Mortgage Banking & Loan Servicing Industry Standard Practices & Procedures in Wrongful Foreclosure Cases
Renowned Banking and Lending Expert Witness Don Coker Presents An Explanation of the Banking, Loan Servicing, and Mortgage Banking Industry Standard Policies, Practices and Procedures in the Foreclosure of Real Estate Mortgage Loans.
When a borrower fails to live up to his or her obligations as recited in the loan documents, a lender sometimes has to resort to foreclosure in order to protect its investment. The most common types of obligations that borrowers fail to live up to are making their mortgage payments on time, physically keeping up their property in a satisfactory manner, keeping their property insured, and paying their property taxes on time.
Failure to Make Payments
This obligation is self-explanatory. Based upon the terms of the note and mortgage (or deed of trust) and the laws of the state in which the property is located, a lender is required to meet certain notice requirements before it can proceed with the foreclosure of the collateral property.
Borrowers sometimes try to forestall foreclosure by making partial payments, but the normal terms of promissory notes allow the lender to obviate continuing collection problems and accelerate the balance due on the loan. That is, the lender can require that the entire balance be repaid, which typically would require the borrower to refinance.
As an example, the following excerpt is from a standard Multistate Fixed Rate Note – Single Family – Fannie Mae/Freddie Mac Uniform Instrument promissory note Form 3200:
“1. BORROWER’S FAILURE TO PAY AS REQUIRED
“(A) Late Charge for Overdue Payments
If the Note Holder has not received the full amount of any monthly payment by the end of ___________ calendar days after the date it is due, I will pay a late charge to the Note Holder. The amount of the charge will be _____% of my overdue payment of principal and interest. I will pay this late charge promptly but only once on each late payment.
If I do not pay the full amount of each monthly payment on the date it is due, I will be in default.
“(C) Notice of Default
If I am in default, the Note Holder may send me a written notice telling me that if I do not pay the overdue amount by a certain date, the Note Holder may require me to pay immediately the full amount of Principal which has not been paid and all the interest that I owe on that amount. That date must be at least 30 days after the date on which the notice is mailed to me or delivered by other means.
“(D) No Waiver By Note Holder
Even if, at a time when I am in default, the Note Holder does not require me to pay immediately in full as described above, the Note Holder will still have the right to do so if I am in default at a later time.
“(E) Payment of Note Holder’s Costs and Expenses
If the Note Holder has required me to pay immediately in full as described above, the Note Holder will have the right to be paid back by me for all of its costs and expenses in enforcing this Note to the extent not prohibited by applicable law. Those expenses include, for example, reasonable attorneys’ fees.”
The same basic requirements appear in paragraphs 1, 2, and 22 of the standard Security Deed (tantamount to a mortgage or a deed-of-trust) as they appear in my home state of Georgia on the following form: Georgia - Single Family – Fannie Mae/Freddie Mac Uniform Instrument, Form 3011.
Failure to Physically Maintain the Collateral Property
This obligation involves a more subjective issue than does the failure to make payments issue. The borrower’s obligation to maintain the collateral property is contained in paragraph 7 of the security instrument, such as mortgage or deed-of-trust, or the Georgia Security Deed as mentioned above, and which is excerpted and cited here:
“7. Preservation, Maintenance and Protection of the Property; Inspections. Borrower shall not destroy, damage or impair the Property, allow the Property to deteriorate or commit waste on the Property. Whether or not Borrower is residing in the Property, Borrower shall maintain the Property in order to prevent the Property from deteriorating or decreasing in value due to its condition. Unless it is determined pursuant to Section 5 that repair or restoration is not economically feasible, Borrower shall promptly repair the Property if damaged to avoid further deterioration or damage. If insurance or condemnation proceeds are paid in connection with damage to, or the taking of, the Property, Borrower shall be responsible for repairing or restoring the Property only if Lender has released proceeds for such purposes. Lender may disburse proceeds for the repairs and restoration in a single payment or in a series of progress payments as the work is completed. If the insurance or condemnation proceeds are not sufficient to repair or restore the Property, Borrower is not relieved of Borrower’s obligation for the completion of such repair or restoration.
