Banks are walking away from thousands of vacant properties after starting and then refusing to complete the foreclosure process because they do not want to pay for maintaining the homes.
The result: hundreds of thousands of homes are being withheld from the market, raising questions about whether the recent run-up in housing prices is artificial.
Meanwhile, former homeowners that have already left the property with the belief they lost the home to foreclosure are ending up on the hook for the unpaid debt, taxes and repairs.
Consumer advocates say the largest mortgage servicers are blatantly ignoring Federal Reserve guidance that require borrowers be notified if a foreclosure is initiated and then abandoned. They also are raising fair-lending concerns because abandoned foreclosures are more prevalent in low-income and minority neighborhoods.
"We're seeing more and more, banks getting a judgment to sell a home but not taking it to a foreclosure sale," says Thomas Fitzpatrick, an economist in the community development department at the Federal Reserve Bank of Cleveland. "Banks speak more openly about how if it's not in their economic interest to foreclose, they're not going to foreclose. It may cost more to cure the back taxes and bring the property up to code than they could ever get from selling the property itself."
Fitzpatrick is helping draft what he calls an "overlay" law that would bring uniformity to the state foreclosure process and would require servicers to speed foreclosures of vacant and abandoned properties. The law, which is being worked on by a committee of the Uniform Law Commission, a non-profit group of judges, lawyers and state legislators, will be finalized in July 2014 and would still have to be passed by each state legislature.
"It's a regulatory gap, or crack in the process," says Judith Fox, an associate clinical professor at Notre Dame Law School, who is researching abandoned foreclosures.
Bank "walkaways" used to be extremely rare, but they have ballooned in the past year or so, resulting in a large number of homes stuck in foreclosure, sometimes for years.
More than 300,000, or 35%, of the roughly 1 million homes currently in the process of foreclosure are vacant and the servicer has not taken title to the home, according to new data from RealtyTrac, the Irvine, Calif., data firm. In 2010, the Government Accountability Office estimated the number of abandoned foreclosures to be between 14,500 to 34,600 homes.
"We call them zombie foreclosures," says Daren Blomquist, vice president at RealtyTrac, which estimated with the number of abandoned foreclosures by cross-referencing addresses of homes in the foreclosure process in the first quarter with vacant property data from the U.S. Postal Service.
The GAO used different methodology in its 2010 report. But the GAO report also found that "because abandoned foreclosures do not necessarily violate any federal banking laws, supervisors did not take any actions against the institutions."
Last year, the Federal Reserve issued guidance requiring that servicers notify borrowers and municipalities when they choose not to pursue a foreclosure.
"Banking organizations should use all means possible to provide notification," the Federal Reserve stated, adding that banks "should employ the same extensive methods they use to contact borrowers in connection with payment collection activities."
Prompt disclosures would inform borrowers of their right to occupy the property until a sale or title transfer, while reminding borrowers of their financial obligations to pay the outstanding mortgage, taxes, insurance and repairs.
The Office of the Comptroller of the Currency issued similar guidance in 2011, noting that banks and servicers "should consider the potential for reputation and litigation risk," of abandoned homes.
But consumer advocates say servicers generally are not complying with the disclosure requirements because there is no specific time frame for doing so. The national mortgage settlement includes an anti-blight provision requiring that servicers either release the lien on a property or complete a foreclosure sale, but that rule sets no specific time limit either.
"Disclosures are not happening on the ground," says Peter Skillern, the executive director of the Community Reinvestment Association of North Carolina. "The question is whether banks are following the guidelines and if federal regulators continue to sanction this practice of abandoned foreclosures."
Many cities have ordinances that require maintenance of abandoned homes. But if a servicer has not taken title to the property, cities instead end up tracking down the former homeowner to pay for liens, upkeep and taxes. These former homeowners could also be on the hook for overdue homeowner association fees, past-due insurance and the mortgage debt.
"We believe bank walkaways are an increasing problem that needs to be addressed by regulators," says Skillern. "In some cases the servicer has simply lost the paperwork and can't keep up with where they're at in the foreclosure process."
Amy Bonitatibus, a spokeswoman for JPMorgan Chase (JPM), says there are many reasons why a servicer would not take title to a property and complete a foreclosure.
"If it's going to cost us $30,000 to foreclose and the unpaid balance on the loan is $30,000 and current market value is not much higher, we might release the lien and give the home back to the borrower."
But Skillern and other consumer advocates say servicers rarely do so.
"No bank just forgives the debt," he says. "Part of why you see an increase in abandoned foreclosures is because it's an accretive problem. Our research shows that homes that banks walked away from in 2008 are still sitting there."
He described a borrower who moved out of her home six years ago after receiving a foreclosure notice, and now the servicer that failed to complete the foreclosure is trying to collect six years of past mortgage payments, taxes and repairs.
Housing experts speculate that banks are purposely refusing to take title of abandoned foreclosures as a strategic move to better manage their ballooning portfolios of real-estate owned or REO properties. If more properties were put on the market, it might dampen the nascent housing recovery, the thinking goes.
"I have long been convinced that the current run up in home prices is a false high," says Ruhi Maker, a senior staff attorney at the nonprofit Empire Justice Center in Rochester, N.Y. "Once all these foreclosures are through the system we could see another decline in prices."
James Kowalski, executive director of Jacksonville Area Legal Aid, says he has clients who have tried for years to get their servicers to foreclose and take title to their homes.
"There are literally thousands of borrowers who have been trying to hand the house back to the bank and they won't take it back," Kowalski says. "They can decide not to file, to rescind a notice of default, or to ask for continuances, and they're doing it repeatedly in Florida. If you want any better proof that the banks are slowing down the process state-by-state, based on their own internal analysis, this is it. The banks control the pacing of the foreclosure process, not the homeowners, not the judges."
Nonprofit housing groups have already filed complaints in the past year alleging that several servicers including Bank of America (BAC), U.S. Bancorp (USB) and Wells Fargo (WFC) violated fair-housing laws by failing to appropriately maintain and market foreclosed properties in minority neighborhoods. The Department of Housing and Urban Development is still investigating.
Fox, at Notre Dame, says failing to foreclose is having a "disparate impact" on low-income and minority communities, contributing to blight.
"I call it redlining because the servicer starts the foreclosure, they give notice to the borrower who moves out, but then when the servicer sends someone to look at the house and sees the neighborhood, they realize it's not in their economic interest so they stop the foreclosure," Fox says.
Still, the "disparate impact" theory of discrimination allows for exceptions if there is a business justification, and servicers are likely to cite the cost of foreclosure exceeding the expected proceeds a sale of the property as the reason abandoned foreclosures are more prevalent in areas with low-value homes, says Fitzpatrick at the Cleveland Fed.
"Lenders will almost never know the race or ethnicity of the owner," says Fitzpatrick. "It simply costs them more to take the property than not to."
Alan White, a law professor at City University of New York Law School, says it is "conceivable" to make a fair-lending case if servicers have specific practices that are tying up otherwise available properties in minority neighborhoods.
"We can see an effect on neighborhoods but is there an actual policy or decision made by servicers not to foreclose on a uniform basis?" White asked. "If a lender had a policy stating they will not proceed to a foreclosure sale on a property of less than $50,000, then it's a policy that has a discriminatory impact. But if there's no policy or practice, you can't really bring a legal challenge and servicers can assert a business justification."