FORECLOSURE DEFENSE: HELOC LOANS DISCHARGEABLE

BK Judge Rules Stated Income HELOC Debt Dischargeable

by Tanta

This is a big deal, and will no doubt strike real fear in the hearts of stated-income lenders everywhere. Our own Uncle Festus sent me this decision, in which Judge Leslie Tchaikovsky ruled that a National City HELOC that had been “foreclosed out” would be discharged in the debtors’ Chapter 7 bankruptcy. Nat City had argued that the debt should be non-dischargeable because the debtors made material false representations (namely, lying about their income) on which Nat City relied when it made the loan. The court agreed that the debtors had in fact lied to the bank, but it held that the bank did not “reasonably rely” on the misrepresentations.


I argued some time ago that the whole point of stated income lending was to make the borrower the fall guy: the lender can make a dumb loan–knowing perfectly well that it is doing so–while shifting responsibility onto the borrower, who is the one “stating” the income and–in theory, at least–therefore liable for the misrepresentation. This is precisely where Judge Tchaikovsky has stepped in and said “no dice.” This is not one of those cases where the broker or lender seems to have done the lying without the borrower’s knowledge; these are not sympathetic victims of predatory lending. In fact, the very egregiousness of the borrowers’ misrepresentations and chronic debt-binging behavior is what seems to have sent the Judge over the edge here, leading her to ask the profoundly important question of how a bank like National City could have “reasonably relied” on these borrowers’ unverified statements of income to make this loan.

And as I argued the other day on the subject of due diligence, it isn’t so much that individual loans are fraudulent than that the published guidelines by which the loans were made and evaluated encouraged fraudulent behavior, or at least made it “fast and easy” for fraud to occur. Judge Tchaikovsky directly addresses the issue of the bank’s reliance on “guidelines” that should, in essence, never have been relied upon in the first place.

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Here follow some lengthy quotes from the decision, which was docketed yesterday and is not, as far as I know, yet published. From In re Hill (City National Bank v. Hill), United States Bankruptcy Court, Northern District of California, Case No. A.P. 07-4106 (May 28, 2008):

This adversary proceeding is a poster child for some of the practices that have led to the current crisis in our housing market.

Indeed. The debtors, the Hills, bought their home in El Sobrante, California, twenty years ago for $220,000. After at least five refinances, their total debt on the home at the time they filed for Chapter 7 in April of 2007 was $683,000. Mr. Hill worked for an automobile parts wholesaler; Mrs. Hill had a business distributing free periodicals. According to the court, their combined annual income never exceeded $65,000.

In April 2006, the Hills refinanced their existing $100,000 second lien through a mortgage broker with National City. Their new loan was an equity line of $200,000; after paying off the old lien and other consumer debt, the Hills received $60,000 in cash. On this application the Hills stated their annual income as $145,716. The property appraised for $785,000.

By October 2006 the Hills were short of money again, and applied directly to National City to have their HELOC limit increased to $250,000 to obtain an additional $50,000 in cash. On this application, six months later, the Hills’ annual income was stated as $190,800, and the appraised value was $856,000.

At the foreclosure sale in April 2007, the first lien lender bought the house at auction for $450,000, apparently the amount of its first lien.

The Hills claimed that they did not misrepresent their income on the April loan, and that they had signed the application without reading it. The broker testified rather convincingly that the Hills had indeed read the documents before signing them–Mrs. Hill noticed an error on one document and initialed a correction to it. No doubt because the October loan, the request for increase of an existing HELOC, did not go through a broker, the Hills admitted to having misrepresented their income on that application. The Court found that:

Moreover, the Hills, while not highly educated, were not unsophisticated. They had obtained numerous home and car loans and were familiar with the loan application process. They knew they were responsible for supplying accurate information to a lender concerning their financial condition when obtaining a loan. Even if the Court were persuaded that they had signed and submitted the October Loan Application without verifying its accuracy, their reckless disregard would have been sufficient to satisfy the third and fourth elements of the Bank’s claim.

This is not an excessively soft-hearted judge who fell for some self-serving sob story from the debtors. “Reckless disregard” is rather strong language.

Unfortunately for National City, Her Honor was just as unsympathetic to its claims:

However, the Bank’s suit fails due to its failure to prove the sixth element of its claim: i.e., the reasonableness of its reliance.6 As stated above, the reasonableness of a creditor’s reliance is judged by an objective standard. In general, a lender’s reliance is reasonable if it followed its normal business practices. However, this may not be enough if those practices deviate from industry standards or if the creditor ignored a “red flag.” See Cohn, 54 F.3d at 1117. Here, it is highly questionable whether the industry standards–-as those standards are reflected by the Guidelines–-were objectively reasonable. However, even if they were, the Bank clearly deviated to some extent from those standards. In addition, the Bank ignored a “red flag” that should have called for more investigation concerning the accuracy of the income figures. . . .

