Zombie mortgages are coming back to life

0:00This message comes from WaterAid. Imagine having no clean water to drink, cook, or clean. That's the reality for one in four people worldwide. You can change that. Donate now and your gift will be matched at WaterAid. dot org slash podcast. This is Planet Money from NPR. One spring morning a couple of years ago, Karen McDonough was having her tea at her dining room table. She lives in a cute little two-bedroom place in Quincy, Massachusetts. She looks at her window to the neighborhood beyond and she sees something unusual. There were like 20 cars and they all came at the same time and they parked like in front of my house, across the street, up the street, and down the street.

0:44I just had this feeling like something really bad had happened. She was right. Something bad was definitely happening to her. And then I saw people get out, and then they were like coming to my lawn. And I'm like, why is everybody at my house? Karen puts on her shoes, goes out to the driveway. At this point, a group of men are milling around the lawn, casually dressed, except for one guy who seems to be in charge. There was somebody, I think he might have had a uniform on or something, and he had a piece of paper. And I said, what's happening? And he goes, we're selling your house. And I'm like, what are you talking about?

1:22He goes, don't pretend that you don't know what I'm talking about. And I go, I actually don't know what you're talking about. And he's like, well, we sent you information. And it was like a foreclosure sale on my home. This made no sense. Karen had been in the house for 17 years. She's a registered nurse, makes a good living, raised two kids here, and she was current on her mortgage. Sure, there were a few bumps along the way. A long time ago, during the great financial crisis, she had asked for a modification of her mortgage. That was perfectly normal back then, lower to payments. But now these men on the lawn were telling her, this is a foreclosure.

1:59You are going to lose this house. Karen is thinking, this has to be some kind of scam, right? I mean, maybe they're trying to rattle me. She doesn't know what to do, so she gets in her car. I almost didn't feel safe. Like, I didn't know what they were doing. And I said to the people, I said, I'm backing up. I said, get out of my way. And I just left. For months, Karen had been getting mysterious phone calls from strangers demanding money. Men insisting that they had dug up some long-lost debt she owed. It seemed so sketchy, like some sort of con game. But the men on her lawn seemed pretty real.

2:31She eventually finds herself at a beach outside Boston. And was it just like you drove to the beach and like look out at the water and you're like, what the hell is going on? Yeah, I was like shaken.

2:43Just like really overwhelmed. I was crying. Just didn't make any sense. I'm a mother and I'm a nurse and I'm being evicted from my house that I've been making monthly payments on. And then I'm current with. By the time she made it back to her house, it was all over. The strangers on her lawn had sold the house out from under her. Hello and welcome to Planet Money. I'm Robert Smith. And I'm Chris Arnold. We've been looking at a Karen's case for months now. And what we found was much scarier than some scam. Karen was right. She'd been paying her mortgage every month for years. This whole drama was about old debt.

3:25Debt that hadn't been heard from in more than a decade. Debt that everyone had told her was gone and forgotten. Our investigation revealed that thousands of other people are getting the same calls and facing the exact same sort of nightmare as Karen. People who took out loans about 20 years ago. Many say they were told the loans had been forgiven, but now the debt collectors come calling anyway. They are known as zombie mortgages. Zombies, because they can stay buried for years and then reach out and grab you. And take everything. Today on the show, why are all of these old debts coming back to life right now?

3:59Is it legal? And is there any way to stop the zombies?

4:31That's Vanguard.com slash audio. All investing is subject to risk. Vanguard Marketing Corporation distributor. Karen remembers the first time she saw her future home, the little yellow cottagey house in Quincy, Massachusetts. It was 2005. She'd just gotten divorced and was living in a small apartment nearby with her two sons. I saw this house. I really liked it. I thought the size was kind of charming. You know, it had a little yard. I thought it would be perfect because it was just the three of us. Back then, a lot of people wanted to buy houses. The housing bubble was filling with steam. I had a friend and she was a realtor.

5:09And at the time, she was telling me that you could buy a home right now, that it was a good time to buy a home. And here's how most people do it. To purchase a house, you put down 10 percent, sometimes it's 20 percent, in cash as a down payment. And then you borrow the rest of the money as a mortgage. Karen had a well-paying job as a nurse at Massachusetts General Hospital. Modest savings, but the house was$365 ,000 and she didn't have tens of thousands of dollars for a down payment. But during the housing bubble, Wall Street and banks wanted more people to buy houses. So they came up with all kinds of ways to do that.

