One of the Consumer Financial Protection Bureau’s (CFPB) new mortgage servicing rules that became effective on January 10, 2014 has resulted in a number of questions from our community bank clients. The new rule, which applies to all mortgage loan servicers, including banks that qualify for the "small servicer" exemption,¹ prohibits a servicer of a first lien residential mortgage loan for a home occupied by the borrower as a principal residence from making "the first notice or filing required by applicable law for any…foreclosure process unless the loan is more than 120-days delinquent."² The CFPB refers to this as the "pre-foreclosure review period."

This new 120-day waiting period is intended to give delinquent borrowers an opportunity to apply to the loan servicer for any available loss mitigation options, and to give certainty to the parties involved as to when a foreclosure can be commenced. The new CFPB rule preempts any state or local laws that would permit a foreclosure to proceed more quickly.

In addition, the rule prohibits servicers from making a "first notice or filing," moving for a foreclosure judgment or order of sale, or conducting a foreclosure sale if the borrower at that time is performing pursuant to the terms of a loss mitigation agreement.

Under Wisconsin’s foreclosure law and practice, the "first notice or filing" to commence a foreclosure typically would be the filing of a summons and complaint by the lender or servicer seeking to foreclose on real estate.³ Prior to the CFPB’s new rule, Wisconsin banks often would file their foreclosure complaints when borrowers became 45-60 days delinquent on their loan payments. If the borrower failed to answer the complaint, the bank could obtain a default judgment shortly thereafter, so that by approximately 90 days from delinquency the servicer could have a foreclosure judgment in hand. At that point, under Wisconsin law there would be an additional six-month or twelve-month redemption period provided for the borrower (depending upon whether the bank elected to waive its right to recover any deficiency), before a sheriff’s sale could be conducted.⁴

In many cases, before the new CFPB rules became effective, a Wisconsin lender acting expeditiously could commence a foreclosure action on a delinquent residential mortgage and realize upon its collateral through a sheriff’s sale within eight to nine months of delinquency under the loan.

The new CFPB rules will undoubtedly lengthen the time period to twelve months or longer from the start of delinquency before a bank may realize on its collateral, as well as create, as described below, some difficult questions as to exactly when the mortgagee is permitted to commence a foreclosure action without violating the CFPB’s new "120-days delinquent" rule.⁵

For example, "delinquency" is defined in the CFPB’s rules purely in the context of a delinquency in the payment of principal, interest, and, if applicable, escrow payments. "Delinquency begins on the day a payment sufficient to cover principal, interest, and, if applicable, escrow for a given billing cycle is due and unpaid, even if the borrower is afforded a period [of time] after the due date to pay before the servicer assesses a late fee." ⁶

If a mortgage payment is due January 1, but includes a fifteen-day grace period before a late fee is charged, and if the servicer does not receive the full payment owed by January 1, then the 120-day waiting period can commence under the new rule starting on January 1.

What if the loan continues to be delinquent for a total of 115 days and on that day the borrower makes a regular monthly payment so that the loan then is 85 days delinquent? Unfortunately, the CFPB’s rules seem to permit a "gaming" of the system by the borrower in this way, as a tool to prevent the commencement of a foreclosure action. There is nothing included in the rule to prevent a borrower from letting a delinquency reach 119 days repeatedly, then making a regular payment of principal and interest, and essentially blocking the foreclosure process from ever starting. The "permanently delinquent borrower" is a likely result of the CFPB’s new rule.

What about the situation where a borrower is not required by the lender to escrow for taxes and insurance and the borrower’s only monthly payment obligation under the note is to pay principal and interest? Assume the borrower is current on monthly principal and interest payments, but failed to make timely payment of property taxes or insurance? While such failures almost certainly would be a default by the borrower under the mortgage, the servicer cannot commence a foreclosure due to this default since the definition of "delinquency" under the new CFPB rules has not been met: Namely, a delinquency only relates to the payment of principal, interest and any required escrow for taxes/insurance; it does not include a failure to meet any other obligation the borrower also may have agreed to perform in the note or mortgage.

Several clients recently have raised this exact scenario with us, including their frustration about not being able to commence a foreclosure after the borrower failed to pay property taxes when due, where amounts for taxes were not being escrowed and the loan was otherwise current.

We have advised clients that, depending on the loan documents, the servicer could declare a default and accelerate the full balance owing under the Note based on the borrower’s failure to pay taxes or insurance premiums when due. When the borrower fails to repay the full accelerated principal balance plus accrued interest within 120-days of acceleration, we believe the servicer could then commence a foreclosure action without violating the CFPB’s new rules.

Other clients have asked whether the foreclosure complaint may only be filed at a time when the borrower is at least 120-days delinquent. For example, assume that a borrower’s payments are 120-days delinquent, but the servicer does not file a complaint for foreclosure for ten more days. During that time before the complaint is filed—day 129 for example—assume the borrower makes a regular payment of principal and interest so that the loan is then 100 days delinquent. We read the CFPB’s rule as prohibiting a foreclosure filing in this situation, since the loan would not be 120-days delinquent at the time the foreclosure process is commenced.

This potential gaming of the new rule by borrowers (and their attorneys who might be advising them) suggests that mortgage loan servicers should be prepared and ready to promptly send letters of default accelerating the principal balance as soon as a default occurs, and also to file to commence a foreclosure immediately upon a loan becoming 120-days delinquent.

The new CFPB rule delaying the beginning of a foreclosure certainly will prolong the foreclosure process in Wisconsin. This delay, in turn, will result in an increase in the amount required to be paid by the borrower to prevent the foreclosure, thereby increasing the risk that delinquent borrowers eventually will lose their homes in a foreclosure. The CFPB’s newly mandated "pre-foreclosure review period" could further result in more borrowers simply deciding to abandon their homes that are "underwater," as well as leading local taxing authorities to move more expeditiously to foreclose on their liens for unpaid taxes.

_{1 A "small servicer" under the CFPB rules is a bank that, together with affiliates, services 5,000 or fewer mortgage loans, when the bank or an affiliate is the creditor or assignee for all of them. 12 C.F.R. §1026.41(e)(4). Servicers who do not qualify for the "small servicer" exemption under the CFPB’s new RESPA rules must also pay attention to several other requirements regarding loss mitigation procedures. A discussion of these additional restrictions and requirements is beyond the scope of this article.}

_{2 12 C.F.R. §1024.41(f)(1).}

_{3 Wis. Stat. § 801.02; see generally Chapter 846.}

_{4 Wis. Stats. § 846.10(2); 846.101.}

_{5 Damages for violations of this rule may be enforced by borrowers and may include actual damages; statutory damages up to $2,000 in individual actions and up to 1% of a servicer’s net worth in class actions; and attorney’s fees and court costs. There is a three-year statute of limitations for violations of this rule. Examiners also may write up lenders for violations of this Rule. 12 U.S.C. § 2605(f); 12 C.F.R. §1024.41(a).}

_{6 12 C.F.R. §1024.39(a)(1).}