Another Layer of the Mortgage Mess: “Zombie Notes”

One of the claims we’ve heard throughout the mortgage crisis is that all the systems and records are fine, that the banks have just made a few “mistakes” and when they find out about them, they correct them promptly and cheerfully.

If you believe that, I have a bridge I’d like to sell you. Not only is evidence of widespread, and very likely systematic abuses piling up in courtrooms all over the US, but even at this late date, new types of misconduct are coming to light.

Lisa Epstein and April Charney pointed out the latest version, that of “zombie notes”. It’s another version of the “who has the note” (the borrower IOU) problem. In this case, thousands of borrowers in Florida (and potentially other states) who were being foreclosed upon were contacted by Fannie Mae and offered the opportunity to have the debt cancelled if they gave a deed in lieu of foreclosure. That’s a fancy way of saying if they gave up their rights to the house and vacated, Fannie would drop the foreclosure action. The advantage to the borrower is that he puts the matter behind him (if the house is sold for less than the mortgage balance, for instance, he can’t be sued for a deficiency judgment) and suffers less damage to his credit record.

But it appears Fannie did not live up to its side of the bargain, and even a representative of the American Bankers Association distanced itself from the agency’s action, saying it is “not a practice we’ve ever heard of.”

From the Fort Myers News-Press:

Here’s what happened, according to Lee County court documents:

1. Marshall Watson, the attorney for Fannie Mae and for Bank of America, sends a document called a deed in lieu of foreclosure to Cruz in late 2009. The document, when signed by [David] Cruz, transfers ownership of the house in Tice from him to Fannie Mae.

In exchange, Fannie Mae agrees “that it is releasing the promissory note” and it won’t sue Cruz for money owed under either the note or the mortgage. Cruz signs the deed and returns it to Watson.

2. On Feb. 15, 2010, Bank of America – which was handling Cruz’s loan for Fannie – simultaneously records the deed in lieu of foreclosure and assigns its ownership of the mortgage and note back to Fannie Mae.

The bank handling a loan typically is assigned ownership temporarily so it can deal with the case. Bottom line: Fannie Mae now has ownership of the house in Tice.

3. On April 23, 2010, Fannie Mae records a satisfaction of mortgage, which discharges Cruz’s $123,750 mortgage.

The document does not, however, mention the note despite the language of the deed in lieu of foreclosure.

The holder of the note, whoever that may be, has the legal right to recover the mortgage money from Cruz….

Xiomara Cruz, David Cruz’s attorney and ex-wife, said she’s looked at court records from around the state and likely thousands of people were treated in the same way….

“Under the commercial code, it’s still alive,” she said. “The deal he made was to cancel the note. If they can’t perform, it’s a fraud.”

Xiomara Cruz said she hasn’t been able to find out who owns the note.

The article points out the risk to the borrower is not theoretical:

Even if Fannie has the note, Cruz should take little comfort from the fact he’s dealing with a federally backed entity, said Jack Williams, resident scholar at the American Bankruptcy Institute and a bankruptcy professor at Georgia State University.

“That note is a legal obligation,” he said, and even if Fannie Mae doesn’t sue, it could sell the debt to someone who would….

“Let me tell you, people made millions of dollars suing homeowners back in the day [in the wake of the savings and loan crisis],” Williams said.

Some of the debt was in the form of deficiency notes: court judgments saying a certain amount was owed even after the property was sold at public auction.

But in other cases, Williams said, it was the note, straight up.

Have readers seen this happen in other states, particularly with Fannie or Freddie?

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  1. Paul Tioxon

    I have not seen this with the current crisis. But I can tell you that if you do sign over the deed, in lieu of a foreclosure, you want to receive the original mortgage note that you signed at the closing when you bought the house or refinanced. You should get a closing package at the table before you leave the door with all of these docs and a notarized Hud-1, confirming the transaction. In the closing package you take WITH YOU, is a copy of the mortgage note, the original goes to the lender.

    When the debt is cancelled for whatever reason, in this case, an agreement to deed the title from your name, to the lender, in exchange for canceling the debt, you should receive the original note back, with a notarized stamp declaring that the note is paid in full, date, authorized signature of bank officer and notary. With this simple, standard procedure,which I have personally seen, no one will have the note to pass around and around to sell and resell or simply lose track of altogether.