5:47And one was a system to get rid of the down payment. Instead of giving you just one mortgage, They would give you two mortgages, two loans. And that second mortgage would basically cover the down payment. They used to say, no down payment, no problem. Just take a second mortgage. And it was called the second because if something happened to the homeowner and they had to foreclose on the house, the big mortgage, the first mortgage, would be first in line to get their money back. The second mortgage would be second in line. It takes longer to explain all this than it took for Karen McDonough to actually get one.

6:20It was the easiest thing I've ever applied for. I just filled out paperwork and submitted it, and it was approved. It was$292 ,000 for the first mortgage and$73 ,000 for the second. The two-bedroom cottage is hers, and she makes one of the great parental sacrifices for her sons. I gave them the master room. My room I gave them because they shared that room. And then I took the smaller room, but it was good. It's all good. And then, as Karen sleeps in her tiny bedroom, the world just goes crazy. The housing bubble collapses, and the great financial crisis begins. We were both reporters then, Chris.

7:00Yeah, we covered this together sometimes, Robert. And it was pretty intense, right? I mean, 2008, Lehman Brothers collapses. Banks were going under. The leaders of countries were scared. You know, it was on the news every night. And while that was going on, a lot of people were losing their homes. And as we all looked into it, we discovered it was those easy mortgages. They had this time bomb in them. The time bomb was that the interest rates were adjustable. I saw this destroy people. It honestly shook my faith in the banking system that anybody would make these loans in the first place. People would be chugging along, paying their mortgage that they could afford.

7:36But after just a couple of years, the loans were set to adjust way up. Yeah. And when you say way up, we mean like$700 more a month,$1 ,000 more a month. I mean, millions of people could not pay their mortgages. They were foreclosed upon and eventually had their houses taken away from them. And it was so many people that the government had to get involved. President Obama at the time, and his name was on the program just because that many people needed help. There had to be this national intervention. Yeah, they were called Obama loan modifications, and they sort of pushed down the interest rates, essentially allowing people to stay in the place they were living.

8:11Yeah. I talked to people who would say, like, President Obama fixed my mortgage. And I didn't really have the heart to tell him like, well, it probably wasn't the president himself who was like, you know, moving papers around and fixing your mortgage. So Karen eventually got one of these loan modifications for her big mortgage, her first mortgage, which was just a huge relief for her. But you may be thinking, what about the second mortgage, the one she had taken out for the down payment? This is the crucial question that will eventually lead to those men standing on her front lawn. As Karen remembers it, her mortgage company told her that that second mortgage was forgiven.

8:48I was actually in my kitchen. I was cooking dinner and I was talking to a representative and he told me I would never have to make a payment again on the second mortgage. And I just didn't question any of it because I was so grateful that the loan was modified. And to be clear, there wasn't any reason to question it. The same company had given her both mortgages. and now a representative for that company handling both mortgages was saying, hey, don't worry about the second. And sure enough, she used to get two bills in the mail for the two mortgages. And after a while, she just got one bill in the mail for her first mortgage.

9:23And that seemed to settle it, right? I mean, this thing must be dead. Years go by, a decade. Karen keeps going to work at Massachusetts General. She keeps paying her first mortgage. Her sons grow up. You can still see the pencil marks on the kitchen wall. If you look at this, you can see like this is them growing up and like their height. We always did that. That's something. Yeah, they are. They're both tall. In 2020, though, she gets a letter. It's from a company she's never heard of, First American National. It sounds like a bank, but it sure isn't her bank or even one that she's ever heard of.

10:00And the letter says, you owe us money. It had an amount and they wanted like a payment. And I think the amount was like$77 ,000. So I was kind of like shocked. I was kind of in disbelief. She thinks it can't be about her mortgage. She's been paying that every month to another company. So she calls the phone number on the letter. I'm like, are you the lawyer that's sending this information to me? And he was like, yeah. And then I was like, well, I'm like, why are you doing this? And he goes, well, why do you think I'm doing this? So he never answered me the way that I thought a professional lawyer would.

10:40So I just thought right away it was fraud. She decides to ignore it. But soon it becomes impossible to ignore. There are more phone calls demanding different amounts of money, threatening to foreclose on her house if she doesn't pay up. Karen starts to piece together that these calls are about that second mortgage that she had so long ago, the one that she'd been told was forgiven. So she calls up her first mortgage company. I was crying on the phone with them, like having a nervous breakdown. And she says they told her, you know what, this is probably fraud. And they kept saying, like, we're going to help you.

11:13You can't lose your home through this. You can't lose your home through this. That seemed logical. If someone official says that a loan is forgiven, then it must be forgiven, right? If no one sends you a statement for a decade, they can't just call you up out of the blue and demand money, can they? We called lawyers and advocates all over the country, government officials. They'd heard of stories like Karen's anecdotal stories about people losing their homes or being forced to sell them to pay the debt collectors. But nobody seemed to know the scale of the problem. In fact, one top federal official told us, if you find out, let us know.