“Lender or its agent may make reasonable entries upon and inspections of the Property. If it has reasonable cause, Lender may inspect the interior of the improvements on the Property. Lender shall give Borrower notice at the time of or prior to such an interior inspection specifying such reasonable cause.”
While this issue involves a subjective judgment that may be challenged, certain classes of damage or deterioration are clearly violations. An example would be a roof leak that permits water to enter the house and cause damage to the structure. Another example would be termite damage that goes untreated.
Failure to Keep the Collateral Property Properly Insured
All mortgages require that a borrower keep the collateral property insured in an amount that will at least cover the loan balance owed to the lender, and that the loss payee clause of the insurance policy reflects the lender as their interest may appear. For example, this means that in the case of a total loss, the lender would receive sufficient funds from the insurance company to repay the remaining debt on the collateral property, including all accrued interest, late fees, delinquent property tax amounts, etc.
When a lapse of insurance coverage is detected, by either the lender itself or an insurance tracking company that has been engaged by the lender to monitor the insurance status of the properties securing a mortgage company’s loans, the blanket insurer is notified that coverage is needed for the particular property. Then the coverage begins retroactively to when the previous insurance coverage ended.
All standard loan documents, including those of Fannie Mae and Freddie Mac, require borrowers to provide insurance coverage for the property that is collateral for the mortgage loan; and standard loan documents also allow the lender or loan servicer to provide insurance coverage for the collateral property if the borrower breaches his or her contractual duty to do so on their own.
Of course, the reason for LPP or LPI is that the owner of a mortgage loan – the lender - must be continuously covered by insurance. Insurance coverage that protects the value of the collateral securing the loan is, in effect, alternative collateral. Just as no lender would make a mortgage loan without collateral, no lender would make a mortgage loan without sufficient insurance covering the collateral. Likewise, mortgage investors require this same coverage and require mortgage companies that service their loans, such as the lender, to maintain a blanket insurance policy that provides insurance coverage in case their borrowers fail to maintain their insurance policies as required.
The requirement for the borrower to maintain insurance coverage appears in paragraph 5 of the security instrument, such as a mortgage, deed-of-trust, or the Georgia Security Deed mentioned above, and which I have excerpted and cite here:
“5. Property Insurance. Borrower shall keep the improvements now existing or hereafter erected on the Property insured against loss by fire, hazards included within the term “extended coverage,” and any other hazards including, but not limited to, earthquakes and floods, for which Lender requires insurance. This insurance shall be maintained in the amounts (including deductible levels) and for the periods that Lender requires. What Lender requires pursuant to the preceding sentences can change during the term of the Loan. The insurance carrier providing the insurance shall be chosen by Borrower subject to Lender’s right to disapprove Borrower’s choice, which right shall not be exercised unreasonably. Lender may require Borrower to pay, in connection with this Loan, either: (a) a one-time charge for flood zone determination, certification and tracking services; or (b) a one-time charge for flood zone determination and certification services and subsequent charges each time remappings or similar changes occur which reasonably might affect such determination or certification. Borrower shall also be responsible for the payment of any fees imposed by the Federal Emergency Management Agency in connection with the review of any flood zone determination resulting from an objection by Borrower.
“If Borrower fails to maintain any of the coverages described above, Lender may obtain insurance coverage, at Lender’s option and Borrower’s expense. Lender is under no obligation to purchase any particular type or amount of coverage. Therefore, such coverage shall cover Lender, but might or might not protect Borrower, Borrower’s equity in the Property, or the contents of the Property, against any risk, hazard or liability and might provide greater or lesser coverage than was previously in effect. Borrower acknowledges that the cost of the insurance coverage so obtained might significantly exceed the cost of insurance that Borrower could have obtained. Any amounts disbursed by Lender under this Section 5 shall become additional debt of Borrower secured by this Security Instrument. These amounts shall bear interest at the Note rate from the date of disbursement and shall be payable, with such interest, upon notice from Lender to Borrower requesting payment.
