Summer 2014 Newsletter: Dealing with Default During Divorce: Foreclosure Considerations for the Family Law Practitioner

By Francis Nolan, Esq.

For over five years, the financial crisis has dominated headlines, with families everywhere facing difficulties making ends meet due to a confluence of events:  a downturn in the stock market, persistently high unemployment rates, and a tightening of credit.   A significantly exacerbating factor was the sudden crash in the real estate market; borrowers facing hard times were unable to extricate themselves from untenable home loans, resulting in a wave of foreclosures that is only now subsiding. 

With the local real estate market showing long-awaited signs of improvement, homeowners who have been stuck “underwater”—with the homes worth less than the mortgages encumbering them—may find themselves with new options when trying to deal with the disposition of burdensome and unwanted real estate in a divorce context.  At the same time, while foreclosure volume in Massachusetts has ebbed significantly in the past couple of years, divorce remains a prime potential catalyst for mortgage delinquencies, even in cases where the marital property shows significant equity.  It is helpful for the family law practitioner to know generally what happens in a foreclosure process in Massachusetts, what options may be available to a borrower (or non-borrower owner) in default, and how to avoid some common problems when dealing with a bank or mortgage company.

The Basics of Foreclosing in Massachusetts

Pre-Foreclosure

Before a lender can initiate foreclosure on a delinquent borrower, it must first give the borrower notice of her delinquency and provide the borrower an opportunity to cure the default condition.  If the reason for default is non-payment, and the property is the borrower’s principal residence, the lender is statutorily required to provide the borrower with a notice that gives the borrower 150 days to pay the amount needed to bring the account current.  Note that the borrower is only entitled to the 150 day notice once every three years, so if your client tells you she is behind on the mortgage, it’s important to find out whether this is the first time they’ve fallen behind or it’s a repeat occurrence. 

The borrower may also be entitled statutorily to consideration for a loan modification.  If so, the borrower will receive a second notice asking her to respond within 30 days with a complete financial package so the lender can analyze the loan and determine whether it would be better served foreclosing or modifying the loan.  There are strict statutory deadlines for the borrower to follow in order to avail herself of this opportunity, and even if the borrower does not want to be considered for a loan modification, the borrower must respond to the inquiry within 30 days.  If the borrower chooses not to respond, the statute reduces the borrower’s cure period from 150 days to 90 days. 

The cure period provides an excellent opportunity for borrowers to communicate with lenders and determine what options are available to avoid foreclosure.  Particularly if the goal for one or both parties is to retain ownership of the home, an open dialogue with the lender is a critical component of developing a realistic divorce settlement.

Foreclosure

Once the cure period has passed and the borrower has failed to cure the default or reach an agreement to avoid foreclosure through other means, the lender may choose to initiate a foreclosure action.  Massachusetts is considered a “non-judicial” or “quasi-judicial” foreclosure state, because in some circumstances a lender may complete the foreclosure process without any court involvement.  In the vast majority of residential foreclosures, there is a limited judicial component which is completed as the first part of the foreclosure process.

Massachusetts law requires a foreclosing mortgagee to file a complaint with the Land Court or Superior Court to establish that the current owners of the property are not subject to the protections of the Servicemembers Civil Relief Act (SCRA), which shields some individuals on active military duty from foreclosure without a court order.  The relief sought in an SCRA foreclosure case is non-monetary; the objective is to have the court confirm that the foreclosure may be conducted because the defendants are not protected by the SCRA.  Failure to obtain an SCRA judgment before conducting a non-judicial foreclosure does not render the foreclosure fatally defective, but rather clouds the title to the real estate, necessitating a “clear cloud” action; but in reality, it is extremely rare for a lender to conduct a residential foreclosure without first obtaining the SCRA judgment.

Once the lender obtains the SCRA judgment, it will proceed to foreclose non-judicially.  There are two notice components to the non-judicial foreclosure process:  notice by mail and notice by publication.  Pursuant to Massachusetts law, the foreclosing mortgagee must send each borrower, owner and junior lienholder a notice of foreclosure sale at least 14 days before the sale.  If the mortgagee intends to preserve the right to pursue a deficiency judgment against an obligor, it must send the obligor notice of its intention at least 21 days before the sale; this notice is typically sent along with the notice of foreclosure sale, so both notices are usually sent at least three weeks before sale.  Practically speaking, then, in most cases the borrower should expect to receive notice of the sale by mail somewhere between two and three weeks before the sale.  In addition to mailing the notices of sale, the foreclosing mortgagee will also publish a copy of the notice, in a newspaper generally circulated where the property is located, once a week for at least three consecutive weeks. The first publication must run at least 21 days before sale.