 

Based on the foregoing, the Court concludes that either the Bank did not rely on the Debtors representations concerning their income or that its reliance was not reasonable based on an objective standard. In fact, the minimal verification required by an “income stated” loan, as established by the Guidelines, suggests that this type of loan is essentially an “asset based” loan. In other words, the Court surmises that the Bank made the loan principally in reliance on the value of the collateral: i.e., the House. If so, the Bank obtained the appraisal upon which it principally relied in making the loan. Subsequent events strongly suggest that the appraisal was inflated. However, under these circumstances, the Debtors cannot be blamed for the Bank’s loss, and the Bank’s claim should be discharged.

In short, while the Court found that the Hills knowingly made false representations to the lender, the lender’s claim that it “reasonably relied” on these representations doesn’t hold water, because “stated income guidelines” are not reasonable things to rely on. In essence, the Court found, such lending guidelines boil down to what the regulators call “collateral dependent” loans, where the lender is relying on nothing, at the end of the day, except the value of the collateral, not the borrower’s ability or willingness to repay. If you make a “liar loan,” the Judge is saying here, then you cannot claim you were harmed by relying on lies. And if you rely on an inflated appraisal, that’s your lookout, not the borrower’s.

This is going to give a lot of stated income lenders–and investors in “stated income” securities–a really bad rotten no good day. As it should. They have managed to give the rest of us a really bad rotten no good couple of years, with no end in sight.

2 Responses

  1. Our original loan was FHA insured, HUD toke it on forbearance when my husband became disabled in 1996. In 1997 HUD sold the note or servicing to OCWEN FSB. We were constantly billed unexplained fees, and overcharged by OCWEN FSB. In 2004 OCWEN FSB sent us a notice alleging we were in default and had 30 days to dispute the debt which we did. 22 days from the date of that notice LaSalle Bank as trustees for certificate holders of a Mortgage Pass-Through Certificate filed a foreclosure on us. OCWEN FSB was sited by the OTS for multiple servicing violations of servicing loans one month after this transfer toke place. Court records show OCWEN did not really transfer the note to LaSalle as Trustee for holders of the securities until 3 months after the foreclosure was filed. Our attorney filed a motion to dismiss for lack of capacity, which the Judge denied. The Judge also denied LaSalle’s motion for summary judgment. Mediation is a joke! LaSalle never provided anything during discovery. There are a lot of strange things going on in my opinion in this case. I terminated my attorney and he withdrew 8 days before a hearing. LaSalle’s attorney in e-mails has said OCWEN has an interest in the property even though there are not listed as a party to this suit. I live in Oklahoma and 99 percent of foreclosures that are filed the defendant have NO representation.
    In a letter responding to my original dispute letter, the attorneys listed my OCWEN loan number as being a COUNTRYWIDE loan number.

    Our home has severe structural damage. I do not believe we were behind when the suit was filed. I am in the process of requesting documents.
    All the attorneys I have spoken to in this Major North Eastern City in Oklahoma say this is too complicated of a case. Most of them do not act like they know what a Mortgage Pass through certificate is.

    I do not believe LaSalle is the “real party of interest in this case”. We have alleged the RESPA violations.

  2. In 2004 OCWEN FSB sent me a notice aledging we were in default and had 30 days to dispute the debt. HUD sold out loan to OCWEN or the servicing in 1997. 22 days after OCWEN sent us this notice LaSalle Bank as trustees for certificate holders of a Mortgage Pass-Through Certificate file a forclosure on us. OCWEN FSB was sited by the OTS for multiple servicing violation one month after this transfer. Court records show OCWEN did not really transfer the note to the holder of the securities until 3 months after the forclosure was filed. Our attorney filed a motion to dismiss for lack of capacity, which the Judge denied. The Judge also denied LaSalle’s motion for summary judgement. Mediation is a joke! LaSalle never provided anything during discovery. I fired my attorney. I am not convinced that some how OCWEN is still involved due to e-mails for the attorney says OCWEN has an interest in the property. I live in Oklahoma and 99 percent of forclosures that are filed the defendant has NO representation.

    In a letter responding to my original dispute letter, the attorneys listed my OCWEN loan number as being a COUNTRYWIDE loan number.

    Our home has severe structural damage. I do not beleive we were behind were the suit was filed. I am in the process of requesting documents.
    All the attorneys I have spoken to in TULSA say this is too complicated of a case. Most of them do not act like they know what a Mortgage Pass through certificate is.

    I do not believe LaSalle is the “real party of interest in this case”.
    You need to change how forclosures are viewed in Oklahoma.

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