“All insurance policies required by Lender and renewals of such policies shall be subject to Lender’s right to disapprove such policies, shall include a standard mortgage clause, and shall name Lender as mortgagee and/or as an additional loss payee. Lender shall have the right to hold the policies and renewal certificates. If Lender requires, Borrower shall promptly give to Lender all receipts of paid premiums and renewal notices. If Borrower obtains any form of insurance coverage, not otherwise required by Lender, for damage to, or destruction of, the Property, such policy shall include a standard mortgage clause and shall name Lender as mortgagee and/or as an additional loss payee.
“In the event of loss, Borrower shall give prompt notice to the insurance carrier and Lender. Lender may make proof of loss if not made promptly by Borrower. Unless Lender and Borrower otherwise agree in writing, any insurance proceeds, whether or not the underlying insurance was required by Lender, shall be applied to restoration or repair of the Property, if the restoration or repair is economically feasible and Lender’s security is not lessened. During such repair and restoration period, Lender shall have the right to hold such insurance proceeds until Lender has had an opportunity to inspect such Property to ensure the work has been completed to Lender’s satisfaction, provided that such inspection shall be undertaken promptly. Lender may disburse proceeds for the repairs and restoration in a single payment or in a series of progress payments as the work is completed. Unless an agreement is made in writing or Applicable Law requires interest to be paid on such insurance proceeds, Lender shall not be required to pay Borrower any interest or earnings on such proceeds. Fees for public adjusters, or other third parties, retained by Borrower shall not be paid out of the insurance proceeds and shall be the sole obligation of Borrower. If the restoration or repair is not economically feasible or Lender’s security would be lessened, the insurance proceeds shall be applied to the sums secured by this Security Instrument, whether or not then due, with the excess, if any, paid to Borrower. Such insurance proceeds shall be applied in the order provided for in Section 2.
“If Borrower abandons the Property, Lender may file, negotiate and settle any available insurance claim and related matters. If Borrower does not respond within 30 days to a notice from Lender that the insurance carrier has offered to settle a claim, then Lender may negotiate and settle the claim. The 30-day period will begin when the notice is given. In either event, or if Lender acquires the Property under Section 22 or otherwise, Borrower hereby assigns to Lender (a) Borrower’s rights to any insurance proceeds in an amount not to exceed the amounts unpaid under the Note or this Security Instrument, and (b) any other of Borrower’s rights (other than the right to any refund of unearned premiums paid by Borrower) under all insurance policies covering the Property, insofar as such rights are applicable to the coverage of the Property. Lender may use the insurance proceeds either to repair or restore the Property or to pay amounts unpaid under the Note or this Security Instrument, whether or not then due.”
Sometimes, there are instances where a lender is unable to documented the existence of adequate insurance, or unable to reach the borrower to verify whether they are making arrangements for the continuation of their existing insurance or the initiation of a replacement policy. When there appears to be an insurance problem, and a lender cannot make contact with a borrower, then the lender needs to make sure that their efforts and findings are clearly logged into the lender’s records in case they are needed later on if further problems pop up.
An inability of a lender to reach a borrower is sometimes documented in the lender’s records as a “UTV,” which is an industry-wide standard notation for the term “unable to verify.” The existence of these UTV entries and other similar notations in a lender’s contact records indicate that the lender attempted to locate the borrower and information on the collateral’s insurance coverage, and took the action of resolving this insurance coverage issue by adding the collateral property to their blanket policy in order to protect the collateral should there be no other coverage on the property.