Foreclosure auctions in Massachusetts are generally held at the property location.  Once a high bidder is established, the bidder pays a deposit and signs a memorandum of sale pledging to pay the remaining balance of the sale price within 30 days.  The resulting foreclosure deed, along with an affidavit confirming compliance with state foreclosure laws, is recorded in the Registry of Deeds for the county in which the property is located.  Massachusetts does not provide for any post-sale redemption period; once the memorandum of sale is signed, the borrower’s right to redeem the property by paying the mortgage in full is extinguished.

Timelines

Massachusetts has a delinquency rate that is lower than the national average, reflecting both a reasonably steady job market and an improving housing market.  However, the average length of time from initial delinquency to foreclosure sale is significantly higher than the national average.  Numerous statutory and regulatory changes, coupled with the impact of several important foreclosure-related judicial decisions, have caused lenders to pause in their foreclosure processes repeatedly over the past 2-3 years.  Delays in the process can provide borrowers with additional opportunities to find ways to avoid foreclosure, but they can also cause complacency (the feeling that the lender will never actually foreclose) and stress.  A borrower who has been informed that the lender has initiated foreclosure can expect, at a minimum, that the judicial component of the process will take approximately 45-75 days from the filing of the complaint to the issuance of a final judgment.  The non-judicial component of the process can be completed in 35 days. 

Procedural requirements relating to the recordation of assignments, resolution of title issues and the execution and recording of multiple affidavits and certifications very often lead to significant delays in the foreclosure process, so this is not to suggest that borrowers should be anticipating a foreclosure sale exactly 80 days after they are informed that a foreclosure has begun.  Rather, it is intended to warn against complacency that often sets in when the foreclosure process encounters delays, the reasons for which are unknown to the borrower and borrower’s counsel.  The attorney’s office handling the foreclosure process should be able to advise borrower’s counsel of the general status of the foreclosure action upon proof of authorization and request.

Resolving Delinquency Outside of Foreclosure

Determining the intent of the parties in a divorce relative to a mortgaged property is vital to establishing a pathway to a successful disposition of the property.  A delinquent mortgage only adds to the complexity of the analysis.  Particularly if one or both parties want to retain the property, addressing the default condition promptly is paramount. 

Retaining the Property

There are four primary means by which a borrower may cure a default and retain the property:  reinstatement, forbearance, modification or refinance.

In a “reinstatement,” the borrower restores the loan to a current (performing) condition.  Typically that means the borrower pays the lender the full amount of the arrearage, so that the loan is paid through the current month.

“Forbearance” or “forbearance agreement” refers to an arrangement by which a lender allows the borrower to cure the default condition over a period of time, either by making regular payments plus a partial payment towards overdue installments or by taking other actions that lead to a point at which the borrower will cure the default (e.g. the borrower agrees to take out a loan against her 401(k) loan, but will not have the money for 30 days; the lender agrees not to take any further action in anticipation of receiving the cure payment in a month). 

“Modification” takes place when the lender agrees to restructure permanently the terms of the mortgage loan, usually by adjusting one or more of the primary conditions of the loan—interest rate, loan duration or loan amount.  A loan modification may allow the borrower to roll a delinquency amount into the principal balance of the loan, thereby “curing” the default but adjusting the monthly payment amounts going forward.

The parties may also refinance the mortgage, paying off the existing mortgage debt and replacing it with a new mortgage loan.  For loans in default and/or borrowers with bad credit histories, this option may be difficult to accomplish even if both parties are interested in refinancing.

Divorce can complicate efforts to establish terms for a forbearance agreement or a loan modification.  If both parties are personally liable for the mortgage loan, both parties must generally agree to the terms of forbearance or modification, and both parties must submit financial information.  Even if only one party is liable for the debt, both parties may need to submit financial information if both are contributing to the payment of a forbearance plan or a modified loan.  Parties who are no longer going to be living in the property may be less cooperative in providing financial information or have less interest in reaching a final arrangement.

Releasing the Property

Even if the divorcing parties do not want to retain the property, it is usually beneficial for them to participate in the process of transferring the property to new ownership.  In many instances, one party may transfer an ownership interest to the other.  If both parties are obligated on the existing mortgage, simply deeding an ownership interest does not release the transferor from personal liability on the mortgage loan; either the transferee would need to obtain a new loan, or the parties would need to obtain the existing lender’s consent to release the transferor from liability.  In any case, there are three primary options for parties seeking to control the transfer of property to new owners:  payoff; short sale; or a deed in lieu of foreclosure.

