This article is published courtesy of the State Bar Family Law Section’s Wisconsin Journal of Family Law Winter 2009 newsletter.

Introduction. Wisconsin has seen a dramatic rise in foreclosures over the past few years.

March 18, 2009 – Wisconsin foreclosure filings continue at escalated levels, according to newly released data compiled by ForeclosuresWI.com, a leading provider of Wisconsin foreclosure resources and statistics. Wisconsin added another 1,949 foreclosures to the tally in May (2008), bringing year-to-date foreclosures up to 10,644 and over 38% higher than the first five months of 2007. “Wisconsin foreclosures have been building up to the current levels for the past three years,” said Robert Jansen, president of ForeclosuresWI.com. Foreclosures have more than doubled from 2005 to 2008, with Southeastern Wisconsin experiencing a 115% YTD increase over the past three years.

The purpose of this article is to give a broad overview of the home mortgage foreclosure process. A detailed and complete overview of mortgage foreclosure would be the subject of a very large treatise. While much of the information provided here applies to the foreclosure of all mortgages, foreclosures of commercial mortgages and land contract foreclosures have their own nuances that do not apply to the run-of-the-mill home mortgage foreclosure and are therefore also beyond the scope of this article.

Causes of Foreclosure. There are several causes of the current high volume of mortgage foreclosures in Wisconsin. The WisBusiness.com article cited above gives a good summary of some of the causes of the recent increase in foreclosures:

Jansen sees several contributing factors driving these trends. “Consistent with the record number of mortgage defaults nationwide, a mix of adjustable rate mortgage resets, a soft housing market, and the collapse of the subprime mortgage market have forced many more homeowners into foreclosure. Furthermore, traditional causes of foreclosure, such as rising unemployment, are also feeding the fire. Adjustable-rate and exotic/subprime mortgage rate resets continue to result in significant increases to many homeowners’ monthly mortgage payments. Furthermore, the deteriorating housing market and flood of foreclosures has made it more difficult for those facing financial trouble to quickly sell their homes to avoid foreclosure. Compounding the issue, many lenders have tightened lending standards in the wake of subprime mortgage crisis and skyrocketing mortgage defaults, which eliminates many refinancing options for those in trouble. Amidst this situation, the U.S. government continues to struggle to agree on the proper course of action.”

The Basics of Foreclosure. The purpose of mortgage foreclosure is to sell the real estate, free and clear of liens, and apply the proceeds to the mortgage. If there are excess proceeds, those are paid to junior lienholders, or under certain rare circumstances, to the debtor. Some liens cannot be foreclosed, such as real estate taxes. Other liens, such as federal tax liens, by statute grant the holder certain rights, such as a right of redemption. There are basically two circumstances in which the debtor may be paid a portion of the proceeds of a foreclosure sale: when the debtor is able to claim a portion of the proceeds as exempt against judgments that are junior to the mortgage being foreclosed, or when the sale proceeds exceed the amounts due on all liens against the property.

In the usual foreclosure, however, the foreclosing lender will “credit bid,” meaning it will bid the amount due on its mortgage, and no actual funds are paid out. Most often, there are no other bidders at the sale, and the lender ends up as the owner of the property. Lenders do not like owning property, so there is some incentive for lenders to avoid completing the foreclosure process. Unfortunately, the steep increase in foreclosures has inured many lenders to foreclosures. As a result, when debtors or their attorneys contact lenders to work out arrangements whereby the debtors can keep the homes, they are hearing statements like this from mortgage workout employees: “We are ABC Bank; we foreclose on people all of the time. We don’t care.”

Foreclosures are quasi in rem proceedings that are equitable in nature.

Also, unlike those in other states like Minnesota, which allow foreclosure by advertisement, foreclosures in Wisconsin are by judicial action. The mortgage foreclosure procedure is set forth in Wisconsin Statutes Chapter 846. The chapter is quite detailed, and most things, but not everything, one would need to know about mortgage foreclosures, at least from the plaintiff’s point of view, are contained in that chapter. The basics of the process are as follows.

First, there has to be a default. Usually the default is the failure to timely make payments, but it could also be the failure to pay real estate taxes or to insure the property. The lender is almost always required by the terms of the note or mortgage to send a notice of default to the debtor and also to give the debtor a right to cure the default. Oftentimes lenders will work with debtors at this point in the process, even if the debtor cannot meet all of the terms of the right to cure within the applicable time limit.