11:50Yeah, so we kept digging, filed freedom of information requests. In just one state, the state of Maryland, we found at least 500 people facing foreclosure from what appear to be long, dormant, zombie second mortgages, just like Karen's. And when we looked across several states, we found at least 10 ,000 people who have old second mortgages from the housing bubble, where now a company is taking the very first step toward foreclosure. Our investigation also uncovered databases with the names of the companies that own these mortgages and that are trying to foreclose on people. There was First American National, the people who Karen had said were calling her and answering her questions with more questions.

12:30And companies with more cryptic names like BCMB1 Trust, First Key LLC, and ARC Private Equity. We tried to reach out to these companies, but a lot of them are LLCs registered in Delaware, which makes it extremely difficult to figure out who exactly owns them. But ARC Private Equity popped up on LinkedIn. The co-founder, a guy named David Gordon, was wishing everybody a happy new year and asking if they happen to have any old mortgages that they wanted to sell. Which, as everyone knows, is the traditional Wall Street way to celebrate the new year. So we called David up to have him explain, why is this happening now?

13:09Why is all this old zombie debt coming back to life? He was happy to talk to us. Hey, how's it going? Good. How are you, Chris and Robert? Excellent. Which one's which? We do get that a lot. David is part of a whole ecosystem of people that buy and sell mortgages. And generally speaking, having a lot of investors pouring money into home loans makes them cheaper and easier to get. David occupies a particular niche in all this. He's buying up bad debt. Now, David doesn't own Karen's old mortgage, but he's bought a lot of old mortgages just like hers, sent letters asking for money and sometimes threatened foreclosure.

13:46Not him personally, of course. He uses a debt collection firm. I'm not looking to take anybody's home. I want to make that clear. But, you know, an investor deserves to make their money back, you know, and there is real money at stake. The zombie mortgage problem was created during the run-up to the financial crisis of 2008. David was there watching it firsthand. He was at Morgan Stanley buying and selling mortgages like Karen's, putting them into bundles, and then selling them off as mortgage bonds. And then people started to default on their mortgages. And Morgan Stanley was on the brink of going under.

14:20He expected to be laid off any day. We were playing literally putt-putt golf on a trading desk for about six weeks. We all knew it was going to happen. It was a matter of when. The mortgage industry was wrecked. Many of the loans they made, close to worthless. We went from being rock stars to all of a sudden being frozen on the desk. You know, Wall Street loves you one day, hates you the next day. And fires you the day after that. David was suddenly unemployed, but he noticed something. All those mortgages he had helped package up into securities and sell for Morgan Stanley, they were on fire sale.

14:53The bank was a sinking ship and they were throwing bundles of dodgy mortgages overboard. Mortgage bonds, good ones in with the bad. You know, I'm looking at some of these bonds that were traded that we helped create. And that's when I had the aha moment. There's a great opportunity to have a good business. The business is to buy these bundles of mortgages for sometimes pennies on the dollar. Sure, some of them were worthless. The people who borrowed the money would never pay it back. But other mortgages might be worth something if you're willing to wait. And wait, they did. David and others like him bought up thousands of these mortgages.

15:32We asked him about Karen, though. She had modified her first mortgage, and she says she'd been told explicitly that she didn't need to worry about that second mortgage. David says he hears this all the time. People think they had their loans canceled. Maybe sometimes they were even told their loans were gone. But in many cases, he says... They still exist. It's not like they went away. And I think people were waiting on the sidelines to collect on those at some points. And that's why so many zombie mortgages are all coming back to life right now. Something big has changed in the real estate market that is causing debt collectors to come off the sidelines.

16:09And that is home prices. This is the fascinating thing about first and second mortgages. As we mentioned before, it's like the two mortgages are waiting in line to get paid back, right? If a house is sold or foreclosed upon, the first mortgage takes all the money, and anything left over goes to the second. So when home prices tanked and the housing market crashed back in 2008, the second mortgages seemed worthless. If you foreclosed and sold the house, you wouldn't even get enough money to cover mortgage number one, so there's nothing left for mortgage number two. But if you bought second mortgages and waited on the sidelines for housing prices to go up, all of a sudden the sad old second mortgage might be worth something.

