Zombie Mortgage

What is a Zombie Mortgage

One of the many results of the real-estate market collapse in the early 21st century was the advent of a “zombie mortgage”.  Sometimes known as a “zombie foreclosure, zombie title, or zombie property”, this is the situation where a property owner has abandoned a property encumbered by a mortgage and the lender will not foreclose and take the property.  In this instance the property owner remains legally liable for all costs associated with the property’s upkeep – including city code violations, liability for blight and personal injury.  All this notwithstanding the costs born by neighborhoods and municipalities who bear the cost burden associated with unpaid HOA’s and taxes, let alone the safety hazards and diminished property values.  Additionally an abandoned property invites within its walls crime, disrepair, pest infestation, and other ills which ultimately cause the property to become even less valuable if not completely condemned.

Why don’t Lender’s Foreclose?

There are a number of reasons why mortgage holders do not exercise on their rights and reposes the collateral.   The foreclosure systems can become overwhelmed which in turn causes delay.  Additionally, lending abuses caused banks to place moratoriums on foreclosures and wait for court rulings to ensure they were safe to foreclosure.  Mortgage holders, particularly in a down real-estate market, have little desire to become owners as they are now responsible for those same costs and expenses with little chance of liquidating the property.  Banking institutions are facing higher degrees of scrutiny from the government as to their liquidity and as such cannot bear the financial burden of owning thousands of vacant properties.  Additionally the federal government has also provided incentives to large intuitions to avoid foreclosures as long as possible – after all it makes for disenfranchised voters when the bank foreclosures deprive people of their homes and the glut of cheap properties slashes everyone else’s home values.  Besides, it allows politicians state that they have done “something” about the foreclosure problem thus making it someone else’s issue.

Bankruptcy and Zombie Mortgages

In bankruptcy this problem can be particularly troublesome.  Oftentimes a debtor will elect to surrender real property thereby eliminating the personal liability to the lender.  This option is allowed by the bankruptcy code and is designed to afford a fresh start.  However if the bank does not foreclose, the debtor become responsible for all of the post-bankruptcy associated costs of home-ownership thereby impeding the fresh start provided by the bankruptcy code.

In bankruptcy there is a small, but growing, body of case law which allows debtors and trustees to force the sale of such properties.  Practically speaking however such measures will require action above and beyond the standard bankruptcy and almost certainly require an adversary proceeding or a contested matter – something beyond the means of most debtors.

In the event that the benefits outweigh the costs debtor can proceed ahead with bankruptcy litigation to force the sale.  Usually courts will look to Section 363 of the Bankruptcy Code for authority to permit sales under such circumstances.  Sometimes a court will use its equitable powers under Section 105.  However the former faces very divergent approaches depending on jurisdiction and the latter requires asking a court to do something it might not be comfortable undertaking.  As of the writing of this document there don’t appear to be any relevant opinions within the Colorado bankruptcy courts.

As real estate markets improve then this issue becomes less of a problem.  Some local jurisdictions are attempting to implement laws designed to remedy this problem.  However they face challenges in that such laws will conflict with long established legal principals in addition to the likelihood that places additional legal burdens would increase the cost of lending for everyone else.