of markets for
(4) subject to sections 1024 through 1026, supervising covered persons for compliance with Federal consumer
(5) issuing rules, orders, and guidance implementing Federal consumer financial law; and
(6) performing such support activities as may be necessary or useful to facilitate the other functions of the Bureau.
III. Foreclosures
If a borrower defaults, or fails to pay a loan, the lender can foreclose on the mortgaged property. The foreclosure
process allows a lender to repossess and auction the property. A foreclosure can be expensive and remains on a
borrower’s credit report for seven years.
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ADDITIONAL BACKGROUND—
Foreclosure Terms
Many of the following foreclosure terms and other words and phrases are defined and explained in the text.
Among the options available to a borrower and a cooperative lender to permit a borrower to keep his or her home
are—
• Repayment plan gives a borrower a certain period of time to pay delinquent amounts by adding some of each
past due installment to current payments.
• Loan modification can change the terms of a loan to make the payments more affordable for the borrower.
Among the terms that may apply when a foreclosure seems to be the only alternative are—
A. HOW TO AVOID FORECLOSURE
1. Forbearance and Workout Agreements
• Forbearance is the postponement of part or all of the payments of a loan in danger of foreclosure. This