Yes, you might be able to sue a bankrupt mortgage lender or servicer, but chances are you won’t get much back, if anything, even if you did win. When a company goes bankrupt, all collection efforts, including lawsuits against the company, are put on hold. The company’s assets are then divided among those to whom the company owes money, in a legally established order of precedence.
Unfortunately, the chances are good that you are not one of the priority persons and can therefore only collect money if there is something left over afterwards. That can’t be anything. A bankruptcy lawyer can give you legal advice on where your case takes precedence in the bankruptcy proceedings and whether prosecution makes sense in your case.
According to the US Census Bureau, about two-thirds of Americans are homeowners. There are numerous benefits that come with owning a home, including:
- Relatively stable housing costs
- An investment that increases in value
- tax benefits
- A sense of permanence and belonging to your community
Most people don’t pay cash from their bank account when buying a home. You receive a home loan from a mortgage lender (usually a bank or credit union) in exchange for an interest in your property. If you fail to make the payments required by the loan to your lender, you will default. This gives the bank the right to sell the property and collect the balance of the loan. This process is called foreclosure.
Mortgage lenders such as Wells Fargo and Bank of America often sell the loan to a third party called the mortgage servicer. There are mutliple reasons for this. Mortgage lenders have legal limits on how much they can lend, so selling the loan allows the lender to initiate new lending. Lenders may also be able to make more money initiating loans than they can service.
Mortgage loan officers help process a loan. Mortgage loan processing includes:
- Accepting mortgage payments from homeowners
- Payments to investors (usually through escrow accounts)
- Sending payment reminders
- Filing foreclosure documents if the loan is in default.
Possible claims against your mortgage administrator
Not every loan processing runs smoothly. Your mortgage lender or servicer could get greedy or just plain wrong. For example, your mortgage servicer could misrepresent your actual interest rates under the terms of your loan agreement. They could also overcharge you for property inspection fees.
If so, you may have basis for a federal claim. The Fair Debt Collection Practices Act (FDCPA) prohibits mortgage lenders and service providers from engaging in abusive, unfair or deceptive practices in connection with consumer credit. The FDCPA applies to the origination and processing of mortgage loans, so you may be able to sue your lender or service provider in federal court if you have a valid legal claim. Many states have similar laws, so you may be able to sue under state law.
What happens if your lender or services file for bankruptcy?
Let’s say you have a valid FDCPA claim against your mortgage lender or servicer. In most cases, your lawsuit will be pursued in court until either it is resolved or you win a verdict. However, this process can be suspended if your lender or servicer files for bankruptcy.
We provide much more detail about bankruptcy elsewhere, but bankruptcy is essentially a court proceeding involving someone who cannot pay their debts. The bankruptcy proceedings begin with an application by the debtor (the debtor) to the federal bankruptcy court under the bankruptcy code. If the application is filed, all debt collection efforts—including legal actions to collect a debt—are put on hold. This is called an automatic stay.
A bankruptcy judge is responsible for overseeing the case. The judge appoints a third party, the US Trustee, to determine what is owed and what belongs to the debtor. Meanwhile, people who are owed money by the debtor (creditor) file claims with the bankruptcy court. The trustee submits a bankruptcy plan to the judge. This plan describes what the debtor’s property can be sold to pay off his debt. It can also identify exceptions (property that the debtor is allowed to keep). Depending on the type of bankruptcy filing, the plan may address restructuring or refinancing options.
Once they receive the bankruptcy plan, the judge will decide whether to approve the plan as submitted or if it needs to be modified in some way. If he approves the plan, the trustee sells the property and distributes the proceeds to the debtor’s creditors.
In many cases, the debtor does not have enough assets to cover his debts. In this case, the trustee must pay out the creditors in an order specified by law. This order depends on what type of believer you are.
There are basically two types of creditors. Secured creditors are those who have a proprietary interest (security interest) in the debtor’s property in addition to the debtor’s monetary debt. For example, if you bought a car and obtained a car loan, your lender likely has a security interest in the car. You would be a secured creditor. In contrast, unsecured creditors are those who have no security interest over the debtor’s property. You are only owed money.
Secured creditors take precedence over unsecured creditors. In other words, the US trustee pays the proceeds of the sale of the debtor’s property to secured creditors first. And if there is any money left over, the trustee pays the rest to the unsecured creditors. There is usually little or no money left over to pay for them.
Once the remaining assets are distributed to creditors, the bankruptcy judge forgives the debtor’s remaining debts and closes the bankruptcy proceedings. You can’t collect a claim if it’s discharged in bankruptcy, which means creditors (particularly unsecured creditors) often get nothing.
You could win, but you could still lose
Now, getting back to your FDCPA lawsuit. If your mortgage administrator files for bankruptcy, your lawsuit – which is an attempt to collect a debt – will be stayed when the automatic stay goes into effect. Since you do not have a security interest in your mortgage administrator’s property, you would be a consumer creditor, an unsecured creditor.
Your mortgage administrator would go through the bankruptcy process. You would file a lawsuit stating the basis of your lawsuit as well as the amount of money you wish to recover. Once the trustee acquired the servicer’s property and sold its assets, it would distribute the proceeds first to secured creditors and then to unsecured creditors. If you have a valid legal claim, you may receive some money. If you do, it will likely be significantly less than what you’re looking for.
A case study: Ditech Holdings
One of the last mortgage lenders and servicers to file for bankruptcy was Ditech Holdings. Ditech Holdings owned two companies: Ditech Financial (a mortgage originator and servicer) and Reverse Mortgage Solutions (RMS) (a provider of conversion home loans known as reverse mortgages). Ditech, through its subsidiaries, has collected mortgage loan payments on approximately 1.4 million residential real estate loans.
Thousands of homeowners are suing Ditech in both individual and class actions, so-called class actions, alleging that it mishandled their mortgage payments and levied illegal fees in a series of scams. In February 2019, Ditech and its subsidiaries in the Southern District of New York filed for bankruptcy for the second time in less than two years. The vast majority of claims were settled in bankruptcy; Most homeowners received little. Later that year, Ditech sold its mortgage businesses, Ditech Financial and RMS, as part of the bankruptcy reorganization plan.
A lawyer may be able to help you recover
Mortgage lenders and mortgage servicers are generally large corporations with significant resources. However, like many other businesses, they can run into financial difficulties and file for bankruptcy.
If you believe you have a claim against your lender or servicer, you may be able to recover it in bankruptcy proceedings. You may not be able to get much back, if anything, but a bankruptcy attorney may be able to help you assess whether your claim is worth pursuing. Keep in mind that if you delay the lawsuit for too long, you may not be able to get anything back once the company’s debt is paid off.