Even after foreclosure, debt collectors still pursue borrowers for repayment
Brian J. O' Connor / Detroit News Finance EditorA grim echo of the housing bust is building for Michigan homeowners who've lost their homes to foreclosure or sold them in short sales. Without even knowing it, they could end up owing tens of thousands of dollars in mounting debts under a previously unenforced provision of the state's foreclosure law.
Until a few years ago, when someone lost a home to foreclosure in Michigan, the owner walked awayembarrassed and financially battered, but owing nothing more onthe property.
"It's a huge problem," said Julia Gordon, senior policy counsel at the Center for Responsible Lending in Washington. "This is the last thing anyone needs."
There are no figures to show how many Michigan homeowners could be liable for deficiencies, but foreclosure rates suggest there will be plenty.
Since 2006, the number of foreclosures in Michigan has more than doubled to nearly 136,000 last year, and the state has recorded nearly 500,000 filings for homes in or near foreclosure.
As a result, property values in southeast Michigan have plummeted. Home prices dropped 34 percent during the past decade and recently hit their lowest point since the summer of 1994.
Before the real estate meltdown, few lenders ever pursued borrowers for mortgage deficiencies, said bankruptcy attorney Stuart Gold of Southfield.
"We used to see it maybe once a year or very infrequently," Gold said. "In the last two years it's become more and more prevalent."
Values sink under waterBefore the recession, foreclosed homes in most cases were worth enough that banks could recoup the amount they were owed plus legal costs, if not more. At the county sheriff's foreclosure auction, lenders would bid the amount they were owed on the mortgage, then sell the property, and banker and homeowner could move on.
But now that many homes in the region are worth far less than their mortgages, lenders aren't bidding what's owed. They enter bids for the current value of the home or, sometimes, even less. Under state law, the lenders can then pursue the homeowner for the shortfall between what was owed and what the lender got when the home was sold, plus legal fees and interest.
Lenders have up to six years to sue for the bad debt and, once they obtain a judgment, can pursue the borrower for 10 years. If they still haven't collected, they can renew the judgment for another decade, repeating the process indefinitely.
During that time, interest can build on the debt at the default rate stated in the original mortgage. That's usually four or five percentage points above the original mortgage rate, so a deficiency on even a low 6-percent loan would be charged 10 percent or 11 percent interest, doubling the cost of the debt in as little as six and a half years.
"The whole situation has gotten kind of crazy," said bankruptcy attorney Mike Greiner of Warren's Financial Law Group. "I have one or two clients a month who are being sued on the first mortgage, and it's usually a large number, $50,000, $60,000 or $70,000. It's quite a shock because the client's attitude is, 'I gave the house back to the bank.'"
Short sales not excludedThese unseen debts also are cropping up on short sales, where the bank approves the sale of a home for less than the amount owed.
But just because the bank OKs the sale and releases its lien on the property doesn't mean it can't sue for the balance, said Dan Lievois, a short-sale expert and chief executive of Devon Title Agency in Troy.
"There are a lot of folks walking around now who don't understand that in three or four years they're going to wake up and have letters coming in from debt collectors," Lievois said. "That's what's sad."
The only way out for the homeowner is to get a specific release on the amount owed, Lievois said. Often in short sales, the deficiency is negotiated down and paid off by having the seller take on a new unsecured loan for the amount owed.
"In instances where the consumer didn't get that waiver of the deficiency," he said, "they have to understand that the lender has the right to sell that debt or collect on it, and do whatever they want with that asset."
This, consumer experts say, is where the real trouble can start.
In the past two decades, a robust business has grown up around the buying and selling of old consumer debt, from years-old credit card balances to long-forgotten traffic tickets and library fines.
Collection agencies buy the debt for pennies on the dollar, then try to track down the debtor with threats of legal action and damage to credit scores. Often, the debt may not even be legally owed because it's beyond the statute of limitations, which is six years in Michigan.
Now, mortgage lenders can start selling their deficiencies to make up some of their loan losses, unleashing debt collectors who may wait years to file suit — well after foreclosed homeowners have rebuilt their financial lives and have assets that can be pursued for collection.
"There are certain lenders that know borrowers will become viable for collection down the road," Lievois said.
The best way for borrowers to avoid the problem is to get a release from the lender in a short sale or, in the case of a foreclosure, file for bankruptcy. If they file soon after a foreclosure, when they have few assets, they can wipe out the debt entirely in a Chapter 7 bankruptcy.
But if they wait until a collector shows up years later, they might have to pay some of the debt under a Chapter 13 bankruptcy, or may not qualify for bankruptcy at all.
"You can garnish their wages or you can seize property," said Greiner, the bankruptcy attorney. "You can go after people for their assets.
"It's like a big iceberg out there. We haven't even seen the beginning of it yet."