Loan Modification Plans Fail, Banks Not to Blame

loan modificationSo it appears that some Congress-critters are agitating about the utter failure that is the suite of government loan modification programs. House Republicans want to repeal the Home Affordable Mortgage Program (HAMP), calling it a "colossal failure". Home Affordable Foreclosure Alternatives (HAFA), a sub-program, is also under attack, and lo and behold, there's a Democrat involved: Sen. Ted Kaufman.

The Treasury Department spent $4.3 million on incentives to servicers and investors through the Home Affordable Foreclosure Alternatives program through November, a fraction of what it spent on HAMP, according to a report from the Congressional Oversight Panel.

It seems only natural that a Democrat would be offended that the government spent too little money. In any event, it's a bipartisan effort in Washington.

But why? Even the government isn't this incompetent most of the time. What happened? And what's likely to happen as a result?

If you're a homeowner who's had some dealings with HAMP/HAFA/whateva, or merely a taxpayer with something of a passing interest in why some $75 billion of your money appears not to be doing much at all in dealing with the foreclosure crisis, you might be curious. Well, let me put some pieces together for you.

Banks Aren't the Problem

In the media and general chitchat, we're told that the problem is the banks who aren't able to get with the program(s) fast enough. Those damn greedy Wall Street bastards! But truth is, unless said bank owns a servicer, it's likely not the problem.

You see, once a mortgage is made ("originated"), the nice loan officer you spoke with isn't dealing with you anymore. His job is to go make more loans. Instead, he passes the mortgage, all of your information, your entire file, to another company called a servicer. The servicing companies are the ones who send out statements, process your payments, send late notices,
Search Homes for Sale
See photos of homes for sale in your area and across the country on AOL Real Estate
answer questions, and generally do all of the things a lender would want done -- including, by the way, initiating foreclosures and alternative actions such as loan modifications, short sales, and the like.

Trouble is, servicers have two issues when it comes to programs like HAMP/HAFA and alternatives to foreclosure.

First, most servicers are not setup to handle large volumes of loan modifications (including short sales). Adam Levitin, a professor at Georgetown Law School, and Tara Twomey of the National Consumer Law Center, have written what may be the definitive paper on servicers and loan modification. In it, they describe a highly automated, machine-like system for handling foreclosures. Once payments get past a certain past-due date, the software automatically bundles all the paperwork, sends an email to a pre-designated law firm (sometimes called "foreclosure mills" for the mechanical way they crank out foreclosures) or some other company that would then file the necessary paperwork to get things rolling. In contrast, loan modification and short sales require human beings, with training and judgment:
In contrast, handling defaulted loans through loss mitigation [industry term for anything other than a foreclosure] involves tremendous discretion, expertise, and manpower. It does not benefit from economies of scale and needs significant well-trained human labor to staff call centers.... Loss mitigation involves pursuit of negotiated outcomes, and each negotiation is individualized, adding significantly to the transaction costs of loss mitigation.
While many servicers are trying to ramp up their loss mitigation departments as quickly as possible, such things take time. People have to be interviewed, hired, trained, monitored, managed, and so on. And all of those things are expensive.

Second, there is a real question as to whether the financial incentives of servicers are aligned with programs like HAMP/HAFA. Under HAFA, the Treasury pays $1,500 to mortgage servicers for a short sale, which would presumably recover more money for the lender than a foreclosure followed by a bank-owned sale. But that would remove the mortgage from the portfolio that the servicer manages. The fee for managing a loan is typically 50 basis points annually on the unpaid principal balance of a loan (for subprime, the most likely loan to get delinquent). So if the mortgage is $300,000, the servicer would make 0.50% on it every year, or $3,000.

But that's not all. Servicers also keep the float from money sent in by the borrower until they have to send that money along to the bank. And finally, and most egregiously, servicers get to keep "ancillary fees" related to a loan -- late fees being the biggest example. In one case of now-bankrupt Countrywide, late fees alone amounted to $285 million in 2006.

Combine the two factors and you get a situation in which a servicer would give up a steady revenue stream plus possible bonanzas from late fees, fax fees, property inspection fees, and so on, while incurring significantly higher costs from personnel intensive loan modification efforts... all for $1,500 from the Treasury (that is to say, you and me)? Mmmmkay.

It would be shocking if doing a loan modification under HAMP/HAFA was not a major money losing proposition for a servicer. Is it any wonder that HAMP and HAFA are such dismal failures?

Plus, The Servicers Often Don't Have he Power

Even if there were servicers who do want to do the time-consuming, labor-intensive work with homeowners to modify a loan instead of foreclosing, they may not have the power to do very much.

Most residential mortgages are not held down at the local Savings and Loan. They are securitized into massive pools of mortgages to be made into mortgage-backed securities. The bank has already sold the loan to these giant trusts. And many of the agreements that govern such trusts make it extremely difficult, if not impossible, to modify a loan.

In many cases, the trust documents prohibit the servicer from changing interest rates, because that's the income that the investors are expecting. Extending the term can also be difficult because of how the mortgages are put together into the trust to have similar termination dates.

So... What Can I Do?

To be sure, the federal government and the industry itself as well as academics and organizations like the National Consumer Law Center are looking at all sorts of ideas. Recently, the Obama Administration blasted servicers and called for a total revamp of the system. While I expect significant regulation to be handed down, none of us knows what would ultimately be the result.

As a consumer, however, is there anything you can do?

Well, if you have any concerns about the economy, about your ability to pay the mortgage (after all, you could lose a job, have a medican issue, etc.), or health concerns, you might ask a mortgage broker to put you into a mortgage from a portfolio lender (i.e., someone who makes a loan and just holds it, instead of securitizing it). This way, if something should happen, you at least have a single lender who might have the authority to work with you, instead of a trustee sitting on top of 7,000 mortgages with little power to do anything for you.

If you are currently in a bad situation and facing foreclosure or short sale or what-have-you, I would consult an attorney. Far too few consumers facing foreclosure bother to contest the foreclosure, bother to talk to a lawyer, and often don't have the cash to hire an attorney. There are some pro bono organizations that take on foreclosure cases if you're flat broke; if not, then spend the money, since you're far more likely to be able to navigate the maze of banks, servicers, securitization trusts, and so on with professional assistance.

Finally, you can care about the issue. A lot of the foreclosure crisis is the result of most citizens just tuning out all the boring legal and high finance stuff, to focus on the latest round of voting for the American Idol. Make a phone call to a Congresscritter, write a blogpost, tell your friends, whatever -- just care about the issue, because it's an important one for every homeowner, future homeowner, and every taxpayer.

For more insight on mortgages and refinancing see these AOL Real Estateguides:

More on AOL Real Estate:
Find out how to
calculate mortgage payments.
homes for sale in your area.
foreclosures in your area.
property tax help from our experts.
Read Full Story

Find a home

Powered by Zillow