Why
collateral?
As described in previous Y-blawgs, Vermont’s foreclosure laws were
designed to protect the homeowner from losing their home too quickly by giving
the homeowner a chance to halt the process, if possible, in order to modify,
reinstate or perhaps even file for Chapter 13 relief. To understand the process more fully, we have
to start with the originating documents: the Note and Mortgage. Most people are unaware of the subtle
differences between all of the documentation they sign at a mortgage
closing. That event itself is
overwhelming. The two main documents
being signed are the Note and Mortgage.
The Note is a promissory note saying that the homeowner is borrowing money
and owes the lender x dollars. The
Mortgage secures that obligation by basically pledging the home as collateral
for the money borrowed. Both components
are necessary to complete the transaction and to give the lender the later
right to foreclose if payments are missed.
When a lender forecloses, the lengthy procedure gives the lender the
ultimate right to do two things if certain steps are followed: One, take ownership of the property in order
to sell; Two, collect any deficiency IF the property doesn’t sell for enough to
pay what’s owed. These are two separate
remedies; the first being a right under the Mortgage and the second being a
right under the Note. In the vast
majority of cases, particularly with large out-of-state lenders, the bank only
seeks ownership of the property, and will not sue the borrower to collect on
any deficiency. Recently, however, some
lenders have sought deficiencies against borrowers in Vermont, so it is
important to review the paperwork thoroughly.
To collect on a deficiency, a lender must ask for it initially and also
seek to recover the specific amount at confirmation of any foreclosure sale
that didn’t make them whole.
It is important to recognize the difference between the Note and Mortgage
and their separate remedies, particularly when a bankruptcy is involved. All transactions involving the pledging of
collateral have these components—one showing the amount borrowed, and one
pledging the collateral. When a person
files for bankruptcy relief, that person is seeking to discharge debt. If a Chapter 7 discharge is received, for
example, all dischargeable debts such as an amount owing under the Note will be
eliminated. The borrower no longer owes
the lender any money.
A bankruptcy, however, does not affect a properly recorded Mortgage. This is why so many people are able to file
for Chapter 7 bankruptcy relief and keep their homes. The Mortgage stays put, and so long as the
debtor continues to pay their mortgage payments, they keep the home. If they are later unable to afford the home,
a lender can commence a foreclosure action.
Post-discharge, however, a lender can never collect on the Note (unless
the debtor “reaffirmed” in their bankruptcy case, which warrants its own blawg
entry), it can only recover from the property itself. Absent a new contract within the bankruptcy
case, called “reaffirmation” the mortgage lenders would never be able to
collect from the borrowers after a discharge.
This benefit of bankruptcy can be huge, especially when dealing with
property that may be upside-down in terms of loan to value.
It is important to know, when borrowing money, what, if anything, is
being pledged as collateral and what rights you have under the agreements. Collateral gives lenders greater rights both
inside and outside the bankruptcy world and significantly impacts a borrower’s
options. Lenders have to follow certain
procedures to validate the Mortgage. Understanding
how a bankruptcy discharge affects a Note but not a Mortgage is extremely
important when considering bankruptcy or even when considering whether to enter
into a deed in lieu of foreclosure with a lender. Giving property back to the lender does not
necessarily eliminate the Note obligation, so it is important to read any
agreement carefully.
Merely
having some understanding of the two essential components of a mortgage lending
transaction gives a borrower the ability to retain some control in an otherwise
overwhelming process. If you are unsure
of your rights and obligations with respect to your home, a consultation with
an attorney concentrating in debtor-creditor relations may be beneficial,
especially if you are having financial difficulties. We at OEBlaw will take the time to review
your situation and any loan documents carefully to best advise you as to your
options.