The foreclosure must be brought in the county in which the real estate is located. There is a 20-day period within which to answer. While it is possible to reopen a default judgment, it is a very difficult process, and if the debtor has a defense, it is always advisable to answer timely. Therefore, it is crucial to have the debtor consult an attorney experienced in mortgage defense as early in the process as possible.

The complaint will contain many allegations, most, if not all of which are statutorily required or are required by the note and mortgage. The most important allegation is most often whether the plaintiff is seeking a deficiency judgment. If no deficiency is sought, the debtor is not responsible for any such deficiency, should the property sell for less than the amount due on the mortgage.

Unfortunately, many if not most debtors involved in foreclosures have more than one mortgage outstanding against the property, and the foreclosing party is almost invariably the first lienholder. Also, the first lienholder usually bids at most the amount due on its mortgage. As a result, even if the plaintiff does not seek a deficiency, the debtor will remain personally responsible for amounts due on second and third mortgages, along with any judgment liens or other liens against the property.

The debtor is entitled to a period of redemption, the length of which can vary. The redemption period can be two, six, or twelve months with a residential property. It is important that the debtor not abandon the property, because abandonment shortens the redemption period to two months. The right of redemption gives the debtor the right to pay off the amount due on the loan and keep the property. The redemption right also allows some debtors with equity in the property to sell it, pay off all liens, and retain the proceeds of their equity. Additionally, junior lienholders may step into the shoes of the plaintiff through redemption by paying the full amount due the plaintiff. Redemption, either by the debtor or by a junior lienholder, can occur anytime before confirmation of the sale.

Unless the debtor redeems, a sheriff’s sale is held after the redemption period ends. Notice of the sale can be published and posted before the expiration of the redemption period except for farm foreclosures. The sale is usually held on the courthouse steps in an auction-like procedure. Once the sale is completed, it must be confirmed at a hearing, usually within a couple of weeks after the sale. The purpose of the confirmation hearing is to ensure that the property has sold for “fair value.” “Fair value” is not market value. “Fair value” is a value that is not so inadequate as to shock the conscience of the court. When property has sold for the amount due on the judgment plus the costs of sale, and the plaintiff has not requested a deficiency, there is a presumption that the property sold for a “fair value.” In order to obtain a deficiency judgment, the plaintiff must prove that the property sold for “fair value.”

Bankruptcy and Foreclosure. Filing a Chapter 7 petition will only delay the foreclosure and will not allow the debtor to force a reinstatement of the mortgage. Additionally, while it is possible to sell a home during a Chapter 7 bankruptcy, doing so complicates the sale and adds costs, which will reduce any net proceeds that go to the debtor. However, in a Chapter 7 proceeding, the debtor will discharge any deficiency, and the proceeding can delay the time by which the debtor will be required to move out of the home by several months. A Chapter 13 proceeding will allow the debtor to force a reinstatement of the mortgage by catching up on delinquent payments over time. The debtor may also be able to litigate claims against the lender in the Chapter 13 proceeding. Sometimes junior liens can be stripped from the property so that the property can be more easily sold or refinanced. There is also some interest in Congress in allowing a debtor to strip down a mortgage secured by the home to the current fair market value of the home, a remedy which is presently unavailable to debtors. If such legislation is passed, a debtor whose home is worth less than the amount owed may be able to force what is in effect a refinance of the mortgage with the present lender, in an amount equal to the present value of the property.

Because interest and attorneys’ fees mount with each day a foreclosure is in process, a debtor who may have issues with foreclosure and bankruptcy should seek advice from a competent bankruptcy practitioner as soon as possible.

Some debtors want to save the family home for the children even though they are divorcing. Although it is legally permissible for divorcing debtors to file a Chapter 13 petition, it is virtually impossible for such debtors to successfully comply with Chapter 13’s stringent requirements.

Possible Defenses. Unfortunately, judges in Wisconsin tend to be quite suspicious of defenses debtors raise to a foreclosure. Many have the attitude expressed by an attorney attendee at a recent foreclosure seminar, who stated: “I had always thought that there were no defenses to a mortgage foreclosure.” In spite of that bias, however, there are circumstances in which defending a foreclosure is advisable.

