Loan modifications aren't reaching struggling homeowners in need of creative financing and foreclosure prevention. And in many cases, the mortgage bailouts backfire on homeowners they do reach.
In a scathing indictment of loan modifications efforts, the National Association of Consumer Bankruptcy Attorneys (NACBA) says:
• When loan modifications are written, fewer than one in 10 of them result in a reduced principal loan balance.
• More than half of loan modifications roll unpaid interest and fees into larger, more drawn-out debt on the back end of the mortgage.
• Only 35 percent of mortgage modifications reduce monthly payment burdens for homeowners.
• A full 45 percent of loan modifications are packaged with increased payments.
The NACBA says that given the failure of loan modifications to put a dent in the number of foreclosures, nothing short of legal intervention will reverse a trend that recently prompted Credit Suisse to forecast 8.1 million U.S. mortgage foreclosures in the next four years. That forecast was up sharply from the 2 to 6 million foreclosures previously forecast by a variety of industry experts.
"Court-supervised loan modification is urgently needed to deal with this problem. Despite a proliferation of voluntary programs, we are not seeing evidence of a meaningful number of sustainable loan modifications," said Henry Sommer, NACBA president.
In its first report in February, the State Foreclosure Prevention Working Group, comprised of attorneys general and state banking departments, reported that the vast majority, 70 percent of seriously delinquent borrowers were not on track for any loss mitigation option. By September that had risen to 80 percent.
"The number of homeowners working toward a loan modification has declined by 28 percent between January and May, falling to a level not seen since late in 2007," the group reported.
What it is
A home loan modification, granted only upon the existing lender's approval, permanently reworks some of the terms of an existing mortgage in order to lower monthly payments and make the loan more affordable to the homeowner.
The strategy is typically designed for homeowners struggling to pay their mortgage, not for those who can pay their mortgage or are eligible for a refinanced loan.
The mortgage modification method of relief is at the top of the list of weapons used in the fight to stop foreclosures because struggling homeowners typically can't qualify for a refinanced mortgage — a brand new loan written to pay off the old home loan. Other options — a short sale (the lender forgives a portion of the debt owed if the owner can find a buyer), bankruptcy or auction sale — all cost consumers their home.
Modifications are generally lender fee-free and involve the lender or loan holder lowering the interest rate and or changing an adjustable rate mortgage (ARM) to a fixed rate mortgage (FRM) with a 30-year term. Some form of mandated homeownership counseling generally comes with the deal.
Complex transaction
"A mortgage is one of the most complex transactions there is. A loan modification is also a gray area for a lot of people. So of course people need someone to walk them through the process to tell them this is what you need and this is what you don't need," said Ginna Green, spokeswoman for the California office of the Center for Responsible Lending in Oakland.
In addition to lowering and locking in the interest rate, less common loan modifications include adding missed payments to the loan balance and extending the term of the loan. The least common, but most sought-after feature, is a reduction in the principal, whereby the lender actually lowers the mortgage balance, to further enhance affordability.
Reduced principal, along with deep interest cuts is, however, at the core of the Federal Deposit Insurance Corporation's (FDIC) more liberal loan modification program "Loan Modification Program Guide -- 'Mod in a Box' " modeled after the agency's mortgage adjusting efforts used on the home loans of IndyMac Bank of Pasadena. FDIC took control of the failed bank earlier this year.
"If they (lenders) reduce the first or wipe out the second, let me know. I haven't heard of lenders doing this. They are staying away from this," said Glenda Queensbury, a mortgage adviser and real estate agent at Referral Realty in San Jose, CA.
No relief in sight
Little relief is expected from the recently announced Federal Housing Finance Agency's "Streamlined Modification Program" designed for loans held by Fannie Mae and Freddie Mac.
The program is the first major effort to help set standards for loan modification programs. It creates a three-month mortgage modification trial period that includes the modification terms that will take effect if the borrower makes the new payments as prescribed during the trial period.
However, the SMP continues some of the ills NACBA says has prevented loan modification from becoming more widespread and successful. SMP loans are voluntary, they allow tacking on accrued interest, they can come with ARM rate-like terms with both rising and balloon payments, they only apply to the first mortgage, not second loans, and borrowers must have loan-to-value ratio of 90 percent or more.
Consumers seeking loan modifications have also been thwarted by the fear of fraud from a largely unregulated cottage industry of private loan modification services that can charge thousands of dollars in upfront fees.
California's Department of Real Estate has issued several "desist-and-refrain" orders against companies offering loan modification services. California Attorney General Edmund G. Brown Jr. recently announced arrests of suspects in a fraud ring preying on struggling Southern California homeowners. Modesto, CA-based Federal Bureau of Investigation (FBI) agents recently announced a task force to zero in on mortgage-related frauds.
"A racket"
"It's become a racket," says Greg Pennington, a San Francisco-based mortgage banking consultant and counselor with Parker-Pennington Enterprises.
The NACBA blamed a host of factors for the failure of mortgage modifications to catch on.
• Borrowers and servicers are often unable to locate multiple mortgage holders all of whom have to agree to the modification.
"The loans have been sliced and diced so many times that all of the owners cannot be found and brought into the process," the NACBA reports.
• Loan servicers fear investor lawsuits. Servicers have a fiduciary responsibility to investors who purchased mortgage-backed securities comprised, in part, of loans up for modification. Servicers are hesitant to modify numerous loans if it will cause the security to lose income and the investors to sue.
• Voluntary modifications typically don't include second mortgages. Second mortgages were heavily in vogue during the housing boom as equity gains allowed homeowners to buy larger homes than they could truly afford and use their home like an ATM.
NACBA also says in 2006, a third to a half of all 2006 subprime borrowers took out piggyback second mortgages on their homes at the same time they took out their first mortgages.
Unfortunately, first mortgage holders don't have any incentive to write modifications to give borrowers money to make payments on second mortgages. Just as risk-averse as first mortgage holders, second mortgage holders, rather than waive their rights in a loan modification that could cost them a 100 percent loss, they'd rather take their chances on collecting a few more payments before the borrower goes into foreclosure.
• NACBA also says overwhelmed servicers are not set up for the case-by-case negotiation process necessary for modifications, but more practiced in the automated foreclosure process -- which comes with financial incentives.
"Many also have monetary incentives to foreclose rather than modify," NACBA reports.
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Broderick Perkins parlayed 30 years of old-school journalism into a digital real estate news service, the DeadlineNews Group, offering "News that really hits home!"™. The Silicon Valley bootstrap includes the Web site DeadlineNews.Com and the back shop Deadline Newsroom. Contact him at news@deadlinenews.com.
