No one buys a home believing they’ll default on the loan; it’s always a possibility — and indeed, anyone who’s lived through the housing crisis in the last decade, knows it’s a very real possibility — but it’s a nebulous possibility especially considering it will only occur if several other things fail: loss of job, savings, inability to find a new job, etc.
However, when a person with a mortgage – known as a mortgagor in legal lingo – fails to make payments to their lender, the nebulous possibility turns into a crushing reality. Sometimes, a mortgagor can repair a mortgage loan by working out an agreement with the lender. But if such an agreement between the mortgagor and lending institution cannot be reached then the mortgagor will inevitably face foreclosure.
Something less talked about is that lenders are still obliged to act within certain ethical bounds even after a foreclosure has been implemented. All lenders – or “mortgagees” – must conduct themselves with “good faith” and exercise “due diligence” to see that the adverse impact of the default is kept to an absolute minimum. Failure to abide by these ethical standards is a serious issue and transgressors can face severe penalties.
When a default occurs, mortgagees must try to reach an outcome to fairly settle the matter, they cannot simply view the default as an opportunity to enrich themselves.
In the case of Murphy v Financial Development Corporation (1985), there’s a clear understanding of what due diligence is and what it requires from a lending institution. This is a case which all mortgagors should be aware of, even those who figure they have not the slightest chance of ever falling into financial trouble.
Murphy v Financial Development Corporation: The Case
The plaintiffs (Mr. & Mrs. Murphy) had purchased their home (with a mortgage loan) in 1966. And although they refinanced in 1980, a job loss resulted in the family falling seven months behind on their payments in 1981.
The plaintiff attempted to negotiate with the defendant (Financial Development Corporation) in order to repair the loan. While the Murphys were able to pay off the back payments, they were unable to pay off the legal fees and late fees. As a result, the house was foreclosed and Financial Development Corporation sold the property to one of their adjacent companies for $27,000 — the exact amount the Murphys owed. Within 2 days, the new owner of the property sold the house to a new buyer for $38,000.
However, the plaintiffs had had the house appraised before it was sold. They had accrued $19,000 of equity in the home, making it worth $46,000. So the Murphys sued because the defendant’s initial sale of $27,000 had the dual effect of making the defendant “whole” while failing to account for the plaintiff’s substantial equity.
Though the defendant acted in good faith by negotiating with the plaintiff and giving them the opportunity to repair the mortgage, the question before the court was whether the defendant acted with due diligence by selling the house to its representative and taking into account the fair market value.
What’s the law say?
Whether a mortgagee has acted with due diligence when selling a house which has been foreclosed upon requires a case-specific analysis. In general, due diligence requires that a mortgagee expend reasonable effort to obtain a fair price for the property.
The Court Rules in Favor of the Murphys
The court (Supreme Court of New Hampshire) upheld the decision reached by the trial court and ruled in favor of the plaintiffs (the Murphys).
The court determined that, in this instance, the defendant had acted in good faith but failed to exercise due diligence. The court based its decision on the following facts: the defendant put only a small amount of effort toward advertising the auction; the defendant did not place a minimum bid at the auction; the defendant accepted an offer substantially below the market value of the property; and the defendant immediately sold the property to a new buyer for a quick profit.
As mentioned before, the determination of whether due diligence has been exercised is a case-by-case analysis. In this case, the defendant acted in good faith, though it was clear not enough action was taken in order to meet the requirements of due diligence.
All mortgagors need to be aware of this fact: even if you fall behind on your payments, you still need to make certain that your lender conducts itself according to prevailing ethical standards.
Image by Gerd Altmann