Could Defense to Foreclosure Claims Stop Foreclosures?

Vague language in the Dodd-Frank Act that entitles borrowers to a defense to foreclosure transfers origination liability burdens to servicers and may even “put a stop” to foreclosures.

According to speakers at the Mortgage Bankers Association’s National Secondary Market Conference in New York, litigation costs can be so high that such risk may motivate servicers to avoid related losses by blocking foreclosures.

Separate provisions of Dodd-Frank address servicing more directly, but as it relates to originations the big issue is defense to foreclosure, said Lawrence Platt, a partner at K&L Gates. “It will be felt by servicers because they are the ones who will be foreclosing.” It is particularly challenging for the mortgage servicing companies that did not originate the loan because they will have to defend foreclosures against claims related to originations about which they do not have enough knowledge. These challenges are powerful enough to ultimately “put a stop” to foreclosures.

Improper payment of salaries to lenders’ employees is one example. The servicer cannot know how the lenders’ employees were compensated, or whether loan officers or real estate brokers were paid the accurate amount or not. That kind of information is not included in the loan file.

If following the foreclosure crisis servicer concerns revolved around securing overall loan data transparency from origination to securitization, filling out the information gap was more of a risk retention measure. Accurate loan data help increase loan buybacks and workouts.

Dodd-Frank elevated that challenge to real potential for new litigation risks.Platt told this publication the difference is that now “there’s an actual statutory basis for the client.”

Borrowers file “all sorts of claims to stop foreclosures,” but usually there is no legal foundation for it. One example is the fairness claim where borrowers state that their lender-servicer’s attempt to foreclose is not fair, he said, but until Dodd-Frank they could not point to a law that explicitly gives the right to the customer to raise it as a defense to foreclosure. “This is such a law.”

Dodd-Frank allows for defense to foreclosure claims on two grounds: The borrower’s ability to repay and improper compensation paid to a loan officer or a mortgage broker.

The issue whether new language can modify the current legislation to include additional data requirements for originators as a means to avoid transferring foreclosure losses due to lender mistakes onto servicers is open. Implications may vary and are not yet very clear, since it is not easy to quantify to what extent the defense to foreclosure litigation risks may increase both servicing and origination costs.

Many in the industry expect to see language changes to Dodd-Frank in the same fashion previously HAMP was modified to best serve a changing marketplace.

Nonetheless new language that would require more data reporting from originators cannot minimize litigation risk. Adjustments to the bill’s language may only help improve reporting on a borrower’s ability to repay as part of a loan origination provision, argues Platt, “but as it relates to compensation paid by an employer to its employee, that’s much harder to include in a loan file.”

Very broad definitions of the loan origination, loan officer compensation and servicing changes required by Dodd-Frank will be painful to implement because there is a constant need for clarification, said Ken Markison, MBA associate vice president and regulatory counsel. Members and the industry at large need to provide feedback on “how Dodd-Frank is not working.”

Wording such as “loans with predatory characteristics” is confusing and will require “pages of definitions” to clarify content and context.

Expansive jurisdictions affect servicers at the state and federal level. Regulatory requirement implementation challenges pertaining to both the loan origination and the servicing process already have diverted resources from curing delinquent loans. The defense to foreclosure issue may cause significant financial losses to servicers in the future. “Servicers do not have the boots on the ground so to speak,” Markison said.

The defense to foreclosure loophole already is a big concern for servicers, Platt said, which is why certain corrections to such entitlement may happen “down the road.”