Loss mitigation and loan modification are popular topics in discussions on how to assist struggling homeowners to avoid foreclosure and keep their homes. By the end of 2008, the Mortgage Bankers Association of America reported that slightly more than 9 percent of all mortgages in the U.S. were either delinquent or in foreclosure.
Mortgage defaults began to grow dramatically when sub-prime loans with adjustable rates reset to rates much higher than the initial teaser rate resulting in much higher payments. As the economy worsens and unemployment grows, scores of homeowners, including those with prime or near prime loans, are now delinquent in making mortgage payments.
A loan modification can turn a non-performing loan into one that generates cash for the lender, mortgage holder (investor), and servicer. The alternative to foreclosure typically results in the holder or servicer taking the property back, and the associated costs to the holder or servicer diminish their returns. Cities and towns are hurt also from the resulting decrease in property values and property tax revenue.
Delinquencies Rising
A December 2008 report by the Office of the Comptroller of the Currency and the Office of Thrift Supervision states that at national banks and federally regulated thrifts, nearly 37 percent of homeowners were sixty or more days delinquent on payments six months after receiving a loan modification.
No data exists stating what changes make a modification successful. Significant reduction in payments over the long term is key in making a loan modification affordable and successful. Payment reduction sometimes requires principal reduction or deferment. Many servicers are reluctant to reduce principal balances because a reduction today might result in a windfall for the borrower sometime in the future should property values increase.
Another major concern for servicers is the securitization or pooling and servicing agreements entered into between servicers and mortgage holders. Servicers who modify mortgage terms run the risk that mortgage holders (or the investors) will bring suit claiming the servicer failed to act in their best interests. A proposed safe harbor for servicers who modify loans is in bankruptcy cramdown legislation currently pending in Congress.
It is also important to focus on the process used to complete a modification. Efforts must be made to contact borrowers immediately upon signs of delinquency because early intervention can be beneficial. It allows a relationship to be established and maintained when the borrower is not at the later stages of embarassment or denial.
A servicer’s department dedicated to loss mitigation staffed with personnel experienced in loan underwriting is recommended. Borrowers must complete a financial statement as well as a financial hardship statement in affidavit form so that income and expense information can be verified. An appraisal should be completed by a reputable appraiser.
Open Field
There is very little regulation in the area of loan modification. Virtually anyone can offer modification services resulting in increased fraud perpetrated in many instances by some of the same individuals formerly employed by now defunct mortgage companies. Borrowers should beware of an entity that guarantees loan modification results. Many companies take money from borrowers and do nothing further. There are many reputable non-profit housing and counseling agencies and attorneys assisting borrowers in home retention efforts.
On February 18, 2009, the Obama Administration introduced its Homeowner Affordability and Stability Plan. The plan provides homeowners who are not delinquent on their Fannie Mae or Freddie Mac investor mortgages to refinance their mortgages with lower interest rates, even though their homes’ values have been reduced.
The Obama administration wants to dedicate $75 billion to create a homeowner stability initiative to provide loan modifications for homeowners (not property investors). Proposed loan modifications include bringing monthly payments down first to 38 percent of the borrower’s income, and then a second reduction bringing payments down to 31 percent of income. The federal government will share the loss dollar-for-dollar. The reductions may be made by decreasing the interest rate or the principal balance.
Mandatory Joint Effort
All financial institutions receiving Financial Stability Plan assistance will be required to implement loan modification programs consistent with U.S. Treasury guidance, although there are significant instances where the program does not apply (jumbo mortgages, mortgages held by private investors, and mortgages that exceed the property value by more than 5 percent). The plan does include a statement of support for pending legislation that would allow bankruptcy judges to modify or "cramdown" home mortgages which often involves principal reductions.
Cramdown may be the only option for homeowners who have exhausted all options. The lending community opposes cramdowns claiming it will result in increased interest rates for everyone.
It remains to be seen whether or not loan modifications proposed in the Financial Stability Plan and other private loss mitigation initiatives will be successful in solving the housing crisis. With the current drive for new legislation that would allow bankruptcy judges to modify home mortgages, it may be prudent for lenders and/or servicers to voluntarily modify loans and maintain control over the process and results.
The specter of investors losing total control of their investments to the bankruptcy courts may be enough to move servicers and private investors to come on board with loan modifications.
Patricia Antonelli and Ann Marie Maccarone are attorneys at the firm of Partridge, Snow & Hahn.
