You gotta know what you own

photo by Kevin Rosseel

By now, you have no doubt heard about the two foreclosures that were overturned by the court in Massachusetts last week. There has been a lot of talk about what this means for the foreclosure system. The opinions floating around are all over the board, from “nothing will happen,” to “foreclosures are rendered illegal.” As is almost always the case, the truth lies somewhere in the middle.


To find the truth, it is helpful to figure out exactly what happened, and to do that, we need to fully understand how real estate financing works.

The vast majority of real estate purchases in this country are paid for with borrowed money. In common terms, we use a mortgage, but that is really a simplification of what’s actually going on. Really, financing real estate purchases involves a two step process involving a note and a mortgage or deed of trust.

The note is a contract between the borrower and the lender. It spells out the terms under which one person gets to use the other’s money. The note is very specific about who is borrowing the money, what it is to be used for, how long the loan is for, and how much it is going to cost the borrower. This is the I-O-U.

Of course, in a real estate purchase, the amount of the loan is pretty substantial. It is not something that the average borrower can come up with at a moment’s notice, and is also large enough that the lender will not usually willingly take on all the risk of something going wrong and the borrower stops making payments during the life of the loan. In other words, the lender wants to make sure that if the borrower does indeed stop making the payments as agreed in the note, there is some recourse. That’s where the second part of the financing process comes in.

The deed of trust – or mortgage, depending on your state – is the part of the process the borrower uses to give the lender some piece of mind. With a mortgage, the lender is given the right to force the sale of the property in order to recover the amount that was lent out if the borrower does not meet the terms of the note.

Here’s where it starts to get a little complicated. The note, while considered a liability to the borrower is an asset to the lender. Assets can be sold, and a whole industry has been set up around the buying and selling of these notes. This is called the secondary mortgage market. It is quite common that loans are not made until it is known who will be buying it, and the loan is sold practically before the signatures are dry. By selling the loan, the lender has a more cash to lend out again, and the process starts over.

What we’re interested in here, though, is where the original note went, and what went with it. The note was sold, but was the mortgage? In some states, yes. In Massachusetts, no.

In Massachusetts, a mortgage is sold separately from the note, but, obviously, usually at the same time and to the same company as the note. In the cases that were just overturned by the Massachusetts high court, that is not what happened, although the banks that owned the notes thought it did. There is a requirement in Massachusetts that states that a mortgage buyer must be identified when a mortgage is sold, or there is no sale for that mortgage. That didn’t happen here, so, in these cases, the note was sold, but the mortgage was not.

Now remember, the mortgage is what gives the lender the right to force the sale of the property. If the lender does not own that right, it cannot foreclose when the loan is not repaid. Technically, the owner of the mortgage can foreclose, but if it doesn’t own the note, why would it bother? The foreclosure process is expensive and time-consuming.

So what’s going to happen? Are hundreds of foreclosures going to be overturned? That remains to be seen, but this is a clear demonstration of why title insurance is a requirement in a real estate transaction. That, however, is a conversation for another day. What I can say, though, is that lenders will be stepping up their efforts to making sure that all the details are taken care of during the foreclosure process, even if it means slowing the process down to make sure it is done.

The foreclosures are not going to stop, though. That, I can guarantee.


Creditors have better memories than debtors. -- Proverb