Modifying Your Mortgage is not Worth the Effort
WHY MODIFY A MORTGAGE?
There are approximately 46.7 million mortgages in the United States. [1] About 60 percent of all outstanding residential mortgages by dollar amount are securitized. Over 90 percent of mortgages originated in recent years have been securitized. [2]
Securitized means the loans are pooled and transferred into a security called mortgaged-backed securities (MBS). The security pays the stream of income from pooled loan payments to investors who buy the securities. The securities are controlled by a trust for the benefit of the investors but the actual collection of the loan payments and decisions on whether to modify or foreclose a loan upon a default falls on the servicer. Services are the connection between the investors who expect their steady stream of income and the home buyers who make the payments. Servicers are often the banks originating the loans but not always. Servicers are paid a steady paycheck when homeowners make their monthly payments. A problem arises when homeowners stop making payments: Servicers look after themselves because there is no incentive to preserve the assets of the investors or help out homeowners who have fallen on hard times. [3] [4]
There have been approximately 5 million foreclosures and 14 million mortgages that are in default according to Mark Zani, Moody’s Analytics chief economist in article “No end in sight to foreclosure quagmire”. [5] Foreclosures will continue at an alarming rate. “Lenders filed a record 3.8 million foreclosures in 2010, up 2% from 2009 and an increase of 23% from 2008, according to RealtyTrac.” [6]
DRAWBACKS AND TRAPS OF MODIFICATION
Modifying mortgages is seen as a way to stem the tide of foreclosures. In 2009 legislation was enacted to encourage but not require loan servicers to reduce mortgage payments by lowering the interest rate and extending the loan term. The legislation known as the Home Affordable Modification Program or HAMP has had little success because it was confusing and was only voluntary which means servicers were not interested in modifying loans. [9] The trial modifications under HAMP, where homeowners agree to pay a lesser amount to prove they can meet the terms of the modification, may have even facilitated foreclosure because the lower payments constituted a default under the original mortgage. See “No end in sight to foreclosure quagmire” above.
The Trap
A word of caution on modifying your home loan outside of HAMP and through the private sector:The servicers, who have been facing a rising tide of litigation relating to chain of title issues including robo signing and filing false affidavits, have resurrected a practice of asking homeowners not to contest a foreclosure or otherwise sue the servicer. These “waiver” provisions are not allowed under HAMP. Even if states have enacted similar prohibitions on waiver provisions in modification agreements, servicers are circumventing the law by including waiver provisions in temporary agreements sometimes referred to as “forbearance agreements”. [12]
WHY WOULD A SERVICER GIVE A HOMEOWNER A BREAK?
There are two more reasons why discussing modification of your loan with the servicer is not worth your time or effort. First, mortgage servicers make money foreclosing on loans not in modifying the loans. Secondly, the servicer may not have the ability to modify a loan according to the structure of a MBS and the contractual relationships of the parties in a MBS.
Servicers Look After Themselves
A servicer’s pay check comes from a percentage of the total unpaid principal balance of the loan pool. Reducing the amount of the loan equates to less money for the servicer and therefore a good reason a servicer has no interest in helping homeowners reduce their payments or loan amount through modification. Servicers also benefit from delinquent accounts because the late fees and interest adds to the overall loan balance and thereby increases the servicers’ income.When deciding to modify a loan or allowing it to go through foreclosure, the servicer’s own self interest will lead to foreclosure because the servicer recover late fees and interest in foreclosures. These fees will most likely be forgiven in a modification. In addition, performing large numbers of loan modifications would cost servicers upfront money in fixed overhead costs, including staffing and physical infrastructure, plus out-of-pocket expenses such as property valuation and credit reports as well as financing costs. “This business model, of creaming funds from collections before investors are paid has been extremely profitable.” [13]
Frankenstein Contracts
The securitization of mortgages creates barriers to modification. The Pooling and Service Agreement (PSA) which controls all parties in a security limit the ability of a servicer to modify a loan. [14] The PSA sets strict parameters for servicers who are handling money that belongs to the investors. These parameters are strict because it is one way that investors retain some control over their money.
Examples of ways to limit servicers include outright prohibition, limited to type, number or circumstance, sometimes third-party consent is required and the most effective is requiringservicers to purchase any loans they renegotiate at the face value outstanding or at a premium. [15]
Contracts that do not allow modification is based on a policy originally thought to encourage homeownership by reducing the risk banks undertook in making home loans. The principle underling this policy was the idea that homeowners would be less likely to default on their loans if there was no way to change their terms. This very same principle also helped sell the securities.