• Errors in Documentation: In the author’s experience, some notes and mortgages have been improperly documented, and sometimes those errors can provide a debtor with a defense to the foreclosure action. For example, in a situation where the mortgage has been assigned, sometimes the plaintiff has not documented that assignment of record, or cannot prove that it is the holder of the note and mortgage, thus giving the debtor a potential defense. However, more often than not, the error would provide a defense for a bankruptcy trustee but would not provide a defense for the debtor. There are occasions where a debtor may well be advised to file a Chapter 7 bankruptcy in order to take advantage of the error.

• Predatory Lending and Mortgage Fraud: Because of the lending environment which existed in the early and mid 2000s, many debtors became the victims of mortgage fraud or predatory lending practices. Again, whole treatises have been written on these subjects, and the substance of these possible defenses is highly technical. There are several good resources on the subjects, most notably, publications that can be obtained from the National Consumer Law Center. Again, the key is to have the debtor contact an attorney who is experienced with handling these types of claims. Unfortunately, such attorneys are not common in Wisconsin, although there is an effort in process, spearheaded by the author’s law firm with the assistance of the State Bar of Wisconsin, to educate consumers and attorneys in these defenses and how to prosecute them. The goal of the project is to have at least one attorney in each county develop expertise with these claims.

Practical Hints for Debtors Facing Foreclosure

• Negotiation: The first option to investigate is the negotiating a repayment plan with the lender. While this is almost always a burdensome task because of the difficulty in communicating with many lenders, it is oftentimes the quickest and cheapest way to resolve the problem.

• Waiting It Out: The debtor is not required to make payments during the redemption period. Therefore, it is oftentimes advisable for the debtor to remain in the home and save the money the debtor would be paying towards the mortgage. This tactic is less desirable where the debtor will be liable for a deficiency on the mortgage being foreclosed or will remain liable on junior liens, unless the debtor will file for bankruptcy protection.

• Mortgage Assistance Programs: There have been several mortgage assistance packages that have been passed. To date, none have required lenders to take any particular course of action, and participation by lenders is voluntary; as a result, they have not been particularly effective. However, debtors are wise to participate in any relief programs offered by lenders, as sometimes a satisfactory workout will be arranged. Advise the debtor that it is not wise for the debtor to rely solely on this option, as the procedures are often lengthy and the foreclosure will proceed regardless of the participation in the workout procedure.

• Predatory Mortgage Rescue Scams: There are many unscrupulous people in the marketplace who are taking advantage of debtors who want to save their homes through various schemes.

Jackie Felton, chief of the FBI’s Economic Crimes Unit, acknowledges that “everyone wants to be a homeowner, but . . . when those homeowners start to fall behind in payments, they become vulnerable. And when these fraudsters come in and they take advantage of those people who are in crisis mode, it’s very disturbing. It’s unfortunate at that time when you are in crisis mode, most of us panic and that’s the worst time to actually try to make a decision. Across the country, as these market conditions continue, I’m afraid we’ll see more.” To cope with rescue scams and other forms of mortgage fraud, the FBI has set up 35 mortgage fraud task forces across the country. A number of states, including California, Florida, Washington, and Texas, have targeted firms exploiting homeowners drowning in the volatile housing market.

Advise your clients to thoroughly research any mortgage rescue plan and not to sign anything without having an attorney review the documentation.

• Short Sales: Lenders will sometimes accept a “short sale,” where the property is sold for less than the amount due. Because the lender can accept such a sale and choose to forgive any deficiency or pursue a deficiency, it is important for the debtor to document the terms of the short sale. Many realtors are assisting debtors with short sales.

• White Knights: Although it is not common, a few debtors have a friend or relative who is willing and able to either loan money to allow the debtor to catch up on payments or even purchase the home and rent it back to the debtor until the debtor can finance a repurchase.

Conclusion. Dealing with a mortgage foreclosure can be a very complicated process. Unfortunately, a pending divorce drains the debtors emotionally and financially, making it that much harder to deal with a foreclosure. While the vast majority of mortgage foreclosures result in the loss of the home, there are circumstances where the debtor is able to save the home, even while divorcing. Because the sooner action is taken, the more likely the action will be successful, it is crucial to counsel the debtor to take action immediately when a foreclosure is imminent.

James McNeilly is Managing Director of Lakelaw, with offices in La Crosse and Kenosha. McNeilly focuses on business law, including creditor/debtor law.

This article is published courtesy of the Winter 2009 edition of Wisconsin Journal of Family Law, published by the State Bar Family Law Section. The State Bar offers its members the opportunity to network with other lawyers who share a common interest through its 26 sections. Section membership includes access to newsletters, email lists to facilitate information sharing, and other resources.