A borrower is required to main adequate insurance coverage on the collateral property by the terms of their mortgage or deed-of-trust. The lender is required by its own operating policies and procedures to make sure that the collateral property is insured. And a loan servicer servicing the loan for another party who owns the loan is required by their loan servicing agreement to see that insurance coverage is maintained on the collateral property.
Any prudent lender or loan servicer that is in a situation where it is unclear whether insurance coverage is in place should comply with safe and sound lending practices and normal and acceptable industry standard procedures, and assure that coverage is in place by placing a lender placed policy on the property until the situation can be verified and clarified. Then, if it is later learned that the coverage was not needed, the charges for the LPP can be reversed.
Essentially, safe and sound mortgage banking practices, and normal and acceptable mortgage servicing industry standards, require that a mortgage servicer act on the side of safety, rather than leave the owner of the mortgage loan (as well as the borrower) open to the possibility of sustaining an uninsured loss. The simple and logical reason for this is that an LPP charge easily can be reversed but an uninsured loss cannot be undone.
It has been my experience in the banking, mortgage banking, and real estate lending industries that it is a normal practice for the insurance industry to refund premiums that were paid in error or where coverage was not needed due to double coverage or no need for coverage. Therefore, lenders often, and correctly, understand or assume that if they do obtain coverage and the coverage was not needed or was in error, that the insurance company will refund the premium.
It is my professional opinion that a lender or loan servicer who encounters a situation where they have tried but cannot determine that there is acceptable insurance coverage on a collateral property should place that property on the company’s blanket policy until the borrower can arrange replacement coverage.
Furthermore, it is my professional opinion that a lender servicing a loan for another party that actually owns the loan should place the subject collateral property on the company’s blanket policy until the borrower can arrange replacement coverage. This industry standard practice provides the collateral protection that is always required by loan servicing agreements.
Failure to Pay Their Property Taxes
If a borrower is paying their taxes directly as opposed to escrowing an amount each month for the payment of taxes, then it is possible for the borrower to fail to make the annual tax payment and thereby place the collateral property in jeopardy of being placed under a tax lien which would be superior to the first lien held by the lender.
The requirement for the borrower to timely pay the taxes due on the collateral property appears in paragraph 3 of the security instrument, such as a mortgage, deed-of-trust, or the Georgia Security Deed mentioned above, and which I have excerpted and cite here:
“3. Funds for Escrow Items. Borrower shall pay to Lender on the day Periodic Payments are due under the Note, until the Note is paid in full, a sum (the “Funds”) to provide for payment of amounts due for: (a) taxes and assessments and other items which can attain priority over this Security Instrument as a lien or encumbrance on the Property; (b) leasehold payments or ground rents on the Property, if any; (c) premiums for any and all insurance required by Lender under Section 5; and (d) Mortgage Insurance premiums, if any, or any sums payable by Borrower to Lender in lieu of the payment of Mortgage Insurance premiums in accordance with the provisions of Section 10. These items are called “Escrow Items.” At origination or at any time during the term of the Loan, Lender may require that Community Association Dues, Fees, and Assessments, if any, be escrowed by Borrower, and such dues, fees and assessments shall be an Escrow Item. Borrower shall promptly furnish to Lender all notices of amounts to be paid under this Section. Borrower shall pay Lender the Funds for Escrow Items unless Lender waives Borrower’s obligation to pay the Funds for any or all Escrow Items. Lender may waive Borrower’s obligation to pay to Lender Funds for any or all Escrow Items at any time. Any such waiver may only be in writing. In the event of such waiver, Borrower shall pay directly, when and where payable, the amounts due for any Escrow Items for which payment of Funds has been waived by Lender and, if Lender requires, shall furnish to Lender receipts evidencing such payment within such time period as Lender may require. Borrower’s obligation to make such payments and to provide receipts shall for all purposes be deemed to be a covenant and agreement contained in this Security Instrument, as the phrase “covenant and agreement” is used in Section 9. If Borrower is obligated to pay Escrow Items directly, pursuant to a waiver, and Borrower fails to pay the amount due for an Escrow Item, Lender may exercise its rights under Section 9 and pay such amount and Borrower shall then be obligated under Section 9 to repay to Lender any such amount. Lender may revoke the waiver as to any or all Escrow Items at any time by a notice given in accordance with Section 15 and, upon such revocation, Borrower shall pay to Lender all Funds, and in such amounts, that are then required under this Section 3.