Investors, not wanting to shoulder the risk of default of mortgages shifted from the banks to the investors in the securitization process were somehow mollified by the fact that the contracts generating the cash flow they bought could not be changed.
“Contracts that cannot be modified are more likely to perform according to their original terms. This is the idea behind the quest for immutability as a method of managing risks from securitization.” [Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities @1087]
Banks Do Not Want to End Up With All the Losses
In addition to this formal rigidity to modifying loan, there is a structural aspect of MBS that discourages modification.
“Most PSAs restrict mortgage renegotiation to loans that are in default or where default is imminent or reasonably foreseeable in order to protect the SPV’s (Trusts) pass-through tax and off–balance sheet accounting status. Allowing modifications under less dire conditions may indicate that the servicer is actively managing the SPV’s assets. Active management would in turn trigger a new layer of taxation on the SPV’s income, in addition to the tax investors pay on their income from the RMBS. Moreover, because the originator is often the servicer, overly active management of the securitized loans could suggest that it did not truly sell the risk. In response, regulators could require the servicer/originator to bring the loans back onto its balance sheet, defeating the point of securitization.” [Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities @1096]
If investors in the MBS do not want an independent party fooling around with their funding sources and if passive management is required to maintain the favorable tax status of the MSB, the question begging to be asked is why do servicers even entertain the idea of modifying loans?
Considering most loans being foreclosed on are not owned by a local bank, the chances of a homeowner successfully obtaining a modification of their loan seems remote. Securitization has effectively transferred the risk of the housing bubble on to unsuspecting investors of the MBS and the homeowners whose dream of homeownership has been shattered.
James Knowlton is a lawyer in Basalt, Colorado.
[1] http://www.census.gov/compendia/statab/2011/tables/11s0993.pdf
[2] Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities, Anna Gelpern, Adam J. Levitin, Southern California Law Review, Vol. 82:1075
[3] Mortgage Servicing”, Adam J. Levitin & Tara Twomey, Georgetown Public Law and Legal Theory Research Paper No. 11-09,http://scholarship.law.georgetown.edu/facpub/498.
[4] “Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior” by Diane E. Thompson Of Counsel, National Consumer Law Center, October 2009
[5] http://www.11alive.com/news/article/190391/40/No-end-in-sight-to-foreclosure-quagmire
[6] Jon Prior, HousingWire.com, Wednesday, January 12th, 2011
[7] Adjustable Rate Mortgages (ARMS) provide initial low interest only mortgage payments with increases in payments several years later. Most homeowners cannot afford the increased monthly payment and return to the bank to refinance. However, as ARM payments begin to balloon in this economic downturn, homeowners are unable to qualify for refinancing under the stricter loan requirements and end up losing their homes to foreclosure.
[8] “Are Foreclosures Contagious?” FDIC Center for Financial Research Working Paper 2011-4.
[9] The House of Representatives recently voted to end HAMP”. The Senate needs to vote to make it final which is not expected.
[10] Obama Anti-Foreclosure Efforts Still Falling Short” Alan Zibel, WSJ, May 6, 2011.
[11] “Private Mortgage Modification Reaches 1.5 Million”, by Kerry Curry, HousingWire.com, December 12, 2010
[12] “Borrowing Trouble- Some lenders are modifying mortgages only after homeowners waive their right to sue”. Pro Plublica at Slate, Paul Kiel, May 9, 2011.
[13] “Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior” by Diane E. Thompson of Counsel, National Consumer Law Center, October 2009
[14] Three kinds of agreements form the core of a securitization transaction: a pooling agreement, in which the SPV purchases a pool of assets from the originator or an intermediary; a servicing agreement between the servicer and the SPV that sets forth the duties and compensation of the servicer; and an indenture, which sets forth the rights of the investors in the SPV’s securities and the duties of the trustee that oversees the securities and the SPV. Typically, these three agreements are combined into a single document (the PSA). “Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities” @ 1088
[15] “Rewriting Frankenstein Contracts: Workout Prohibitions in Residential Mortgage Backed Securities” @1090
[16] Resolving The Foreclosure Crisis: Modification of Mortgages in Bankruptcy”, by Adam J. Levitin, Wisconsin Law Review, 2009. Electronic copy available at: http://ssrn.com/abstract=1071931.
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