While I applaud President Barack Obama’s plan to rescue the housing market through the restructuring of distressed mortgages, the current landscape of loan modifications appears to be something of a bad joke, littered with inept, if not fraudulent, practices by some loan servicers.
"Insanity" is the word Jay Meadows uses to describe current loan modification efforts.
"Let’s do the same thing over and over again and expect a different result," exclaims Meadows, CEO of Fort Worth, Texas-based Rapid Reporting.
"The people who we have talked to about re-mods, for the most part, are doing the exact thing they did to create the original loan. And the bottom line is, in a re-mod situation, we have already proven that the people (homeowners) can’t pay for the house they are in."
Actually, if servicers were just doing the same thing over and over again that would be a step in the right direction. Instead, the re-mods can make things worse for the borrower. Is it any wonder that the redefault rates are nearly 60 percent?
Here’s the problem in the proverbial nutshell: Many loan modifications result not in lower payments, but higher monthly mortgage obligations.
It seems most people are confused by exactly how a loan modification works, observes Steve Ozonian, executive chairman of Sorrento Capital, an Irvine, Calif., private asset management firm.
"In 2008, about a third of the modifications did not result in a lower payment for the modified borrower — the payment remained the same or increased," Ozonian reports.
"The redefault rate has been in excess of 60 percent, but where the remodification resulted in a lower monthly payment, redefault rates were just 20 percent. Clearly, the data tells us, to modify a loan you need to lower that monthly payment or you are probably not going to have much success."
In excess of 60 percent redefaults? How did we reach this apex of re-mod ineptitude?
First, some of the big servicers have been running queries through their database, generating thousands of modification agreements and blanketing the country with them. They are received by borrowers, who never knew a modification was coming and probably in a situation where the terms of the modification did not meet their particular circumstances.
Secondly, evidence of slimy practices by servicers homunculi are emerging from the mortgage swamp. Earlier this year, the Associated Press reported at least 30 servicers have been accused in lawsuits of harassing borrowers, imposing illegal fees and charging for unnecessary insurance policies.
This past summer, the Wall Street Journal highlighted the practices of Carrington Mortgage Services LLC, a subsidiary of Carrington Capital Management LLC of Greenwich, Conn. And what is Carrington Capital? It calls itself a privately managed investment management company. The Journal calls it a hedge fund.
There’s nothing wrong with hedge funds (my son works in the hedge funds industry), as some really bright people run these alternative investment shops. However, a hedge fund needs at least a 20 percent return on its investments and will do anything to squeeze that kind of return. So, do you want one of these guys servicing your loan? …CONTINUED
Carrington has been modifying loans on its $17.3 billion portfolio of subprime loans at twice the rate of the industry, but the company has been criticized for, in effect, establishing future defaults. The Journal reports the attorney general of Ohio has filed a lawsuit against Carrington for failing to offer reasonable loan modifications to borrowers, quoting the assistant attorney general, who said, "It isn’t unusual for Carrington to increase loan balances by $15,000 or more as part of a loan modification."
Why would Carrington do that? I don’t know the company so I don’t have the answer to that question.
However, on a general level there are structural problems in certain segments of the loan modification business because of conflicts of interest among investor/portfolio holders.
Loan pools are often held by senior investors such as pension funds and other institutional parties, and junior investors, which could be private equity investors. In some instances, the junior investors are also the servicers. If the homes in the portfolio are sold at a loss, the proceeds go to the senior investors first, with nada left over for the junior investors.
However, the servicers receive fees, interest on the mortgage, etc., by doing their job of loan servicing. So, if they stall home sales, they keep getting fees. As a junior investor doing servicing, what would you do: unload homes and lose income, or find some way to keep homes in portfolio?
Borrowers commonly end up in re-mods with higher loan payments when the servicer gives the homeowner a vacation from payments, but then tacks on those months of unpaid loan payments onto the loan balance along with any unpaid fees and taxes.
"There are institutions that will let you miss three payments, but will put them on the back end of the loan," explains Ozonian. "Part of the problem is, three months later a lot of people have not straightened out their financial dilemmas and are right back where they started (only now with higher mortgage payments). Yet, the financial institutions count that as a remodification — although it leads to redefaults."
There are a number of ways to increase the odds a loan modification will work. The first is to scrutinize the borrower’s ability to repay: Is the borrower employed and what is the income of the borrower?
There’s also nothing wrong with the Obama administration’s plan requiring participating loan servicers to reduce monthly payments to no more than 38 percent of a borrower’s gross monthly income. (The government would then bring payments down further, to no more than 31 percent.)
One very good idea comes from Steve Horne, founder and president of Carrollton, Texas-based Wingspan Portfolio Advisors. He suggests having an in-depth meeting with borrowers, figuring out exactly what borrowers can afford and then set them up with a modification they are involved in creating.
Says Horne, "We find that when borrowers are actively involved in the solution, they feel they have worked for it, earned it and then are committed to that solution."
Steve Bergsman is a freelance writer in Arizona and author of several books, including "After the Fall: Opportunities and Strategies for Real Estate Investing in the Coming Decade."
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