“Lender may, at any time, collect and hold Funds in an amount (a) sufficient to permit Lender to apply the Funds at the time specified under RESPA, and (b) not to exceed the maximum amount a lender can require under RESPA. Lender shall estimate the amount of Funds due on the basis of current data and reasonable estimates of expenditures of future Escrow Items or otherwise in accordance with Applicable Law.
“The Funds shall be held in an institution whose deposits are insured by a federal agency, instrumentality, or entity (including Lender, if Lender is an institution whose deposits are so insured) or in any Federal Home Loan Bank. Lender shall apply the Funds to pay the Escrow Items no later than the time specified under RESPA. Lender shall not charge Borrower for holding and applying the Funds, annually analyzing the escrow account, or verifying the Escrow Items, unless Lender pays Borrower interest on the Funds and Applicable Law permits Lender to make such a charge. Unless an agreement is made in writing or Applicable Law requires interest to be paid on the Funds, Lender shall not be required to pay Borrower any interest or earnings on the Funds. Borrower and Lender can agree in writing, however, that interest shall be paid on the Funds. Lender shall give to Borrower, without charge, an annual accounting of the Funds as required by RESPA.
“If there is a surplus of Funds held in escrow, as defined under RESPA, Lender shall account to Borrower for the excess funds in accordance with RESPA. If there is a shortage of Funds held in escrow, as defined under RESPA, Lender shall notify Borrower as required by RESPA, and Borrower shall pay to Lender the amount necessary to make up the shortage in accordance with RESPA, but in no more than 12 monthly payments. If there is a deficiency of Funds held in escrow, as defined under RESPA, Lender shall notify Borrower as required by RESPA, and Borrower shall pay to Lender the amount necessary to make up the deficiency in accordance with RESPA, but in no more than 12 monthly payments.
“Upon payment in full of all sums secured by this Security Instrument, Lender shall promptly refund to Borrower any Funds held by Lender.”
Essentially, if a borrower fails to pay the taxes that are due on a collateral property, the lender my pay the taxes and either require the borrower to reimburse the lender, or the lender may add to the borrower’s loan balance the amount of the taxes paid.
The basic philosophy of the matters discussed in this article is that a lender is empowered to act in the absence of action by a borrower to properly oversee the management of the collateral upon which the lender is relying as its security.
If a borrower fails to meet its obligations in the areas cited here, then the lender is justified in proceeding with a foreclosure according to the foreclosure laws in the area where the collateral property is located.
When a lender acts in an industry standard manner in responding to an action or inaction of a borrower that can jeopardize the safety of the collateral, and foreclosed in accordance with the area’s foreclosure laws, then the lender is on solid ground in defending its actions later on if challenged.
ABOUT THE AUTHOR: Banking and Mortgage Banking Consultant and Expert Witness Don Coker
Mr. Coker provides expert witness and consulting services.
500 cases for plaintiffs and defendants nationwide, 119 testimonies, and 12 courthouse settlements in all areas of banking and finance. Listed in the databases of recommended expert witness consultants of both the DRI and the American Association for Justice.
Clients have included numerous individual plaintiffs and over 60 banks.
Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, Guaranty Bank, and a two-year stint as a high-level governmental financial institution regulator.
Holds a B.A. degree from the University of Alabama, and completed postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School.
Called on by clients in 28 countries for work involving 57 countries. Widely published, often called on by the media.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.