A mortgage loan may be paid off through a sale by the current owners to a new third party; in the transaction, the existing mortgage is paid in full, and the parties to the divorce no longer have any personal liability for the mortgage loan (although, as mentioned above, one of the parties may be the “new third party” and may have a new mortgage loan obligation as a result). 

If the property value is less than the amount of the mortgage debt and other liens and obligations of record, the borrowers may still be able to coordinate a sale of the property if the lienholders will agree to compromise their claims by accepting less than the full amount they are owed to release their respective liens.  This “short sale” scenario became particularly prevalent in 2009 and 2010 and while the improving real estate market has reduced the need for short sales, they are still frequently encountered.  Because all of the lienholders are involved in the transaction, short sales tend to take longer to negotiate than regular sales, but if successful, a short sale can provide the borrowers with relief from some or all of their secured debts on the property.  (Keep in mind that forgiveness of debt in a short sale context may trigger tax implications.)

In some instances, the borrowers do not want to retain the home any longer and do not care to sell the property, but would like to avoid the lingering uncertainty and/or public notice aspects of foreclosure.  Lenders may be amenable to taking a deed voluntarily from the borrowers in exchange for elimination of some or all of the borrowers’ debt obligation (this deed being known as a “deed in lieu of foreclosure”).  The presence of junior lienholders on title makes this transaction more difficult, if only because the lienholders must agree to release their interests; unlike a foreclosure, which extinguishes as a matter of law liens that are junior to the foreclosed mortgage, a deed in lieu of foreclosure has no effect on other liens, and in fact resets the relative priorities in favor of pre-existing lienholders.  Still, deeds in lieu of foreclosure are often favored by lenders because they eliminate the potential for borrower contests, accelerate the process by which title is transferred, and avoid the expenses associated with foreclosure. 

Practical Considerations

When dealing with a loan that is in default, or may soon be in default, in a divorce context, there are some practical issues that should be addressed in order to avoid headaches down the road.  For example:

Does your client have authority to talk to the lender?  If your client is a non-borrower owner, the lender may refuse to communicate with her due to federal and state privacy laws.  Make sure you obtain a letter of authorization from the borrower (preferably one that also authorizes you as your client’s counsel to speak with the lender) that you can provide to the lender if needed.

Does your client have personal liability?  The optimal outcome of how a home should be disposed through the divorce may vary based on this issue.  Be wary of arrangements that involve assumption of liability without a complete resolution of the default condition—if your client is going to become a borrower and assume liability, make sure wherever possible that the client starts fresh with a performing loan.

Is a workout a realistic possibility?  In some instances, it is clear that retention of the home is not a realistic outcome.  Spending time, energy and money to achieve the unachievable may increase stress and ultimately cause you to run out of time that is needed to sell the property to someone else, thereby ending up with an unnecessary foreclosure.

For a sale of the real estate, whether it be via short sale, deed in lieu of foreclosure or a regular transaction—will you need spousal cooperation?  If so, will that be a problem?  In some cases, one party will enter into a sale contract, only to find out that the other party is a necessary signatory and is unwilling to cooperate.  Again, anticipating the issue and addressing it ahead of time helps to avoid last-minute problems.

Make sure the parties pay attention to the notices they are receiving.  Lenders are required to send many pre-foreclosure and foreclosure notices to borrowers, and often send plenty of additional letters on top of the ones required by statute.  Failure to read and react (and in some cases, as noted above, respond) to a notice can have an adverse impact on your client. 

Finally, a word to anyone trying to resolve a mortgage delinquency during a divorce process:  be patient.  Both because of the foreclosure laws and the volume of files with which they are dealing, lenders tend to move uncomfortably slowly with respect to resolving issues.  Make sure you provide the lender with the documentation it requests, and have copies available in case someone needs one or more documents re-sent.  Recognize that a proposed solution that might seem to your client to be a “no-brainer” may implicate investor guidelines or insurance rights, and the lender has a number of important considerations that are invisible to the borrower and might lead the lender to a different conclusion.  Patience in dealing with the lender may pay dividends for your client in the end. 

Francis J. Nolan is an attorney director at Harmon Law Offices, PC, in Newton. He is admitted to practice in Massachusetts, New Hampshire, and Rhode Island. Fran is a graduate of the University of Rochester and the Catholic University of America, Columbus School of Law.  He is a member of the Rhode Island Bar Association Title Standards Committee and REBA’s Executive Committee and serves as the co-chair of REBA’s Legislation Committee.  He has participated in numerous seminars regarding Massachusetts foreclosures for MCLE, REBA, MBA and the Worcester County Bar Association and has authored foreclosure-related chapters in MCLE’s Massachusetts Mortgages, Foreclosures and Workouts, Crocker’s Notes on Common Forms and Real Estate Title Practice in Massachusetts.