    The problem in the past has been that even when you had the cancelled note, no one went to the court house to record this fact. It was up to you, not the bank to look after the correct status of your property. In future sales or refis, it would come up in a title search and would be a stipulation that is easily cleared by producing the note which was returned to you, stamped paid in full. If not that, a letter, a mortgage satisfaction piece, usually a copy of the letter sent to record the cancelling of the debt to a court house would also work.

    These 2 documents were typically the only 2 documents that would determine the authenticity of a mortgage debt, and then the authenticity of its cancellation when paid in full.

    Clearly, MERS has wreaked havoc with the entire real estate property system in America by trying to bypass the very structure which ensure property rights to begin with. Property, is not privacy, but a publicly acknowledged record that a piece of real estate is yours. Without the clear paper trail of deeds and their transfer and the liens recorded against property, we are witnessing the fog of ignorance that written records, publicly recorded and publicly available for review would clarify.

    The closing package of documents will contain the mortgage note, and the name of the lender, or its assignees, you are taking a loan from. There is also a mortgage service transfer agreement, where you acknowledge that the servicing of your mortgage may be regularly transferred, but that this does NOT change the terms of the loan spelled out in the note. The note may be assigned, but that happens after the closing, and you will not know who that is. The original note along with the assignment of the note, if necessary due it being sold or moved to a trust, will be 2 sets of documents that will establish who you owe money.

    If you use deed in lieu of foreclosure, you must get the original note and in the case of transfer, the agreement of assignment. Simply a mortgage satisfaction piece, recorded at the court house, may not stop an aggressive attorney, if they produce a note that has NOT been stamped as “paid in full” and notarized. MERS opens this window of opportunity by destroying the paper trail and leaving only their electronic version of events.

    1. Anonymous Jones

      “Property, is not privacy, but a publicly acknowledged record that a piece of real estate is yours. Without the clear paper trail of deeds and their transfer and the liens recorded against property, we are witnessing the fog of ignorance that written records, publicly recorded and publicly available for review would clarify.”

      You make good points.

      It can become very frustrating dealing with people who have no idea that they have no idea what they are talking about.

      The system of public recordation is a long-developed set of rules to communicate priority of property rights to the community at large, so that members of this community can make informed decisions regarding purchases, sales and secured lending. The idea (so crazy) is that informed decisions are more likely to yield better results than uninformed decisions. [Yes, it is so obvious that this would work in libertarian, propertarian or anarchist utopias, but let’s ignore that obvious utopian reality for just a minute].

      I wish I didn’t have to go on, but the ignorant, as they say, are insistent. The Statute of Frauds didn’t develop in a f’ing vacuum. You know, there might have been, I guess, a reason for it? Just maybe?

      Look, we have a well developed legal framework that depends on the original promissory note. The reason for this is obviously that big promissory notes are, you guessed it, ‘big deals’ that require a higher than normal proof.

      You can’t just junk this for expediency’s sake, just like you can’t ‘Ox Bow Incident’ someone just because you’re ‘sure’ it’s in the interest of ‘justice.’

    2. Nathanael

      Nowadays, with this utter, utter mess, you may not be able to get your original cancelled note.

      In which case your best — well, only really — option is to file a quiet-title.

  2. Gwailo

    There is another problem lurking here as well. The amount of the debt in excess of the value of the property transferred by the deed in lieu may be “Cancellation Of Debt income”, at least if the debt was “recourse” (i.e. if there could *potentially* have been a deficiency judgment.) The theory is that people are better off when their debts are “forgiven”, so “relief from liability” is treated as taxable income in many cases. Section 108 of the tax code provides some exceptions from C-O-D income for homeowners and bankrupts, but someone who gives a deed in lieu may be unpleasantly surprised down the road when they receive a Form 1099-COD from the lender/servicer. The C-O-D rules actually do make sense, technically, but they put the IRS in the unfortunate position of kicking people when they are down.

    Note that different rules may apply to non-recourse debt, for example in nonjudicial foreclosure states such as California.


  3. Jack Straw

    The tax consequences are far more serious than a potential collection action on the note. IMO, woe unto a party seeking enforcement of a note after a DIL if any representation is made anywhere in writing that the debt has been cancelled. A “cancelled” note is not necessary to prove this. The lender/note enforcer’s DIL package is enough if it states that the debt will be cancelled in consideration for the DIL and the borrower can show acceptance and performance of the DIL transaction. Borrowers defending against cancelled debt not only have a bullet-proof defense, but likely would get Rule 11 attorneys fees as well.

    For tax information, see,,id=179414,00.html

    This provision is set to expire in 2012.