16:52The house would be worth enough money that people like David could show up and say, ahem, time to pay back that long forgotten debt. This is what was happening to Karen. The house she'd bought for$365 ,000 in 2005 is now worth more than$600 ,000. And home prices have risen massively all over the country. And as that's happened, more people like David have been buying up the old second mortgages and sending those letters. These zombie mortgages have been opening their cold dead eyes and finally coming to life. Now, David tells us he's reasonable. He follows the rules. He'll negotiate with the homeowners, even lower the amount that he says they owe just a bit sometimes.

17:33And we're trying to work with our borrowers. Nine times out of 10, we're working with our borrowers. And most of those borrowers have been open to that. But he says, look, if you borrow money, you have to pay it back. You are sitting on a very expensive home, and this debt helped pay for that, helped you buy that home. And if somebody doesn't pay or doesn't respond, he does foreclose on houses. Nothing is free in this world. And if you signed up for a loan, you know what you signed up for. It blows my—it just—you know, it is what it is. It is what it is. You know what you signed up for, sure. But in Karen's case, she believed that what she had signed up for had changed, that the second mortgage was forgiven.

18:15When we last left Karen's story back in Quincy, Massachusetts, she was just starting to get those phone calls that felt like a scam. And these debt collector guys, they weren't just asking for the original$73 ,000 she borrowed. The numbers kept changing with different calls and different letters. Like, all of a sudden, here's a$73 ,000. No, it's$77 ,000. No, oh, actually, it's$112 ,000. One document says they were trying to collect two and a half times what she had originally borrowed,$184 ,000. She calls her first mortgage company again. It's called PHH. These are the people she pays every month.

18:52The ones she says told her it was probably a scam and to ignore the letters. They told me not to talk to them. PHH told me not to talk to them anymore. Don't give them any information. Hang up on them. Don't talk to them. So then I stopped talking to them. This would turn out to be exactly the wrong thing to do. We reached out to PHH, and they said they have not been able to find any record of giving Karen this advice, or even that they told Karen that her loan was forgiven in the first place. In 2021, that mysterious company, First American National, started foreclosure action on Karen's home.

19:27They did the usual legal things. They sent her letters, took out ads in a local newspaper. They eventually sent that guy in the uniform to stand on her front lawn that spring day. While Karen was sitting at the beach, wondering what was happening, they auctioned off her home. And the winning bidder ended up being that same company, First American National. Her house is now worth more than$600 ,000. They bought it for$180 ,000. A few weeks later, Karen got an orange eviction notice posted on her front door. And I saw the orange thing and then it said like, you have like 72 hours to get out. This is July 1st.

20:06It was a Friday. They did it on a Friday. So the 72 hours, because Monday was the holiday. I'm like, I have... This is the 4th of July. 4th of July weekend. So I couldn't get any legal help, even though I was trying to... So for those three days, 72 hours, I didn't sleep and I just started packing everything. You actually started to pack? Yeah, I was crying for three days straight. I just packed. And you're calling lawyers? Yeah. Most of the lawyers say, look, it's too late. I mean, lady, your house is sold. There's nothing we can do. But she does find one group of legal aid lawyers, a team that agrees to take a look at her case.

20:42They tell her, look, whatever you do, don't leave that house. Stop packing. Don't move out. We're going to fight this. After the break.

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22:17So you can focus on the pie you forgot to bake. When every second counts, count on ADT. Visit ADT.com. I've seen a lot of zombie movies. I'm kind of an expert. And the whole thing about zombies is that once they come back to life, they are relentless. You can cower in your home, but they just keep coming. And there are thousands of them. And that's pretty much what's been happening with zombie mortgages. It's not just Karen. and there are thousands of people waking up and finding that their whole life is threatened. And just like with zombies, hiding in your house and hoping it will be OK does not work.

22:56You have to fight back. There are lawyers and there are people out there who are willing to help you because it is not right. You should not lose your home. Christy Kelly has a consumer law firm in Fairfax, Virginia. She's not Karen's lawyer, but she's represented a lot of people who are in basically the same situation. Christy started out doing legal aid work during the housing crash 15 years ago. And like most of us, she thought this whole housing bubble debacle was over and done with. Ancient history. Until a few years ago, she began to get calls from people who were getting these threatening letters about old second mortgages.

23:33You know, you see like a lot of scams as a consumer lawyer. And I thought this can't be right. There must be something going on. And then I realized that this is not an error. It's a new trend. Christy calls the debt collectors and asks for the records on the loans. And what she sees is actually really ugly. Some of the loans have no documentation, no payment history. The record keeping was terrible. And Christy was especially shocked by how cheap these mortgages are bought and sold for. Remember, these companies are calling up homeowners and demanding tens of thousands of dollars. But sometimes these debt collectors have purchased that debt for almost nothing.