A zombie mortgage property is one that has usually been abandoned by the owner, but not yet foreclosed upon by the lender. Sometimes years pass with no activity. The property might be overgrown and truly abandoned, or a property management company might be cutting the grass and periodically posting notices with contact information.
Properties that seem to be abandoned usually have one of four explanations:
- The lender decided it was not worth the trouble to foreclose. Every lender has its own “secret numbers.” For lender ABC, they might not foreclose on anything with an appraised value less than $20,000. For lender XYZ, it might be $35,000.
- The property has dangerous “warts” and the lender does not want to foreclose. It could be reports of meth production or toxic waste. It could be a liability issue with a collapsed vinyl lined pool. It could be a casualty loss for which the lender received some insurance proceeds, and now the property is a ruined hulk not worth rehabbing, at least for the lender.
- The mortgage loan (called an “asset” by the lender) slipped between the cracks. The bank does not know it owns that asset.
- The loan is owned by a local or regional lender that will think about it later, because they are too busy with larger loans and high value properties.
Bankruptcy and Zombie Mortgages
- In bankruptcy this problem can be particularly troublesome. Oftentimes a debtor will elect to surrender real property thereby eliminating the personal liability to the lender. This option is allowed by the bankruptcy code and is designed to afford a fresh start. However, if the bank does not foreclose, the debtor become responsible for all the post-bankruptcy associated costs of home-ownership thereby impeding the fresh start provided by the bankruptcy code.
- In bankruptcy there is a small, but growing, body of case law which allows debtors and trustees to force the sale of such properties. Practically speaking however such measures will require action above and beyond the standard bankruptcy and almost certainly require an adversary proceeding or a contested matter – something beyond the means of most debtors.
- If the benefits outweigh the costs debtor can proceed ahead with bankruptcy litigation to force the sale. Usually courts will look to Section 363 of the Bankruptcy Code for authority to permit sales under such circumstances. Sometimes a court will use its equitable powers under Section 105. However, the former faces very divergent approaches depending on jurisdiction and the latter requires asking a court to do something it might not be comfortable undertaking. As of the writing of this document there don’t appear to be any relevant opinions within the Colorado bankruptcy courts.
- As real estate markets improve then this issue becomes less of a problem. Some local jurisdictions are attempting to implement laws designed to remedy this problem. However, they face challenges in that such laws will conflict with long established legal principals in addition to the likelihood that places additional legal burdens would increase the cost of lending for everyone else.
What will it take to fight zombie mortgages?
The walking dead haunts the land of real estate finance. A “zombie mortgage” is an abandoned property with a mortgage during foreclosure. The house sits in limbo, at best continuing to deteriorate because of lack of repairs; at worst, vandalised, trashed, used for illegal activities, and being a drag on the neighbourhood.
Recognising the potential negative impact of these foreclosures, some states have tried to fight the zombies by expediting the foreclosure process for vacant properties and requiring mortgage services to maintain these properties. This is part of a bigger conversation on the costs of long foreclosure timelines versus the benefits of more borrower-friendly foreclosure processes. To have this conversation, policymakers must reduce the emotion in this discussion and carefully balance the economic and other interests of borrowers, communities, mortgage services, states, and municipalities.