  4. Tim Sprayopolis

    Fannie Mae, captured and used as a weapon. If they built MERS
    to get around inconveniences, what other systems can you think of that might be used to get around other “inconveniences”?

  5. Up the Ante

    When Ahnold said, “Let’s Party”, the mortgage industry heard its call.

    ” .. even a representative of the American Bankers Association distanced itself from the agency’s action, saying it is “not a practice we’ve ever heard of.””

    Yes, of course.

  6. Fraud Guy

    I’ve paid off four mortgages over the last 10 years, two via re-financing, one via sale of the property, and one (through good fortune) by simply paying off the balance. I never received a canceled note with any of them. Was I supposed to? Am I theoretically exposed? Have others received canceled notes in these scenarios? All of my mortgages were through Wells Fargo.

    1. Yearning to Learn

      We just paid off our mortgage because of all the issues out there (and ZIRP kills any chance of return except high risk assets).

      I’ll let you know what I get in the mail!

      I was never able to find out if my note was securitized. (my loan was through Wells, and it was serviced by Wells the whole time, and I never got documentation that it changed hands… but who knows)

      I’m terrified I’ll get the loan papers and see robosignatures and then I’ll have paid off a mortgage on a home with a note out there somewhere



      1. Nathanael

        If you do find trouble, consider filing a quiet-title when you have the money to do so.

    2. Nathanael

      You are exposed. I wouldn’t worry about the properties you’ve already sold, but you’ll probably need to quiet-title on the ones you still own.

  7. Jack Straw

    I would not worry a whole lot about paid off mortgages, but you should keep your records. If the release/reconveyance is filed with the recorder, then in most states – and definitely my state – you’re good to go.

    Many releases also have satisfaction of debt language in them, but as Iyves points out, some do not. If so, then that really is all you need. If not, and someone shows up to collect on the note, provide them with the release/reconveyance, and if they persist, you have a nice attorney’s fees case.

    Just remember, anybody can be sued for anything. Certain lawsuits are exceedingly unlikely, however.

  8. Marcie

    In reviewing our documents in preparation of a response to a Motion for Sanctions we found that we have not one but two active loans in MERS. Federal Case 1:11-cv-00042-MSK -KLM Document 68 Filed 05/31/11 USDC Colorado. Look at all the exhibits.

    So Freddie Mac has a FED against us and Fannie Mae is also an investor for a note that was allegedly paid off. I reported this to the FHFA and recieved a letter from the Deputy Inspector General, Office of Investigations stating that our issues were very important to them.

    It appears that Fannie Mae and Freddie Mac were double dipping on the same property and counting loans that were either never closed or were paid off. If you look at this case in PACER and look at that filing it has several exhibits that document exactly what Yves is saying is happening. They have been caught though because TBW was shut down for fraud and we have been in the courts for months now, getting nowhere.

  9. bill n

    It really sounds like the most normal case is that no one knows where the “note” is these days.

    This could be a decent basis for new law to the effect that some “credible path of documentation” can be declared sufficient to have standing as showing ownership. ??

    Probably, per several of the above comments, in the last few years there are millions of “zombie notes” floating around out there, including those for paid off mortgages.

    This sounds like a big payday for an out-of-work lawyer. Lesse … who has big pockets that can be said to have wronged the entire class of homeowners… Of course! The Gument!

    1. Nathanael

      Some >700 year old rules of our legal system:
      – if you can’t prove a lien on property exists, the lien is unenforceable.
      – if you can’t prove a debt exists, the debt is unenforceable.
      – possession is nine tenths of the law.

      Accordingly, the traditional rule in cases like this is that the person living in the home gets it free and clear. We’ll see what happens, but some NY courts have already started ruling this way.

  10. Bravo

    If Ms. Cruz couldn’t find the note, the likely culprit was either a securitization fail that Fannie doesn’t want to expose, or the note could not be tracked through the MERS system due to negligence on the part of its members. Not a bad deal for Uncle Sam to make…trading what is quite likely an unsecured or lost note for somebody’s house and making an empty promise not to sue for a deficiency on a note that it can’t produce or may not have ever been conveyed to its respective trust per the PSA. A fine state of affairs here, with Uncle Sam’s GSE’s now taking advantage of unknowing homeowners, rather than offering meaningful participating pricipal modifications (taking a piece of the upside) that would be far more equitable to both parties given their respective positions and help to stabilize the overall housing market by further slowing supply growth through foreclosures.

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