If you look from 50,000 feet, there are two sides to the debate over mortgage modifications. On the one hand, a surprisingly large group, which includes beleaguered homeowners, mortgage investors and town and municipal governments, all favor mortgage modifications, particularly principal modifications. Their argument is simple. If you are dealing with a big enough loan, it’s always better for a bank to take half a loaf rather than none when a borrower gets in trouble. That’s why, historically, banks would quietly cut a deal with a stressed homeowner who still had a viable level of income and was committed to keeping his house.
Against them have been arrayed a peculiar band of moralists who argue that people who can’t pay their obligations should suffer, no matter how high the cost of this cut your nose to spite your face attitude is in terms of damage to home prices in the community and lost tax revenues. And in keeping with that, the press has taken up the “strategic default” meme, which perversely tries to depict lenders as victims of calculating borrowers.
The interested group that seldom makes its wishes known in public, of course, is the one that benefits most from this perverse status quo of “fewer mods than there ought to be” which is mortgage servicers. They aren’t set up to do mortgage modifications while they have set up streamlined processes for foreclosure. And they also get paid additional fees when borrowers are delinquent and enter foreclosure (many aren’t legitimate; as we heard from whistleblowers at Bank of America, foreclosure abuses and fee padding were endemic).
The foregoing means that modifications are always preferable and servicers need to be pressed harder to do more, right?
Not necessarily. Never underestimate the ability of banks to game a system.
On the one hand, if a borrower can get a mortgage modification that enables him to keep his home, everybody wins except the servicer, who doesn’t get his late fee/foreclosure pound of flesh (note various incentive fees to servicers under programs like HAMP and HAMP 2.0 alleviate but don’t necessarily solve this wee problem).
However, the part the modification proponents often underplay is borrower redefaults. The moralists love to inveigh that redefaults are just proof that the borrowers were deadbeats and should never have been cut a break. But the reality is that the redefaulting borrower also comes out a loser. If they had not gotten the modification, they would have lost the home sooner, which means they would have saved the additional payments under the modification. That’s more money to establish themselves in a rental, since moving and putting down a deposit require outlays. And for some people, those savings may mean the difference between living in a car or on the street.
And who wins in a redefault? The servicers. They get to collect even more late fees and other padded fees than they would have otherwise. For instance, the Bank of America whistleblowers (and others) have found evidence that banks inflate attorney fees during the foreclosure process. In many states, there are limits on how much is permissible, and on top of that, Fannie and Freddie have their own caps. If a mortgage is modified, all the past due charges, such as attorney fees, are often rolled into the principal balance. File reviewers reported numerous instances of impermissibly high attorney fees ($5,000 to $10,000 was common, and one case featured a simply implausible $85,000 total). Similarly, whistleblowers at another servicer, PNC, report that a crisis erupted during their OCC mandated foreclosure reviews when the guidelines were modified to require that they find and check the documentation of third party fees such as attorney fees. They stated that it was clear the attorney fees charged through the widely used Lender Processing Servicing platform could not be substantiated. So the evidence points to widespread abuse.
One example comes via a sad tale in the Puget Sound Business Journal (hat tip kimberly k). A young man bought a condo in Maine in 2006 at peak of bubble prices with a fixed rate loan and 10% down. He could afford the loan. However, when the crisis hit, a number of people in the condo defaulted, leading to increases in HOA fees. In addition, he met his fiance and they both struggled post the crisis in the crappy Maine economy (Maine is not exactly robust even in the best of times, and suffered not only a fall in tourism but other important sources of income (such as decommissioning of a major airbase, low lobster prices, etc). They put the condo on the market in 2011, six months before their move to the Seattle area.
To shorten a long and painful story, after they failed to attract a tenant and kept lowering the asking price, Bank of America refused to entertain a short sale offer. They insisted the couple default. They then refused to accept a post default second short sale (the persistent buyer kept trying to work with BofA for nearly a year). The latest chapters:
After that second short sale was rejected, we began what is called a “deed in lieu” process, which basically means you skip the foreclosure process and hand over your deed to the bank….
Then, as things looked like they were finally going to be over, we got a letter back-dated by two weeks that said Bank of America was selling our loan to another company….
The company that now owns our loan? The lawyers we’ve talked to call it the worst mortgage company in the country….
The new company, Green Tree Servicing, has nothing. No documents. No idea who we are when we call. No idea that we’ve been through two short sales and a deed in lieu process. They just offered us a loan modification.
You can bet that Green Tree will locate and/or make up every sort of charge they can since this couple defaulted and capitalize it. They don’t care if the mod works. In fact, their incentive is to have the mod fail since they’ll get all the charges they bundle into the mod first if the condo is foreclosed upon (the servicer reimburses itself first out of sale proceeds for principal and interest it has advanced to the investors and foreclosure and various other fees, like late fees and its servicing fee).
So modifications can serve as a way not to save borrowers, but to extract more blood from them.
And the worst is the officialdom has no idea of how often this sort of abuse occurs. Oh, they do collect overall statistics on modification redefaults. But they have no idea what a good level of redefaults is, in part because numbers alone don’t tell the story. People can redefault because Shit Happened (job loss, death, disability, medical emergency, divorce) or because they were going to hit the wall regardless or because the modification was too small and the servicer knew or should have known that. The first category can’t be foreseen but the latter two can be, and the authorities should be just as keen to avoid those outcomes as they should be to get big enough mods to borrowers who can be salvaged.
And there is some evidence predatory mods are taking place now. See this table from the OCC’s latest mortgage metrics report (hat tip MS):
Notice the 47% redefault rate after 12 months for “government guaranteed” loans. The narrative attributes the disparity to “differences in the loans and modification programs as well as the servicers’ flexibility when modifying mortgages they owned” but the OCC and other regulators lack the underlying data to know what is really afoot. And a near 50% redefault rate looks a lot more like borrower abuse than misguided servicer charity.
So be careful what you wish for, even for long-suffering borrowers. The Puget Sound article depicts clearly that being allowed to keep a home can be a curse rather than a blessing.